Buying seller finance deal and tax implications for inheritance

[Jacob Michaels]

Hello all,

I'm talking with a seller who is fairly motivated as she is quite elderly (even has a great great grandson). She owns a few properties, each worth about $100,000 and is thinking of selling them. She owns them free-and-clear, so although she wants cash I think seller financing could be a possibility.

My question is how can I pitch her the benefits of seller financing for her situation? She has a will and her grandson is the executor. She is planning on giving the proceeds from the sales to her heirs.

I would like to find a way to explain the pros and cons of selling a house traditionally (for cash, from her perspective), and with seller financing (again, from her perspective). If she sells for cash, she'll be hit with capital gains of 15%, from what I understand. I want to use that somehow to persuade her towards the seller financing option.

I heard there is some kind of $10,000 gift limit that one can give their family members each year. If I were to structure a sale with some interest paid to her each year, and she were to receive let's say exactly $10,000 as income, could that $10,000 be given directly to one of her heirs either before or after she passes and could it pass to them tax-free?

I'm not sure if my question makes sense or not, but I hope you understand what I'm getting at, in trying to explain the tax advantages of owner financing versus the seller selling for cash.

I really appreciate anyone knowledgable taking the time to reply in advance!

Jacob

[Dave Toelkes]

If I were in your position, I would NOT give the seller tax advice unless you are a licensed tax professional. You might suggest that the seller consult her own tax professional to discuss whether a cash sale or an installment sale would be the best solution to her current needs. Her tax pro may advise against selling at all, since inheritance is the best tax outcome for the seller and her heirs.

Her tax pro may tell her that if she sells, there will be capital gains taxes. Tax rate depends upon her marginal tax bracket, so long term capital gain rate could be 20% with 3.8% medicare surcharge added on top of the capital gains taxes. Does not matter if she sells for cash or sells with owner financing, there will be capital gains. Her tax pro won't overlook the possibility that AMT will be triggered with an even worse impact on her tax bill unless some tax planning is done before the fact.

From her perspective, if she wants to sell, and if the taxable sale would be taxed at 15% capital gains rate, she might be better off selling for lump sum cash. If she uses an installment sale, her tax bill will be paid in installments with the tax due on profit as it is received. The pitfall here is that the installment sale profit is taxed in the year received at the capital gains tax rate in effect at that time. There is no guarantee that the tax rate will be lower in a future year.

If the properties were rentals, then there is unrecaptured depreciation that will be taxed IN FULL in the year of sale. Even with an installment sale, the unrecaptured depreciation is taxed in full in the year of sale. So, she may have a tax bill that is larger than the down payment and installment sale payments she has received.

From her perspective, it would be better to keep the properties and give them to her heirs by inheritance. that way, the heirs can sell the properties at stepped up basis with no capital gains tax due at all. Better outcome for everyone, because if the seller does not have to pay taxes, there is a larger estate to pass to the heirs. This may also be a better outcome for you too, if you are patient. Heirs often don't want inherited property and may be willing to sell for less that you were prepared to pay today.

On the other hand, if she needs casn from the sale to support her lifestyle, then an installment sale that gives her a monthly income over several years may just be the solution she needs. You won't know what might be better for the seller until you have this conversation with her.

Depending upon her state tax law, there could be state inheritance taxes due on the value of the estate passed to heirs. States do not always follow the federal estate tax treatments. Another reason to have her own tax pro discuss all of this with the seller.

BTW, the annual tax free gift amount this year is $14000 per year/per individual recipient.