What benefits are there for Seller on seller financing?

[Jeremy Hawkinson]

So I recently reached out to a laundry mat because I heard they might want to sell. I’m more interested in the real estate it sits on primarily because it has corner building that I could open up another coffee shop. My wife and I currently own 3 coffee drive thrus but 2 are on leased land, my 3rd is An owner contract.

The older lady who owned the laundry mat called me back and said they just want to sell the laundry mat business and not the property. But then she went on to express they actually do want to sell the property but they don’t want to because of capital gains. I didn’t have an answer for her about that but this Covid time has left me time to catch up on dozens and dozens of podcasts and I keep hearing how seller financing can actually help the seller because it alleviates or defers or some of the capital gains. Can anyone help me understand the way that works so I can approach them again with a clear way to help them out and hopefully help myself in the process.

Thanks

[James Storey]

@Jeremy Hawkinson yes, the seller financing doesn't eliminate any capital gains tax at all. It simply defers the capital gains payments over the life of the seller financed structure.

The capital gains percentage is not determined buy how much gain is collected, it is determined based on how much the owners earn as earned income in the form of adjusted gross income. So if their is adjusted gross income put's them in the 20% tax bracket for long term capital gains, then that is how much they would pay on their net gain compared to their original basis in the property (how much they paid for the property originally).

Check out bank rate for examples of this: 

https://www.bankrate.com/investing/long-term-capital-gains-tax/

Keep in mind, this isn't the only capital gains they would pay, the tax code also permits a gain on recapture tax which is a flat 25% rate regardless of anyone income earned. This 25% rate is paid on all of the depreciation the owners took on the property since they owned it.

For example, Let's say for simplicity purposes, they purchased the property for $100,000 30 years ago and they are selling it today for $200,000. They would pay 20% on the difference between the two ($200,000 - $100,000 = $100,000 long term gain on appreciation X 20% = $20,000 tax on appreciation) assuming they are in the 20% tax bracket. Let's also say that since the owned the property for 30 years they fully depreciated the property from $100,000 to $0. They would pay the 25% on depreciation as well ($100,000 - $0.00 = $100,000 gain from depreciation X 25% = $25,000 tax on depreciation). Therefor their total capital gains tax would be $45,000 ($20,000 + $25,000 = $45,000). This however, does not include any net investment tax (typically 3.8% if they meet an income threshold) and state capital gain tax (varies by state).

In the case of seller financing, they would owe the $45,000 over the course of how long  you amortize the seller financing terms.To keep it simple, if you amortize the $200,000 over 10 years without interest (again for simplicity) then you would pay them $20,000 every year and they would pay $4,500 in capital gain every year ($45,000/10 years = $4,500). Keep in mind, they would also pay taxes on any interest they collect as well.

Hope this helps.

James Storey, CCIM