Seller finance to reduce taxes?

Question

I am in final negotiations on acquiring a property that was inherited.  The property is in a good location, thus attaching $value to the purchase price, but there are years of deferred maintenance, and a full rehab is needed.

I am looking to negotiate as much time as I can, however, the seller is reluctant to agree to owner financing.  Is there a benefit to the seller by spreading out the gains/ proceeds of the property ($275K) over two (2)  different tax years?

We are gathering that $275K is her number and we are currently asking for that purchase to be made in 4 payments, every 90 days, until paid in full July 2024.

Doug Smith · Answer

OK...that's a huge help. P - 1/2% is a great rate in this day and age. If they don't want to take seller financing to keep you from drawing down on the line, discount out you offer by about $25K for a cash offer. That would be about a year's worth of interest on your line. Cash in hand might be more attractive to them without having to wait for financing. Once you get the property up to snuff, then you can do a cash-out refi...either conventional or DSCR. You'll want to be careful about borrowing too much against the property as, with higher rates, taxes, and insurances lately, I'm seeing more and more properties not cash flowing at higher-levels. You'll probably want to count on 75% or less for a cash-out refi. I'm sure you know that you can use the appraised value if you've owned the property for more than 6 months, so who knows, if it cash flows and the ARV is $333K or more ($250K/75%), you might get your cash back out and cash flow too. It sounds like you're in a great position and you've done this before, so forgive me if my answer insulted your intelligence. You seem to know your stuff. That being said, I'm not sure you can't get an even better deal by not using owner financing.

Chris Seveney · Answer

There is potential benefit along with potential risk. I will not be surprised in 12-24 months where we see these seller financed deals done with low down payments and properties needed work and the borrowers just walk away from them when the market starts to slide. I am a take my money now versus carry back the loan (and full disclosure I have a mortgage note fund so we buy notes all day long).

Boyd McClean · Answer

Have you given thought to a Novation?

Eric Williams · Answer

There may be. But keep in mind although he pays taxes later, he also receives money later and thus has an opportunity cost for all missed investments in the meantime.

Steve K. · Answer

The potential tax benefit to the seller will depend on when they inherited the property, and their personal tax situation/ how they handle their taxes. Capital gains taxes on inherited property are calculated as a "stepped-up cost basis" if the property qualifies. This means that the tax basis "resets" to fair market value of the property at the time when the trustor passes away as a starting point for cap gains. The heir pays taxes only on appreciation that occured after they inherited the property. So if they inherited it recently, they may not have much in the way of cap gains. There are other variables on their end that would effect their tax hit when they sell also: whether they ever lived in it, rented it, have expenses to deduct, qualify for an exclusion, etc. so it depends on a wide range of factors. Typically seller financing helps alleviate significant cap gains tax consequences when the owner has owned the property for a long time, and it has appreciated greatly during their ownership.

Doug Smith · Answer

That would depend heavily on your personal financial situation. Can you cash flow conventionally? If the property cash flows on it's own, then that opens up a great deal with something more tailored to rental property (yes, including DSCR). Without knowing the details of your personal situation, it's hard to pinpoint the exact course.

Brannon Hamby · Answer

@Doug Smith thanks.

You mentioned other, more traditional, financing as an option that might be even better..

How would you structure the financing here… considering everything is difficult to cash flow and really analyzing to get to break even+.?

Doug Smith · Answer

Technically, the property would be free and clear as the HELOC is a line against another property, so your refinance to pull money out would technically be "cash out".

Brannon Hamby · Answer

@Doug Smith

I wanted to try to get clarity on one point you made.. about doing a refi after the property is up to snuff.   all given that the property is going to be purchased with HELOC, could you explain what you meant by cash out refi..?  Or did you mean doing CO-Refi later on down the road?

Brannon Hamby · Answer

@Doug Smith

The property is in rough shape and I assumed conventional lending would not underwrite.  I am planning to use a HELOC (prime minus 1/4%) to purchase ($275K) and rehab ($73K) before securing permanent.2-3 month rehab and it will be held and rented back by the small business I own.

Seller finance to reduce taxes?

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