Unique deal structure - advice wanted

St. Petersburg, Florida
1031 Exchanges
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Unique deal structure - advice wanted

Jim Myers
Investor · Indian Rocks Beach, FL · Member since 2015 · 2 posts · 5 votes

I own and operate 7 MHP communities in Florida. I have a elderly MultiFamily property seller that wants to avoid capital gains taxes in his lifetime by implementing this unique deal structure which my CPA said would work. I want to know if anybody has heard or completed a similar deal or can offer advice. In this special circumstance the seller does not want or need a lump sum of cash from the sale, The seller would be happy with a monthly bonus from the operation and leave the remainder of the asset sale to his heirs.

$5,000,000 MHP community (current value) @10CAP

Conventional financing of $5MM, 30% down ($1.5M down) , 20yr term 6.75% = $26600/mo pmt or $312,000/yr P&I. ...This would result in seller having a capital gain tax burden. 

Seller suggests:

Option1
 Master Lease the community for 120 months @$25,0000/mo and option to purchase for $2,300,000 in 2033 (equilavent to mortgage balance in 10yr). In 2033 seller will be dead, His heirs will get a STEPUP BASIS in the property and avoid capital gains, the seller will get a monthly benefit without the hassle's of operating the community while he is alive.

In this option I did NOT pay the 30% down payment , but I could provide a 1st position cash out refi too the seller for $1M - $1.5M 

I would need to make sure the seller did not encumber the property during my master lease with a mortgage, i would lose any ability to do a cash out refi for 10yrs and I would lose the ability to capitalize expenses, and have depreciation, The seller would need to make sure that I did not operate the community where code liens or tax liens encumbered the property.

Has anybody heard of such a deal strategy? Any recommendations?

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
3y

@Jim Myers, be careful about structuring so you get credit on the sales price with your lease payments if you're thinking to 1031 into this property in 10 years.  A lease where there is credit to purchase can create a beneficial interest in the property for you.  this is not good if you're wanting to stay away from anything that looks like a contract for deed purchase.  This would end any attempt to 1031 into this property.

But @John Underwood, makes a good suggestion if you want to tighten up the property control by you.  Credit toward purchase price makes it legally much harder for him to get rid of you if it comes to that.  As part of crafting the lease and option you could make part of your down payment a minimal interest loan to him.  It doesn't cost him anything.  You'd be giving him money anyway.  But the loan can go into first position so he can't refinance out from under you.

It will save him a big capital gain.  Maybe his depreciation offsets his income.  But it's an elegant situation for you if he likes it.

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  • John UnderwoodPro Member
    Investor · Greer, SC · Member since 2014 · 13k+ posts · 17k+ votes
    3y

    I would want some credit towards the purchase price while I am in the lease period.

    Use a recorded pure option to give you the right to buy the property in the future at a set price. 

    Your option would be recorded ahead of any potential other mortgages or liens.

    1Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    3y

    @Jim Myers, be careful about structuring so you get credit on the sales price with your lease payments if you're thinking to 1031 into this property in 10 years.  A lease where there is credit to purchase can create a beneficial interest in the property for you.  this is not good if you're wanting to stay away from anything that looks like a contract for deed purchase.  This would end any attempt to 1031 into this property.

    But @John Underwood, makes a good suggestion if you want to tighten up the property control by you.  Credit toward purchase price makes it legally much harder for him to get rid of you if it comes to that.  As part of crafting the lease and option you could make part of your down payment a minimal interest loan to him.  It doesn't cost him anything.  You'd be giving him money anyway.  But the loan can go into first position so he can't refinance out from under you.

    It will save him a big capital gain.  Maybe his depreciation offsets his income.  But it's an elegant situation for you if he likes it.

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    3Reply
  • Jim Myers
    OP
    Investor · Indian Rocks Beach, FL · Member since 2015 · 2 posts · 5 votes
    3y

    Thanks for the insight and comments. @johnunderwood I googled pure-option and it mentioned Option without a lease. I did NOT know a Option could prevent him from potentially getting a mortgage by being in first position. And yes the option purchase price reflects what a traditional mortgage balance would be at the end of the lease date.

    @DaveFoster thanks for the 1031 insight its something that I have never been involved with as I have never sold only purchased properties , it was not my intention to show lease pmts offsetting purchase price, but have the option price below market price to account for the lease payments.

    Thanks for the response.

    1Reply
  • Glenna Wood
    So MD · Member since 2019 · 294 posts · 191 votes
    3y

    I'm wondering what happens if the owner dies before 2033. Wouldn't the heirs get the stepped up basis at that point in time and inherit your lease? What would prevent them from raising the rate? The future sale price equal to the mortgage in 2033 doesn't take into account any appreciation on the property. Seems likely the heirs would fight for a future FMV price. You need to dig up a really good attorney to watch your back. Is another option the owner sells the property now and does a 1031 to a DST? Passive for him now and leaves a chunk to the heirs. Is there a stepped up basis for a DST to shelter the gains? IDK.

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  • Paul Klei
    Investor · TX · Member since 2023 · 57 posts · 5 votes
    2y

    Credit toward purchase price makes it legally much harder for him to get rid of you if it comes to that.  As part of crafting the lease and option you could make part of your down payment a minimal interest loan to him.. the loan can go into first position so he can't refinance out from under you.

    It will save him a big capital gain.  Maybe his depreciation offsets his income.  But it's an elegant situation for you if he likes it.


     Interesting. Would you mind elaborating on this point? 

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    2y

    @Paul Klei, If a tenant is not paying their lease I may use all legal means to evict them.  If someone has an interest in the real estate itself (either they own part of it or have earned part of it by credited payments) then I can use all legal means to Foreclose on their interests.

    Generally, it is much easier to evict someone than it is to foreclose on them.  This is why the OP would find that a situation where part of his payments were credited toward the purchase places him in a much stronger legal position than that of a tenant.

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