The following acquisition strategy can be put into play whether you’re a flipper, long term investor, even a spec builder.
Heck, wanna buy the lot on which you’re gonna build your dream home? This will work for ya big time. The first part of the recipe is to own a discounted note, secured by real estate. Seriously though, you can begin by makin’ a deal with a seller before you actually have one. I know, cuz I’ve seen me do it.
What you’ll be doin’ is taking advantage of your discount.
Sometimes you’ll get full credit for the note’s balance, sometimes you won’t. But I’ve never been forced to transfer title at my purchase price. I’ve always received more credit for the note than I paid — which is the idea, right? (Captain Obvious rollin’ his eyes.) It sounds a lot more complicated than it is, though tryin’ this using the DIY approach will, in my opinion, end up becoming a life lesson.
Let’s say you own a note with a balance of $100,000 for which you paid $60,000. Using the note as full or partial payment of the purchase price is the goal. Though I’ve known seasoned investors who’ve agreed to take what they had into it, what went unsaid was the years they may’ve held the note making thousands a year in payments. However, most times you’ll be able to get credit exceeding your initial capital output. Make sense?
If you do indeed succeed in buyin’ some real estate using a discounted note, understand there will many times be tax consequences.
For example, if I paid $X for a note and traded it for face value, which was $30,000 over $X, that difference would be subject, at least most of the time, to taxation. Sometimes it would be at ordinary tax rates, but most of the time it would be under the more attractive capital gains rates. There are strategies we can use to either reduce those taxes or avoid them altogether.
A Tax Strategy I’ve Often Used
For example, several times I’ve avoided a taxable event completely by using the note itself as collateral for a new note carried back by the seller.
The seller does their own due diligence to ensure their own security. This also works in the seller’s favor tax wise. It allows them to claim installment sale treatment to the extent they carried back a note. Many believe when a seller carries back some of the purchase price in the form of a note that it must be secured by the subject property itself.
Wrong installment sale breath. In fact, in my experience it doesn’t hafta be secured at all, though I’ve only been able to execute that once.
Simply have the seller carry back all or a portion of the sales price evidenced by a newly created note. That note will then be secured by the secured note you already own.
When the seller’s note is ultimately paid in full, your note is then released as a security instrument, and you still own the note. Nice, eh? In that scenario you either paid no taxes on the payments you received from your discounted notes, or very little. The reason is the offset of interest payments made by you on the seller carry back note. You made use of the principle of hypothecation. Make sense?
You can make use of this strategy in many ways, both mechanically and tax wise. The bottom line benefit most of the time is the ability to save cash. Many times the owner of a fixer will prefer getting a note they perceive as a better deal for them down the road, than a lower cash amount now.
Also, older sellers often look at note income very favorably. Transactions for them can be structured such that any tax liabilities can be spread out over several years. This works especially well when, for whatever reason, their primary residence or investment property presents a tax problem by taking any or too much cash in the year of sale. You can be of real benefit and service to them by presenting this option.
I’ve had a few times when the seller literally couldn’t sell in that year in the traditional way, but loved what their tax accountant had to say about our proposal. In the end, investors with the ability to acquire discounted notes secured by real estate, can create some pretty nice equity positions for themselves if done correctly and with the right professionals advising them.
This doesn’t in any way touch on all the strategies you can implement with discounted notes when investing in real estate. But it’s a dang good start, right?
How did you begin investing in notes?
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