Wraparound Sale Tax Consequences & Depreciation Recapture

[David G Vreeland]

Trying to structure the purchase of a property at favorable terms for the seller in order to negotiate a lower price.

Property: 2 unit for $300,000 (property is worth $350k)

Seller Initially Bought it for $100,000 years ago

Adjusted Cost Basis $50,000

Sellers Existing Mortgage: $100,000

Seller has little to no yearly taxable income (5-10k) so installment sale would be ideal to keep them at 0% capital gains rate (under 40k/year).

Summary of Questions:

Is a wraparound mortgage the best structure to eliminate the sellers tax burden while keeping the existing mortgage?

Would the sellers conventional or FHA mortgage work with a wraparound?

Could a rent to own contract be used in conjunction with an installment sale to keep the sellers taxable income under 40k a year?

Is depreciation recapture relevant? If so when would the seller need to recognize that gain and how much would that be?

Are there any other items I need to consider when structuring this deal?

I'm a bit unfamiliar with installment sales but ideally the seller wants to keep the mortgage and do seller financing to us over 15 years.  So in a perfect world seller would keep their existing mortgage (which I believe if owner occupied conventional) and a portion of our payments would go towards paying off that mortgage.

Wraparound mortgage seems like the best bet and I would like to try and mitigate the risk of seller defaulting on their mortgage by paying through a third party if possible.  

I also considered a rent to own agreement that turns into a an installment sale once enough has been paid to the seller to pay off the mortgage.

The seller wants to walk away with $200,000 meaning the deal would need to be structured to avoid all or almost all taxes.  Depreciation recapture is a concern but the property has been depreciated straight line and from my very limited research straight line depreciation may avoid depreciation recapture.

[Ashish Acharya]

Originally posted by @David G Vreeland:

Trying to structure the purchase of a property at favorable terms for the seller in order to negotiate a lower price.

Property: 2 unit for $300,000 (property is worth $350k)

Seller Initially Bought it for $100,000 years ago

Adjusted Cost Basis $50,000

Sellers Existing Mortgage: $100,000

Seller has little to no yearly taxable income (5-10k) so installment sale would be ideal to keep them at 0% capital gains rate (under 40k/year).

Summary of Questions:

Is a wraparound mortgage the best structure to eliminate the sellers tax burden while keeping the existing mortgage?

Would the sellers conventional or FHA mortgage work with a wraparound?

Could a rent to own contract be used in conjunction with an installment sale to keep the sellers taxable income under 40k a year?

Is depreciation recapture relevant? If so when would the seller need to recognize that gain and how much would that be?

Are there any other items I need to consider when structuring this deal?

I'm a bit unfamiliar with installment sales but ideally the seller wants to keep the mortgage and do seller financing to us over 15 years.  So in a perfect world seller would keep their existing mortgage (which I believe if owner occupied conventional) and a portion of our payments would go towards paying off that mortgage.

Wraparound mortgage seems like the best bet and I would like to try and mitigate the risk of seller defaulting on their mortgage by paying through a third party if possible.  

I also considered a rent to own agreement that turns into a an installment sale once enough has been paid to the seller to pay off the mortgage.

The seller wants to walk away with $200,000 meaning the deal would need to be structured to avoid all or almost all taxes.  Depreciation recapture is a concern but the property has been depreciated straight line and from my very limited research straight line depreciation may avoid depreciation recapture.

Straight-line depreciation doesn't avoid the unrecaptured 1250 deprecation ( it avoid 1250 deprecation - I know its confusing). 

You need to talk with the attorney and seller to execute the wraparound mortgage. 

When the gain from an installment sale of depreciable real property consists of both unrecaptured section 1250 gain (25%-rate gain) and adjusted net capital gain, the taxpayer recognizes 25%-rate gain as payments are received before recognizing any adjusted net capital gain. This “front-loaded” allocation method is consistent with IRC § 1(h)(3), which defines adjusted net capital gain as the residual category of capital gain not taxed at higher rates. The front-loaded method keeps taxpayers from recognizing some adjusted net capital gain from an installment sale even when the amount ultimately recognized proves to be less than the amount subject to recapture at the 25% rate.