Owner Finance & Capital Gains

[<Steve> 82]

Hello DaveT-

 

It has been a while since I have posted here, and I have a question regarding the Capital Gains Tax.

 

I am currently working with a seller who has multiple singles family investment properties for sale. originally he wanted to do a 1031 and move his family to the beach and reinvest there.

 

However, after speaking with him, the seller is willing to owner finance with little to no money down and receive a monthly cash flow from his properties, instead of selling for all cash and doing the 1031.

 

One of the sellers issues is having to pay capital gains. So, If he sells a few of his properties to me via owner finance is the seller responsible for paying all the capital gains of the sale?

 

I have heard there are some exceptions for the smaller investor. When doing an Installment Sale (owner finance), rental properties that sell for less than $150,000 are exempted. Therefore, if the seller takes a note from me for his properties he does not need to worry about paying tax on anything but the money he actually receives. Is this correct?

 

Thanks DaveT for any comments you may have.

 

<Steve>

[Dave T 0]

Steve,

 

I would be thrilled if there were "exceptions" for the smaller investor, but I think you are misinformed on this point. Perhaps, you are really thinking about the $150K income cap on using passive losses to offset ordinary income. When taxable income exceeds $150K, the rental property investor is prohibited from offsetting ordinary income with his net passive losses from rental property operations. Instead, the taxpayer suspends his passive losses and carries them forward to the next tax year.

 

Regardless of your seller's taxable income, he is able to use installment sale tax treatment for all investment property sold to you with seller financing. Depreciation recapture (if applicable) must be paid in the year of the sale, but the capital gains tax on his profit is only paid in the year received. Interest paid on the seller carried notes is reported as ordinary income in the year it is received.

 

The seller can defer capital gains taxes indefinitely by using a 1031 exchange to acquire like-kind replacement property. If your seller wants to reinvest in another area, a 1031 achieves this goal without incurring any capital gains taxes en route. The disadvantage to you is that the seller can not do a 1031 if he is taking back financing. You would need to find your own source of funds if the seller chooses to proceed with a 1031.

[<Steve> 82]

Well, that is good news. I will be able to let the seller know that he will be able to use the installment sales tax treatment for all his properties sold to me by owner financing.

 

Basically if he sold a property to me this year the seller would pay taxes on:

 

1. Any depreciation he has taken would be taxed this year.

 

2. All interest from notes is taxed as ordinary income.

 

3. No capital gains tax until the year he receives his profit.

 

 

I think I've got it. Thanks DaveT!!!

 

Steve

[Dave T 0]

Steve,

 

Why are you giving the seller tax advice? Don't you think this should be left to the seller's own professional tax advisors? You are not a tax professional, licensed to practice are you?

 

You already said that the seller is amenable to an installment sale.

However, after speaking with him, the seller is willing to owner finance with little to no money down and receive a monthly cash flow from his properties.

If the seller is willing to use an installment sale, I would assume that the seller already knows his tax ramifications.

 

You brought up tax questions which I thought you wanted clarified for your own personal edification, not for the seller's education. Because you don't know all of the seller's financial circumstances and especially since you may not know everything a professional tax advisor would need to know to render competent tax advice, I think you should stay quiet on the seller's tax treatment.

 

If you feel compelled to tell the seller anything about the potential tax treatment, you should say "I am not a licensed tax professional and therefore I am not comfortable offering tax advice. In my opinion, an installment sale does create a potential tax liability; however, you should confirm this with your own tax advisor and review with him the tax ramifications that would accrue to you".

 

Do not place yourself in a position of giving legal or tax advice for which you may be held liable. It is really in the seller's best interest to use a 1031 like-kind exchange, rather than an installment sale. You do not want to appear self-serving by offering the seller "tax advice and guidance" that is contrary to his best interests.

[<Steve> 82]

Yes DaveT, this is for my personal edification, and in no way am I giving tax advise to the seller. I am trying to educate and understand for myself to avoid any surprises I may or may not encounter because I have overlooked something in this deal.

 

I'll let the seller worry about his taxes, to keep my nose clean of any liability.

 

Thanks for your replies.