Seller Financing to Avoid Paying Lump Sum Capital Gains; Virginia

[Eric Doerr]

I'm just getting started in my real estate investing career (still looking for my first deal). I have been doing direct mailers to absentee owners in a few towns in my area of northern Virginia for the past couple months. I recently met with a potential seller who lives in the area and owns a second home free and clear. He bought the house nearly 40 years ago and has about $350K of equity in the house due to improvements he has made and general appreciation. The house was once his primary home (20+ years ago) and then he and his family moved across town to a bigger home, but kept the property with the intent of renting it. He had a renter for a while, but didn't like being a landlord. He then allowed family members to live there for 10-15 years (his mother-in-law); however, the house has been sitting vacant for about 2 years (I think the mother-in-law passed away). Over the past year or so, he has done updates throughout...new kitchen w/ granite (stainless steel appliances still have protective plastic on them), bathrooms, flooring throughout, new deck out back, etc. The house is in great shape; no real room for forced equity through a rehab.

Here's the deal...the house is too "finished" so my cash offer just didn't make sense for him; however, with all the factors I have to take into consideration, my offer was as high as I could go. I told him his best bet was probably to just sell through an agent and I even pointed him to my agent. He didn't seem overly pleased with that approach, but I'm not sure why. He's not overly motivated to move quickly because he owes nothing on the house other than property taxes (which are actually about $4300 annually so not insignificant). However, as we talked, he began to ask questions about how he would be taxed on the sale of his house...and that got me thinking...

Seller financing may allow me to offer a higher purchase price and help him avoid paying capital gains tax on a very large ($300K+) lump sum gain.

Am I thinking about this the right way?

One concern I have is, how do a structure the deal so that it works for both of us?

Would my best bet be to offer a long-term balloon, maybe 10 years, so that he can spread out his gains over a long period of time and pay them slowly rather than a lump sum? I would like to hold it as a rental, but I'm having a hard time running the numbers because I'm not sure I understand the seller financing approach well enough. Using seller financing, am I paying principal and interest the way I would in a traditional mortgage? If so, that would be a very high monthly payment and make this deal not worth it. Also, what happens if I sell before the balloon date?

Here are the numbers I know:

1. 3 beds, 2.5 baths, 1900 sq ft, 1 car garage
2. Target Purchase Price: $390K-$395K
3. ARV: $440K-$460K
4. Repairs Needed: $0 (Maybe budget $5K-$10K because I haven't done a full inspection)
5. Rental Estimate: $2000-$2200/month (maybe we could push to $2300)
6. My down payment and any closing costs would come from a HELOC @ 6.25%

Should I pursue this? Should I walk away?

Any advice or guidance is appreciated!