Creative financing or impossible to do financing?

Question

Hello BP!

I might be a bit ahead of myself but I thought I'd check here and see!

I recently came across an older landlord who has several duplexes, SFR and 6-8 unit buildings.  He was selling two duplexes next door to each other but when I finally got ahold of him they were under contract.  I asked if he had any other properties they might want to sell, he said yes.  His hesitation is coming into a large capital gains tax.  Currently, the family (Father in 80's, son is likely in his 60's and a daughter unknown age) has these properties in a variety of different names.  None are in a holding company or LLC and they've owned them since the 70's (most of them).  None have been acquired in the last 15 years.

My hope is that I can pick the properties that would best suit my investment strategies as a package deal and let him sell the rest to others.  Each of them will need some updating as they're long-time holds from the family with no real updates.

In order for me to even think about executing on a multi-property deal, I'd need some owner financing.  Since the owner(s) are looking to get rid of multiple properties but don't want to pay a huge tax bill, I wanted to bring some creative ideas to the table.

Hypothetically, could this work:

- We agree to terms on an overall package - likely at a good discount (50-60% of retail) since there is maintenance and rehab needed.

- Owner(s) refinance all of the properties that I want to buy and cash out a large chunk of money suitable for their needs.

- I execute "subject to" contracts with each property, servicing the refinanced debt and collecting any cash flow.

- I update/rehab the properties

- We refinance/transfer title/"sell" or??? to get the properties in my name and out of theirs.

- Their capital gains is limited since they've taken a large chunk of cash out on a refi and the increased value of the rehabbed units covers enough that I can cash flow on the new "full price" after I refinance them.

Does this work?  Does this make no sense?  Any other thoughts or strategies to try and facilitate a deal and alleviate some tax burden? I'm newer to investing but would love to put a bow on a package deal to accelerate my portfolio.

Thanks!

Matt

Steve Vaughan · Answer

Seller financing, especially on property owned long enough to have pre-1997 depreciation only will be taxed a little with each payment, spreading it out.  A portion of each payment will be cost basis recoup, interest and cap gain.  A good way for older LLs to sell usually.  Talk to a CPA.

I think if you go too far into the weeds with a cash out refi and sub2 you will lose them for sure.  A lot of these old LLs absolutely hate debt.  They remember the 70s and 80s with rates in the teens and the S&L crisis.  A young grasshopper suggesting they go to a bank and get in debt would have to be too crazy to deal with!

Wayne Brooks · Answer

More to the point, the amount of debt through refinancing/cash out financing has No effect on the sellers cap gain tax. If he had a property, financed it for $80k, sold it to you sub to with no additional cash, his cap gain taxes are based on the $80k sale price.

Jeff Glass · Answer

When a seller of highly appreciated assets wants a cash exit without paying capital gains tax they can use a monetized installment sale to accomplish both of those goals. They would defer their capital gains tax for 30 years and they would obtain about 93.5% of the net sales proceeds in cash at closing. There would be no need for refinancing.

This will not defer their depreciation recapture tax but it will defer the part of the gain that is over and above their accumulated depreciation, which could be quite significant if they have experienced a lot of appreciation. Generally this type of transaction is best for a sale in excess of $1 million.

This approach might be best for the seller. It does not address your need for financing. That would have to be arranged separately by you. So the monetized installment sale would be best only if:

a) the seller wants a simple cash exit without paying capital gains tax (until after 30 years)

b) you can line up your own purchase financing

Or, maybe the seller would benefit by using this approach to dispose of other properties they own that are not the ones you wish to buy.

Matt Gilroy · Answer

@Caleb Heimsoth Thanks for the reply.  The dad is the one with poor health, thus them selling their properties.  I think their desire is to get out of the landlord business and the kids (in their 60's) retire.  I don't disagree that it might be a long-shot, but trying to make sure I could even present the idea.  I appreciate the reply!

Creative financing or impossible to do financing?

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