Selling rental home idea

[surprising]

I have a few rentals that I will eventually need to sell. They have appreciated a lot so I do not look forward to the large tax consequences. I have a crazy idea but don't know if it would work. My renters are long term, and I bet they would love to own the homes instead of rent. I want to offer to sell the home to them but with the stipulation that they use me as the loan provider for a number of years. We would work together to come up with a competitive sale price, mortgage terms and down payment. Once agreed we'd work with title company to get the home transferred to them with me as a lien holder. They would pay the down payment and would own the home.

I was thinking since the only money that changed hands are the down payment and then the monthly mortgage payments, those would be income that would be subject to tax. So instead of a one time large hit to taxes if I were to sell the home outright, this would spread it out over a number of years. And bonus it would provide way more income then current rents minus expenses. No longer need to pay ever increasing HOA, property taxes etc. But I just realized I will still have the same problem if in the future they decide to refinance, or move, or I decide to sell the loan. That will be a large one-time cash infusion.. So I guess I'm just delaying the problem, but it still might be a win as I will have a number of years where I'm just collecting money with no other responsibilities.

Is this feasible? Has anyone done some crazy financial engineering to reduce impact of selling rentals?

 

[jazz4cash]

I’m no RE guru but I believe It’s a common strategy for personal residences. Not sure about rentals. Some places it’s known as a land contract but I think that’s just semantics. When I was looking to buy my first home in ‘83 interest rates were 12-15% and this strategy became popular. Seller retains deed until contract is satisfied. I think it is also similar to the Delaware Statutory Trust process. Good on you for trying to help your tenants.

 

[Souschef]

I am not a CPA, but IMO if you transfer ownership, regardless of the financing, it is a taxable event.

 

[euro]

Yes, this is totally feasible and an excellent tax strategy. Look up rent/lease to own. If you do any creative financing structures, make sure you cover all your bases in terms of downpayment and other terms, so you are protected if the buyer stops paying (use of an attorney and/or CPA highly recommended).
Another strategy to manage the impact of selling your rental is a 1031 exchange that lets you defer the gains. You will have to reinvest your proceeds in something similar though, but that could be something like triple net commercial real estate that is completely hands-off.
Another way is to donate the property to charity.
Finally, you can just hang on to the property and once you pass away, your heirs will benefit from the "Step up" tax basis and the property escapes any taxes. Of course, in order to realize this particular benefit, you will have to be dead, so there is that....

 

[euro]

I am not a CPA, but IMO if you transfer ownership, regardless of the financing, it is a taxable event.

Not if you structure it as a "lease to own" deal

 

[38Chevy454]

Seller financed mortgage is essentially what you are talking about. Yes, the tax consequences are spread out over the length of the terms. Unless something changes like your tenants sell, or you sell the mortgage. But in simplest answer, your idea is valid to help getting a big one-year hit on income. Note that the interest on the loan becomes income, as well as the capital gains, during your spread out timing.

 

[CaliKid]

This is very common. In fact, we have one rental we are contemplating. I was advised 10% down, 10% interest, 10 year prepayment penalty and balloon (or re-fi) in 10. Keep it simple! There are serving companies who can handle the loan paperwork, property taxes, insurance, etc.... I would definitely talk to your CPA and a good real estate attorney.

 

[surprising]

Not if you structure it as a "lease to own" deal

For lease to own, will they be responsible for all expenses (HOA, prop taxes, maintenance)?

 

[cathy63]

This is called an installment sale for tax purposes. One thing to be aware of since you're selling property that's been rented out is that you have to recapture all the depreciation you took (or could have taken) during the entire rental period in the first year of the installment sale. That amount is taxed as ordinary income but the tax rate is capped at 25% if any of it falls into a bracket higher than that.

See IRS Pub 537 for more details, but I think you would want to make sure the down payment is large enough to cover the depreciation recapture, or at least the tax you have to pay on it.

 

[pjigar]

This is a viable strategy depending on the state but please understand pro/cons of each strategy and legal requirements. Best option is "Land Contract" if your state allows (seller keeps the title until loan is paid in full). A lot of states have cracked down on "owner-financed" loans after 2008. YMMV.

PS: If your state requires that the title be transferred to the buyer then it is not worth doing owner-financed sell. If renter stops making payments then you will have to go through a lengthy foreclosure process along with all the risks that comes from a property that is being foreclosed (damage to property, eviction, possession, etc.)

 

[Kings over Queens]

Is this feasible? Has anyone done some crazy financial engineering to reduce impact of selling rentals?

I did it with a commercial property. paid tax on the down payment and then tax going forward on mortgage payments as they were received. Make sure you consider your exposure to default. My deal was working great until covid hit and my guy was forced to close his business. Ultimately I had to forclose and he sold before I could take the property back. I was made whole, but it took over 2 years and a lot of aggravation.

 

[OldShooter]

Be careful to not let the tax tail wag the investment dog. If you sell this way, it is a lot like getting married. Tenant/buyers fall on hard times, maybe lose a job, and come to you for help. Tenant/buyers get jobs far away and want out of the deal; how is that handled? I had rental real estate for many years and can guaranteed you that unforeseen things will happen.

Talk early and often to a real estate lawyer about what your options are. Mortgages come with lots of rules and baggage plus foreclosure is difficult. In our state there is a "Contract for Deed" conveyance that is much easier for the seller to deal with. Basically, buyers miss a month and you can kick them out. Kick them out of a totally trashed house possibly. How much time and money might that cost?

 

[pjigar]

FWIW, I am a landlord and I have decided against doing seller-financed selling when we are ready to liquidate our real-estate holdings. We will just bite the bullet and pay tax. If we really don't need the equity/income from rentals when we liquidate then we may do 1031 transfer and buy land that would go to the next generation with a stepped-up basis.

 

[euro]

For lease to own, will they be responsible for all expenses (HOA, prop taxes, maintenance)?

Yes, that's how these are typically set up, but anything you want to customize can be included/excluded.

 

[JDARNELL]

I have done 2 1031s and I have a rental property that I am listing next week. I'll be biting the tax bullet. They have done their job now it's time to do something else. Painful though

 

[calmloki]

We are long time landlords still - we bought most of our places when interest rates were 9-14%, they were tough to get financed, so the majority were bought "owner carry contract". Now that we are divesting we are selling owner carry; currently have four contracts paying.
Yes, depreciation recapture is paid in the first year, but on the sunny side, maybe you've owned it 22 years and it's fully depreciated, but dang you didn't pay much for it way back then, so compared to your current sales price it could be worse.
Sold a raggedy little house to the tenants 8 years ago for $80k (property tax appraiser's "true cash value"), 7% interest, 30 year contract, $5k down. Did that so his PITI payments would be really close to the rent he was paying then. Took him 3-4 years to manage to get on track, but he's doing fine now, and his payments are tiny in todays climate. House is even more raggedy now, but it's not my house. We have a letter with our payment escrow company that contract ownership and payments will shift to our niece when the last of us two dies.
DO use an escrow company - third party keeps signed loan doc and reconveyance paperwork, takes payments and generates tax documents and most importantly - makes a business face for the buyer to interact with as opposed to having them show up on your doorstep with a sad sad story.
A multi unit we sold to someone we care about we sold sans real estate agent, just a lawyer. Priced it cheap, subtracted 6% RE commission from that number, and did another 30 year contract. On this one, we did more down payment, low 4% interest, and, after waiting a month, gave the escrow company a TOD document. Buyer is real aware that we aren't likely to last 30 years, so he's big bucks ahead to just keep making payments rather than selling.
Another multi we sold to a 1031 buyer with 30 year contract, 10 year balloon - again, all of these we've used the same escrow company for collections.

On the other side, we bought a 5-plex with owner carry from an older gent at 9% interest. Several years in we came into some money and looked for our highest interest loan to pay down; we had two at 9%, his would be paid in full , I contacted the old gent to tell him the story and told him if he lowered the rate we'd pay the other loan, if not we'd pay him off. Pretty sure he thought I was trying to work him with a bogus story; I'd have felt the same. We got a paid in full property; he lost an asset paying 9% and had to pay big taxes and find somewhere to have what was left generate comparable income. Scary business, I think about it now that I'm on the old gent's side.

Calikid's 10/10/10/10 suggestion is great if you can get a buyer to spring for it - I like the prepayment penalty, but the 10% interest feels like you will be foreclosing - only buyers short of funds would pay that in current rate climate. We were subject to a 3-year prepayment penalty once - I hated it and pushed that loan to payoff ASAP.

I like loans, paying them off is exciting and challenging, getting paid is pretty ok too, but it sure jacks up the taxable income - hard to finagle keeping your AGI in control.

 

[jazz4cash]

I am not a CPA, but IMO if you transfer ownership, regardless of the financing, it is a taxable event.

IME there may be transfer (property) taxes due but it is the income tax that most want to minimize. Receiving income over many years vs a lump sum could be a benefit. Also, with a land contract I believe the property is not transferred until the contract is satisfied.