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Buying model and leasing back
Old 11-06-2016, 08:44 PM   #1
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Buying model and leasing back

DW and I have been thinking hard about moving back to our old haunts, closer to DD and family, as well as other friends and family. We aren't in a huge hurry, but it's definitely on our agenda. We're currently snowbirding between the Eastern Shore of MD and the Gulf Coast of FL. We love our house in MD, but the 3.5 hr. drive to where DD lives makes it a difficult trip, especially since we have to deal with the DC Beltway as part of the trip. We've gotten a little spoiled by living in a less dense, more rural area, with far less aggressive traffic, at least when the summer crowds are gone.

The hard part of making the move would be giving up our lovely house with a pond and amazing views of the bay. We're looking for something with single level living (master bedroom on main living level), as we're not getting any younger. Also we've both dealt with parents becoming infirm and unable to deal with stairs and such. We've found numerous houses we like, but they're all in places where we'd be stacked on top of other people. The Northern VA area is pretty dense, and they are putting houses anywhere they can shoehorn them in.

To make a long story slightly less long, we've found a really nice house design. The houses they are building are, like most, packed tight like sardines. However, the model is in a different part of the community and is on a nice half acre lot with no other house within a stone's throw from us. At least, as far as I can throw these days. Also, it backs up to farmland and a conservancy, so the land should stay open for the foreseeable future. It's really quite lovely. Being a model, it's decked out, probably a little more than we'd have chosen had we bought one that wasn't built out yet, but not too much. We tend to go fairly top of the line.

The situation is that since it's a model, they're willing to sell it to us but would need to lease it back until they've sold all the rest of the houses they are building. The contract would guarantee at least one year, with up to 20 3-month extensions. So a max of 6 years. But most likely it would be a year or two or three. The lease/rent would be quite reasonable, especially since no one would actually be living there and using the facilities. They'd pay the HOA fees while they are there, take care of the lawn and gardens, and do any cosmetic repairs that were needed. I suspect these would be minimal, and that keep the place looking nice since it is their model. The rent would be ~8% of the cost of the house per year, so not a bad return. We'd have to pay the taxes and insurance, but since we'd be buying it for cash there wouldn't be a mortgage to deal with. We have enough after-tax cash to pay for it, so we wouldn't have to liquidate assets that would create a significant taxable event. So we'd continue to live in our beach/FL houses until they were finished, then we'd put the MD house on the market and move. The money for the new place would be a decent chunk of our investable assets, but not a majority of it. When we sell the MD place, God willing, we'd recover pretty much the same amount or more. The income from the rental would push us out of the 15% bracket, so no more Roth conversions or 0% CG stock sales, but only for a few years. I know it might take a while to sell the MD house, so that's a negative, but I'm willing to sell for the market price. I know I'll be taking a loss no matter what, and I accept that. So I wouldn't keep it on the market for an extended time to get a higher price than the market would bear.

So my questions are, has anyone else ever done this sort of lease back deal? If so, what are the negatives I haven't thought of? Also, since we'd be renting the place we'd be forced to take depreciation just like with our other rentals. However, since we wouldn't be selling and instead would be moving in would we be required to recapture the depreciation? This would be a second home, since FL is our primary residence, so I'm not sure how that would effect things. There are obvious possible problems, like another housing collapse or some other black swan, but sometimes you take chances. And since this is a DC suburb, history indicates that even a 2009 would tend to be recovered from fairly quickly. So, don't be afraid to be frank. I will appreciate any constructive opinions.
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Buying model and leasing back
Old 11-06-2016, 10:13 PM   #2
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Buying model and leasing back

We thought about doing this when we returned to the DC area just as things were starting to heat up back in 2000. We learned to investigate/study the habits of the particular builder. Do they have other communities nearby? Do they have another model with this floor plan? Are there future communities nearby? How old are the other model homes. We believe the builders discriminate (legally I guess) as to who they will offer the purchase/leaseback program to. Everything is negotiable (e.g. You think the drapes are not to your taste and want them replaced or addl discount. ). Consider things like clean/replace carpets at the end of the leaseback, etc). Make sure they will convert the garage back from an office if you plan to park cars in there. The people we spoke to were especially willing to provide items that align with their normal routine like upgraded landscaping at the end of the leaseback, etc. I do believe their margins are slim so it's a huge deal to them to get that model off the books and redeploy the capital.

As far as depreciation I was thinking you could just skip claiming it since you know it's only for a few yrs but I never really looked into that part of it.
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Buying model and leasing back
Old 11-06-2016, 10:15 PM   #3
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Buying model and leasing back

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Old 11-06-2016, 10:34 PM   #4
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.....
As far as depreciation I was thinking you could just skip claiming it since you know it's only for a few yrs but I never really looked into that part of it.
You cannot simply skip depreciation, as you will be forced to recapture it as the IRS will simply consider you took it, even if you didn't.

Along that line of course is the illegal move of not declaring the rent, which would be a mistake as the builder will be claiming as an expense the rent they pay.

Personally I would not want to be involved in this kind of deal, I'd much rather buy the place with a closing date of 3 yrs from now.
It does not solve your issue of visiting.
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Old 11-06-2016, 10:37 PM   #5
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Wouldn't you also have to pay income taxes on the rental income minus depreciation?

Doesn't seem like such a good deal to me. Our family once built a substantial house that required a better than run of the mill contractor. We interviewed a number of builders and checked them out financially. Few were strong fiscally. Many even finish houses and have to move in them when the houses aren't sold--no cash flow to hold on to them.

I'd do the deal short term--long enough for the developer to build himself another show house. No longer.
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Old 11-06-2016, 10:53 PM   #6
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Dupe
Lol. Thought you were calling me a dupe.
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Old 11-06-2016, 10:55 PM   #7
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You cannot simply skip depreciation, as you will be forced to recapture it as the IRS will simply consider you took it, even if you didn't.

Along that line of course is the illegal move of not declaring the rent, which would be a mistake as the builder will be claiming as an expense the rent they pay.

Personally I would not want to be involved in this kind of deal, I'd much rather buy the place with a closing date of 3 yrs from now.
It does not solve your issue of visiting.
I'm definitely claiming the rent as income, so no issue there. I'm just not sure what would trigger the recapture. It's usually from the sale of the rental. Maybe whenever we sell the house (although I hope to keep it until I die)? I might need to consult a tax attorney on this one. But I thought someone might have had a similar situation where they moved into a preciously rented house.
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Old 11-07-2016, 04:46 AM   #8
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I googled "recapture of depreciation when converting rental to principal residence".

The short answer to the recapture SEEMS to be that it is triggered when you sell the house, not if you move into it. Once the rental becomes your primary residence, you can take advantage of PARTIAL tax free gains at sale under the 2 of last 5 years rule. Basically, there are two different time periods considered for taxation: during rental, and during principal residence and gains are pro-rated. I am sure CPA's love these....

Previously, converting to the principal res. was used as a loophole to escape recapture entirely, but was restricted by Congress (2008) to the current rules.
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Old 11-07-2016, 05:00 AM   #9
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Who is paying insurance in the interim?
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Old 11-07-2016, 05:34 AM   #10
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I'm a little confused. Why not just buy the lot next door and have them build the same unit and not have the potential of a several year delay before taking possession?
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Old 11-07-2016, 07:56 AM   #11
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We bought a lease back home in Venice Florida . We only leased it for a year since we were tied into a rental agreement on another property . We had a lawyer draw up the agreement . We also had the builder change a few things . Before we moved in they cleaned all the carpets . Tax wise I am not sure how my late husband handled it . He was an ex IRS agent and a real stickler about taxes.
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Old 11-07-2016, 10:35 AM   #12
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I googled "recapture of depreciation when converting rental to principal residence".

The short answer to the recapture SEEMS to be that it is triggered when you sell the house, not if you move into it. Once the rental becomes your primary residence, you can take advantage of PARTIAL tax free gains at sale under the 2 of last 5 years rule. Basically, there are two different time periods considered for taxation: during rental, and during principal residence and gains are pro-rated. I am sure CPA's love these....

Previously, converting to the principal res. was used as a loophole to escape recapture entirely, but was restricted by Congress (2008) to the current rules.
Thanks. I'll google the same thing and do some more reading.

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Who is paying insurance in the interim?
Probably us, but that may be negotiable.

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I'm a little confused. Why not just buy the lot next door and have them build the same unit and not have the potential of a several year delay before taking possession?
There are no additional decent lots. The only place they are building the same units are stacked up on top of each other. This is an opportunity to get the house we like with excellent views instead of looking at the side of your neighbor's house from 20' away. And the delay in taking possession isn't a bug, its a feature. We're not quite ready to leave the MD home yet. I'm just curious if anyone else has done something like this and if there are any gotchas I haven't thought of.
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Old 11-07-2016, 11:01 AM   #13
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Who is paying insurance in the interim?
We would pay the home insurance (to protect our property). The builder would pay renter's insurance for their property.
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Old 11-07-2016, 11:01 AM   #14
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I like the big lot thing, it's the main reason I'm not moving from my little tract house.

It was built before the "zero lot line" homes of today and it right on a street corner. I have one neighbor on the side, about 30 feet away instead of 10. To the rear is an open empty dug out (down about 20 feet) area bigger than a football field that is the reservoir for all the storm drains in the south of town. Nearest neighbor behind me about 700 feet. On the other side is the cemetery, a nice wide open cool and green lawn area.

So even though I live in a city of 85,000, I feel like I live in the country. Very nice!
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Old 11-07-2016, 11:06 AM   #15
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Buy the model in your Roth IRA. Use a self directed IRA.

Then, all the rent is tax free. There will be no depreciation recapture when you sell it.

You cannot move into it, that is the only draw back.
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Old 11-07-2016, 12:08 PM   #16
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Buy the model in your Roth IRA. Use a self directed IRA.

Then, all the rent is tax free. There will be no depreciation recapture when you sell it.

You cannot move into it, that is the only draw back.

I really think this is a great idea. If the Roth balance was less than the purchase price, could you use Roth for the down payment, get a mortgage, and still get the tax benefits ?
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Old 11-07-2016, 12:17 PM   #17
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I really think this is a great idea. If the Roth balance was less than the purchase price, could you use Roth for the down payment, get a mortgage, and still get the tax benefits ?
Yes, you can. It has to be a 'no recourse' mortgage or other no-recourse financing. It has to be the the Roth's Account's name, not the person who owns the Roth.

And if you are 59.5 years old, you can take the profit out as you get it.

I am not sure if you can 'withdraw' the property when you want to move in, and then it's out of the Roth. But I believe so.
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Old 11-07-2016, 12:19 PM   #18
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The rent would be ~8% of the cost of the house per year, so not a bad return. We'd have to pay the taxes and insurance, but since we'd be buying it for cash there wouldn't be a mortgage to deal with. We have enough after-tax cash to pay for it, so we wouldn't have to liquidate assets that would create a significant taxable event.
On the surface, an 8% cap seems decent - but a few things to consider:

1) Flooring condition - Is the flooring mostly carpet? Hardwood? Pre-finished hardwood floors have anywhere from 20-50 year warranty - for RESIDENTIAL. If this is the display home, the manufacturer (if they found out it was the display home for years and years) would likely say that it had a hell of a lot more than standard residential traffic, and would void the finish warranty, possibly requiring you to patch or refinish (if solid hardwood) or replace it (if it's a thin 3/8" engineered wood floor). If it's carpet, even if they have plastic covering down to protect it, all those people might take a toll on the carpet, and require replacing the carpet. And think about many random people in the public that walk through the house, and want to see what the display is like - I'm sure a few of them will be rough and abusive on the flooring to see if it can withstand that high heel, or a kid running something over it, etc.

2) Taxes - How are the property taxes in this area? 1% of approximate market value? 2%? 0%? Take that into account with your cap rate.

3) HVAC systems - Many renters don't care about the landlord's house, which is why many people warn of those who plan to "rent the house out to someone eles, t hen move back into it later on". Double that for a commercial setting. Not only do you have tenants (real estate agents) that don't care about teh house, but also hundreds/thousands of potential neighbors. If they turn the HVAC up and down to extremes, that has some wear and tear on your equipment.

4) Roof - How old is the roof? Take that into your CAP rate analysis.

5) Security deposit - do commercial rental agreements include security deposits or "prepaying" one, two or three months rent in advance at the start to act as the security deposit? I'm sure that between the public walking around and the people moving out when they end the lease, there will be various nicks and scratches. Imagine trying to get them to come back and honor it when they're all out of the subdivision and onto the next project.

6) Put option - instead of you buying it and then renting, is it possible to simply have a lawyer write up a put option for the builder to sell to you at a certain date in the future, with discounts? Have a simple table - just like a mortgage payment table, except it shows decreasing purchase prices you would pay for the house at each month/quarter in the future, taking into account wear and tear on the house as they use it more and more over time. This has the advantage of being "tax-free" to you, whereby you still get the same "net after-tax out of pocket cost to buy the home" while not having to mess with record keeping. Only negative to the builder is that they have to delay getting the cash for selling the house, and they would have to come after you if you decide to walk away when they are ready to close.

7) Warranty - are they offering any warranty after you finally move in? If there are 'problems' with the house, do you think they will disclose it to you right before you buy it, or do you think you'll only find out later on after you are moved in that there's something wrong with ______, and you had no way of finding that out on your own (but they knew about it while they had their office there). Also, there can be issues with things like plumbing fixtures that aren't used in a long time - look at a shower valve that hasn't been operated a single time in 5-7 years, and there's a chance calcium has built up to the point of it not working properly (or possibly even being completely frozen).

8) Add'l insured - if you do this, make sure they list you as an additional insured on their renter's insurance. It means it extends insurance coverage to you as the landlord in the event they are sued. Otherwise, many people who slip and fall in the model would not only sue the person operating the office, but the landlord as well. If you aren't an additional insured, then your own personal policy would have to cover you in that instance, which subjects you to risk of not only the judgement, but also all future insurance rates going up.
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Old 11-07-2016, 11:09 PM   #19
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8) Add'l insured - if you do this, make sure they list you as an additional insured on their renter's insurance. It means it extends insurance coverage to you as the landlord in the event they are sued. Otherwise, many people who slip and fall in the model would not only sue the person operating the office, but the landlord as well. If you aren't an additional insured, then your own personal policy would have to cover you in that instance, which subjects you to risk of not only the judgement, but also all future insurance rates going up.
Lots of excellent input, especially this one.
Although the odds are extremely low, OP should consider packing on some extra umbrella insurance just because of this rental. Obviously anyone falling or whatever are going to sue a builder for many many millions and the landlord too, and juries are going to say the landlord should have fixed the problem. Which is easy to forget since the builder is renting and using it.
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Old 11-08-2016, 08:15 AM   #20
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Lots of excellent input, especially this one.
Although the odds are extremely low, OP should consider packing on some extra umbrella insurance just because of this rental. Obviously anyone falling or whatever are going to sue a builder for many many millions and the landlord too, and juries are going to say the landlord should have fixed the problem. Which is easy to forget since the builder is renting and using it.
I agree. Moore Bonds pointed out a few things I hadn't thought of, and especially the warranty and insurance. We do have a significant umbrella policy, but I'll make sure we get added to the renter's insurance (assuming we do this). Thanks again everybody for all your input.
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