Got a Flip deal but seller is concerned about huge capital gains. What can be done?

Question

I recently identified a single-family home (SFH) in California that is currently unoccupied and may require some rehabilitation. After reaching out to the owner, I learned that he is open to selling but is concerned about the significant capital gains tax he would incur.

It appears that he purchased the property in the 1980s for less than $100K, and the after-repair value (ARV) is approximately $1.5M. However, he is not interested in pursuing a 1031 exchange.

I am exploring potential strategies to help the seller minimize his tax liability. Any insights or recommendations would be greatly appreciated.

Natalie Bender · Answer

@Harish M.

Your sellers only option to sell and defer the capital gains tax is via 1031 exchange.

He should speak to his CPA as a sale even in installments will/ can trigger additional consequences. For example he will be required to pay not only capital gains but also depreciation recapture, the Obama tax (as mentioned above) and his medicare premiums will most likely go to the max for 2 years, longer if the sale is spread across different years.

If he is not interested in purchasing more homes via 1031 exchanges you could suggest 1031 exchanging into passive real estate; specially Delaware Statutory Trusts. I have worked with several clients in your homeowners situation. DM me I would be happy to give you an overview that you can take to your owner.

Peter Mckernan · Answer

You can ask for seller financing on the property, he holds the note for you and you bring in cash to close along with a certain amount of money to the seller at closings (i.e. $100K etc). Then you can pace out the sums of money, year two is 50K, year three is 150K, and so on. Then you talk to them about a rate for their interest rate they want and payments they want per month..

If you can do a lengthy escrow, 90 days, then if your rehab is long 3-4 months.. you could do half payment this year for the property, pay them interest/payment on their property and then pay them the second half of their net proceeds when you sell the place which at these timeframes would be into next year.

Obed Calixte · Answer

Why is seller against 1031 exchange?

Bad experience? Lack of knowledge of the process? Wants some cash out the deal? based on the limited info shared, 1031 may be in their best interest if they are truly looking to sell.

Ying Tang · Answer

Very interesting question. I don't know the answer to this so I asked chapgpt. Here is the answer, hope this helps:

1. Installment Sale: Instead of a lump-sum sale, structuring the sale as an installment sale can spread the gain over several years. This can potentially keep the seller in a lower tax bracket each year.

2. Deferred Sales Trust (DST): A DST allows the seller to defer capital gains by transferring the property to a trust. The trust then sells the property and distributes payments to the seller over time, potentially reducing the immediate tax burden.

3. Charitable Remainder Trust (CRT): By placing the property into a CRT, the seller may receive a charitable deduction and then get an income stream from the trust. This can help offset capital gains taxes while supporting a charitable cause.

4. Cost Basis Adjustments: If the seller has made capital improvements over the years, ensuring that these are properly documented can increase the property’s cost basis, thereby reducing the taxable gain.

Matthew Gigantelli · Answer

@Harish M. if he doesn't want to manage anything I think he can 1031 into a tenants in common (TIC) fund.

Maybe consult an exchange intermediary and see what they suggest.

Seems like he just needs a way to make passive income, and hopefully pass it along to his heirs so they can step up in basis.

Steve K. · Answer

Has the seller lived in the property for 2 of the past five years? If so they may qualify for the section 121 cap gains tax exclusion (up to $250k/individual, $500k/married couple). If he really doesn’t want to pay a lot in cap gains and hasn’t lived in the property for 2 of the past 5 (doesn’t need to be consecutive btw), he might even want to consider moving in for 2 years.

Henry T. · Answer

Yup, forgot about the Medicare premium jump, (6 or 7k?/yr) , which he most likely receives.

Henry T. · Answer

You would have to confirm with a CPA, but I believe once his adjusted gross income exceeds 250k, the Obama  3.8 tax kicks in. Also, once he passes 500k, ALL capital gains are 20% instead of 15%.

Aasia Kinney · Answer

HAVE HIM SELLER FINANCE TO  ME. Where is the property

Got a Flip deal but seller is concerned about huge capital gains. What can be done?

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