Tax creativity on owner finance (with step up in basis)

[Todd Rasmussen]

I'm about to make an offer on a SFH portfolio. The owner passed in the last couple of months and his children are selling his portfolio. He's owned the homes for a long time and they are currently titled in LLC, I'm sure being retitled into a trust prior to sale. Since all homes need lots of attention, the seller is willing to carry back down amount and I'm planning about going to a commercial lender for the majority of the purchase price; then using cash on hand to renovate.

My questions for the tax pros / creative deal makers are:

How much of a step up in basis is allowed at time of inheritance for the seller and does it apply to investment properties?

If the seller is planning on investing the money as a nest egg for their retirement at some point they will be paying tax on it?

Now it all comes together:

If I overpay for these properties in exchange for 0% owner financing, then I would have greater depreciation write off and a higher basis in the portfolio.

Would the seller would have income tax free as long as the purchase didn't exceed their basis?

If they sold the note at a discount, then would they get to show a loss from the sale?

Finally, do I sound like I missed my calling? Or like my CPA really needs to return my voicemail?

Most importantly, any pros/cons I missed? Especially for my side of the deal?

[Michael Plaks]

@Todd Rasmussen

The step-up basis is supposed to be to the fair market value at the time of death, adjusted for the condition of the properties. In other words, if available for sale in the open market, how much they would be worth? Let's say $1 mil for an example.

If you buy for $1 mil, they have no gain and no loss, regardless of how you finance the purchase. If you buy for more, they have a taxable gain. If you buy for less, they have a loss. How your price compares to the area averages is irrelevant for taxes, only relevant to establish the FMV.

If they sell a note at a discount - yes, they will have a loss. But why would they sell it at a discount?

Finally, 0% financing potentially opens up the imputed interest issue. Search this forum, it has been discussed at length. In short, the IRS wants the sellers to pay taxes on some interest. If there's none, they might assess it anyway, although the IRS is not known to raise this issue. They might start tomorrow, who knows.