Seller just wants to finance.

General Real Estate Investing
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Seller just wants to finance.

Jason Patterson
Real Estate Investor · Deer Park, TX · Member since 2013 · 24 posts · 0 votes

Ok about to make a offer on a very clean rental house that has been rented for 25 years by same renters. Owner doesn't want to sell out right because they don't want to show a big capital gain. They are interested in seller financing though.

Our offer is going to be 90k with 15% down @ 4% interest. In need of small repairs around 5 to 7k homes sold in the area range from 135k to 150k same year, sq/ft, 3/2, two car garages, rural neighbor. Comps are on same street with in 3 months. We are going to rent it out for 1,400 a mth time being. Cash flow looks good all numbers come out great.

My question is what happens if someone wants to buy it from us?
Do we make a contract up saying no penalty for early pay off?
How does this effect the purpose of seller financing for the seller if we where able to sell it for a larger profit?
So in the end seller would still get a large capital gain when we sold it to pay them off.

If we are 100k into the house and can sell it for 145k You Bet Its SOLD!
I just don't know how seller financing works on such terms like this.

Any help would be appreciated.

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Account Closed
Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes
13y
Originally posted by Mary B.:
Why can't you just continue to make monthly payments to your seller after you get your $45K profit, imo? If you really want to help the seller not get a big payout than continue to make monthly payments for a year or two(whatever you negotiate) and then pay the rest in full. If not just do the monthly payments for the full term of the agreement whether its 3yrs or whathaveyou.

Kudos,
Mary

This suggestion didn't make sense to me. If the OP sells the property to a retail buyer, his buyer's lender will not let him keep the note open. The note and all other liens would have to be paid at closing. It's the seller's job to make sure they create a note that works for their purposes. It's not the OP's job to help them avoid capital gains. What am I missing?

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  • Mary B.
    Real Estate Investor · Lansdowne, PA · Member since 2013 · 1k+ posts · 656 votes
    13y

    Why can't you just continue to make monthly payments to your seller after you get your $45K profit, imo? If you really want to help the seller not get a big payout than continue to make monthly payments for a year or two(whatever you negotiate) and then pay the rest in full. If not just do the monthly payments for the full term of the agreement whether its 3yrs or whathaveyou.

    Kudos,
    Mary

    0Reply
  • Account Closed
    Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes
    13y

    Let the seller worry about the capital gains and possible tax consequences. An installment sale might not even be the best way for them to deal with a fully depreciated property. Let them get professional advice. Put a clause in your purchase agreement that says they have been advised to seek legal and financial advice.

    Escrow can do all the paperwork for the note. A standard promissory note and mortgage instrument do not usually include a prepayment penalty. If the seller asks for one (it's their note), make sure the terms will work for you if you think you might want to re-sell.

    The sellers' gains have nothing to do with your re-sale. Their gains come from their basis, depreciation, sale price, and in this case possible interest from a note.

    Why do you think they will sell for $90K if the comps are $150K? What's the situation with their tenant? Are they month-to-month and what's Texas law for terminating their tenancy?

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  • Account Closed
    Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes
    13y
    Originally posted by Mary B.:
    Why can't you just continue to make monthly payments to your seller after you get your $45K profit, imo? If you really want to help the seller not get a big payout than continue to make monthly payments for a year or two(whatever you negotiate) and then pay the rest in full. If not just do the monthly payments for the full term of the agreement whether its 3yrs or whathaveyou.

    Kudos,
    Mary

    This suggestion didn't make sense to me. If the OP sells the property to a retail buyer, his buyer's lender will not let him keep the note open. The note and all other liens would have to be paid at closing. It's the seller's job to make sure they create a note that works for their purposes. It's not the OP's job to help them avoid capital gains. What am I missing?

    1Reply
  • Andy Argonaut
    Real Estate Investor · San Francisco, CA · Member since 2013 · 47 posts · 11 votes
    13y

    You can make this work by ensuring:
    1. Your note does NOT have a due on sale clause
    2. Adding a substitution of collateral clause allowing you to move the note to another property with equal or greater equity

    1Reply
  • Mary B.
    Real Estate Investor · Lansdowne, PA · Member since 2013 · 1k+ posts · 656 votes
    13y

    @K. Marie Poe

    True yet it really depends how soon he chooses to market the property for sale and how the agreement is structured. For example: If its written up that Jason can't sell the property for at least one year or no sooner than three years after purchase. There's no need to market it as soon as he closes.

    @Jason Patterson

    If you want to provide your seller with information on net long-term capital gain as apposed to net short-term capital gain which can lower their taxes here's a link.
    http://www.irs.gov/taxtopics/tc409.html

    You can only help them but so much....

    Kudos,
    Mary

    0Reply
  • Aaron Mazzrillo
    Investor · Riverside, CA · Member since 2011 · 2k+ posts · 3k+ votes
    13y

    I'll just never understand why someone would want to liquidate a property with good seller financing in order to get a short term capital gain tax....

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  • Adam Johnson
    Rental Property Investor · Holley, NY · Member since 2011 · 507 posts · 347 votes
    13y

    I am with K. Marie Poe, make your deal today, try to avoid them writing in a pre-payment clause, and if the property sells in the future, cash out and pay them off and let them worry about the gains tax. Remember, you are investing for YOUR benefit, not theirs.

    It is admirable that you are trying to make the deal balance so that it is a win-win for both you and the seller. The point about recommending that they seek their own professional advice is important too. At the end of the day, however, you need to make the best deal for you.

    Personally, if this were my deal and somebody offered to buy it out at a profit in the future (after considering tax implications for gains) I would prefer to simply sell it and pay the note, even if the deal structure allowed me to do otherwise. The only exception might be if the exit involved a wrap-around, lease-option, or similar financing arrangement between me and the buyer.

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  • Tom Goans
    Real Estate Investor · Englewood, CO · Member since 2013 · 988 posts · 258 votes
    13y

    Jason Patterson,

    From what I am reading in your post, this long-time investor sees Red Flags. Is it possible you are overlooking something or somethings?

    You may want to dig deeper, inspect more thoroughly, and reconsider the comparables - a very unreliable judgment of the considered property.

    Surface numbers can be deceiving.

    I also strongly recommend becoming much more familiar with owner financing, especially the legal aspects, before you ever consider using owner financing. Without a doubt, have an experienced real estate attorney that you hire draw up the agreements, including the owner financing agreements should you decide to use this method of financing. There are many critical legal issues to consider and address BEFORE you sign.

    Andy Argonaut has an excellent addition with option #2: Adding a substitution of collateral clause. This is an excellent option for all of your future agreements that includes financing.

    Another term I include in all of my agreements: The terms of this Agreement may be renegotiated by mutual agreement by both parties. This sentence also accomplishes the avoidance of triggering a sale as defined by IRS code. Seek professional advice with regard to this prior to relying on this conception.

    0Reply
  • Tom Goans
    Real Estate Investor · Englewood, CO · Member since 2013 · 988 posts · 258 votes
    13y

    Added consideration, completely understand why the seller wants to sell. Look beyond what is being said. This will reveal if your number considerations are valid.

    0Reply
  • Jason Patterson
    OP
    Real Estate Investor · Deer Park, TX · Member since 2013 · 24 posts · 0 votes
    13y
    Originally posted by K. Marie Poe:
    Let the seller worry about the capital gains and possible tax consequences. An installment sale might not even be the best way for them to deal with a fully depreciated property. Let them get professional advice. Put a clause in your purchase agreement that says they have been advised to seek legal and financial advice.

    Escrow can do all the paperwork for the note. A standard promissory note and mortgage instrument do not usually include a prepayment penalty. If the seller asks for one (it's their note), make sure the terms will work for you if you think you might want to re-sell.

    The sellers' gains have nothing to do with your re-sale. Their gains come from their basis, depreciation, sale price, and in this case possible interest from a note.

    Why do you think they will sell for $90K if the comps are $150K? What's the situation with their tenant? Are they month-to-month and what's Texas law for terminating their tenancy?

    The tenants after 25 years decided to move out and buy a house. Not sure if they are even going to want 90k for house. Just a offer we are going to make to see if they will accept it or maybe they will make a counter offer.
    They had mentioned that they were looking up the Appraised value to see what it is worth, which as of 2013 showed only 94k. I looked up all other houses in area and all were in the same range of 101k to 110k range Appraised value and those where selling in the 130k to 150k range. Which this house does need minor upgrades to be compared to those houses.

    0Reply
  • Andy Argonaut
    Real Estate Investor · San Francisco, CA · Member since 2013 · 47 posts · 11 votes
    13y

    I would disagree with K. Marie Poe that it's the seller's problem and therefore not worth thinking about. This is a really good opportunity to have a win-win solution: you get long term financing at a low interest rate under very favorable terms and the seller gets to defer capital gains.

    You can absolutely continue making payments even after selling the property if you have a substitution of collateral clause in your note. The way I'd really structure this deal would be:

    Get a private first money loan for 50% of the "as-is" value, which would be around $60k if your numbers are accurate. Use this money to fund the seller's downpayment as well as the cost of your repairs and pull cash out at closing.

    Give the seller 2 options - lower downpayment with higher price and higher downpayment with lower price.

    Have the seller take the remaining amount as a note in 2nd position and make sure the total monthly payments on the 1st and 2nd do not exceed your cash flow. You might need to defer interest on the 2nd note or reduce the interest rate. Interest income is taxed at regular income tax rates, so you can make the case for paying the AFR (applicable federal rate).

    Also, it would be nice to make it a non-recourse loan. Either that, or form an LLC and make it the borrower/purchaser, so this does not get attached to your credit.

    Finally, sell it on a wrap. You've pulled all your cash out of the deal at closing anyway and you'll get a downpayment from a future buyer as well while ridding you of managing rental property. If you weren't in Texas, I would suggest a lease option as another possible exit.

    0Reply
  • Account Closed
    Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes
    13y
    Originally posted by Andy Argonaut:
    I would disagree with K. Marie Poe that it's the seller's problem and therefore not worth thinking about. This is a really good opportunity to have a win-win solution: you get long term financing at a low interest rate under very favorable terms and the seller gets to defer capital gains.

    I wouldn't say it's not worth thinking about. I would say the OP shouldn't be suggesting or giving any kind of financial advice. IMO, the OP has no business trying to work his offer to accommodate the seller's supposed tax concerns when it's apparent he barely understands the basics of seller financing or capital gains. Without all the details, none of us know the seller's capital gains picture. Capital gains and how to deal with them can't be isolated from the seller's entire financial situation. The OP is in no position to do anything other than make an offer that works for him and see if it works for the seller.

    0Reply
  • Andy Argonaut
    Real Estate Investor · San Francisco, CA · Member since 2013 · 47 posts · 11 votes
    13y

    K. Marie Poe - wouldn't you agree that it'd be a win-win scenario if the OP were able to structure the offer in a way that works for him and the seller? Also, there's a better likelihood of the deal closing and the offer being better for both parties?

    There are lots of ways to structure the offer, so understanding what works for the seller is critical.

    0Reply
  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    13y

    I guess that depends on whether you believe that giving the seller a 2nd mtg, at 100% LTV, and nonrecourse/shell LLC if you can.......constitutes "in the best interest of the seller".

    0Reply
  • Andy Argonaut
    Real Estate Investor · San Francisco, CA · Member since 2013 · 47 posts · 11 votes
    13y

    Wayne Brooks - it sounds like this seller is mainly concerned about capital gains, not so much the price or interest rate. If the seller was trying to sell the note, then obviously this isn't in their best interest. But, it doesn't sound like what they want or need.

    Fact is, a lot of people are worried about a large amount in capital gains and whatever is left after that in cash would go into a bank account or a CD and earn them a horrible return, or into a mutual fund and perhaps disappear if the stock market takes a downturn. A LOT of people are in this situation and really don't have a good, safe way of investing those proceeds. A note pegged at the AFR secured by a 2nd lien is a much better option for them.

    Best option? Probably not. The best option might be to get the cash, pay capital gains and then become a hard money lender I suppose. They'd have to do the math and figure out the amount lost in capital gains, how long it would take to recover it and if they're able to really do the private lending effectively, if there's enough deal flow, etc.

    0Reply
  • Mary B.
    Real Estate Investor · Lansdowne, PA · Member since 2013 · 1k+ posts · 656 votes
    13y

    The net long-term capital gain would be the benefit of both Jason and the seller. Do a chart (Excel spreadsheet)on all of the possible exit strategies for this deal and see which one provides the best outcome for YOU, Jason.

    Kudos,
    Mary

    0Reply
  • Jason Patterson
    OP
    Real Estate Investor · Deer Park, TX · Member since 2013 · 24 posts · 0 votes
    13y
    Originally posted by Mary B.:
    The net long-term capital gain would be the benefit of both Jason and the seller. Do a chart (Excel spreadsheet)on all of the possible exit strategies for this deal and see which one provides the best outcome for YOU, Jason.

    Kudos,
    Mary

    Thanks Mary,
    We do have a few exit strategies. We put offer in today so maybe we will hear something back soon. Its either going to be a ok or a Hell NO are you crazy?? lol :-)

    0Reply
  • Account Closed
    Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes
    13y
    Originally posted by Andy Argonaut:
    K. Marie Poe - wouldn't you agree that it'd be a win-win scenario if the OP were able to structure the offer in a way that works for him and the seller? Also, there's a better likelihood of the deal closing and the offer being better for both parties?

    There are lots of ways to structure the offer, so understanding what works for the seller is critical.

    "Win-win" is over-used and over-stated. There doesn't need to be any winning or losing. A buyer and seller coming to a mutually agreeable price and terms is the only way to get a deal done. The seller in this case has to first get clear about their goals and the impact, if any, of capital gains. And they need to get clear about the implications and risks of owning a note. For an inexperienced buyer to advise in any way on these topics is such a bad idea. The seller may not even be best served by seller financing.

    I love seller financing and go for it whenever possible. But it's not my job to analyze or comment on a seller's situation. Let the seller first get clear about their situation and their goals with professional advice. Then, if it works for me to make an offer that aids those goals, great.

    0Reply
  • Jason Patterson
    OP
    Real Estate Investor · Deer Park, TX · Member since 2013 · 24 posts · 0 votes
    13y
    Originally posted by K. Marie Poe:
    Originally posted by Andy Argonaut:
    K. Marie Poe - wouldn't you agree that it'd be a win-win scenario if the OP were able to structure the offer in a way that works for him and the seller? Also, there's a better likelihood of the deal closing and the offer being better for both parties?

    There are lots of ways to structure the offer, so understanding what works for the seller is critical.

    "Win-win" is over-used and over-stated. There doesn't need to be any winning or losing. A buyer and seller coming to a mutually agreeable price and terms is the only way to get a deal done. The seller in this case has to first get clear about their goals and the impact, if any, of capital gains. And they need to get clear about the implications and risks of owning a note. For an inexperienced buyer to advise in any way on these topics is such a bad idea. The seller may not even be best served by seller financing.

    I love seller financing and go for it whenever possible. But it's not my job to analyze or comment on a seller's situation. Let the seller first get clear about their situation and their goals with professional advice. Then, if it works for me to make an offer that aids those goals, great.

    I Agree about the mutually agreeable price and terms to get a deal done.

    0Reply
  • Ben R.
    Investor · Nashville, TN · Member since 2013 · 187 posts · 23 votes
    13y

    Why not just create an assumable note.?

    0Reply
  • Derek W.
    Investor · Kern county Riverside County, CA · Member since 2008 · 494 posts · 261 votes
    13y

    Was there any resolution to this? Did you make a deal?

    @Jason Patterson

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