Seller wants 1031- I want seller financing

Investor · bristol, RI · Member since 2017 · 52 posts · 19 votes

I am trying to finalize terms on a seller financed deal. The seller wants to do a 1031 exchange and has reservations about seller financing understandably so. I'm considering offering a large down payment(maybe 50%), then no monthly payments, and a balloon payment for the balance due at 5 years. Effectively it would be a 0% loan. Would this structure help the seller from a 1031 perspective?

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Dave FosterBusiness Member

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

@Adam R., you're heading the right direction. But 50% may not be enough to benefit him. It all depends.

In order for him to defer all tax he must purchase at least as much as his net sale. And he must use all of the proceeds of the sale in the next purchase. Proceeds include both cash and cash equivalents (the note).

This is the problem. If he only reinvests the cash he has taken boot in the amount of the note and that will be taxable to him. Yes as it comes in but still taxable.

However, if he can replace the 50% note that is in his exchange account with cash from any other source then he could still do a complete exchange and offer owner financing to you.

Easy example - The property is for sale 100K. You give him 50K cash and a note for 50k. Both go into his exchange. He has to buy 100K in real estate and spend 50K in cash and 50K in a note to do that. Offering an unseasoned note to a 3rd party as part of a purchase is tough. But if he were to replace the note with 50K of cash then his exchange acct. has 100K in cash and he can complete his exchange.

Meanwhile outside the exchange he has a note from you that is now non-taxable except for the interest which sounds like would be 0.

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Account Closed
Real Estate Agent · Las Vegas, NV · Member since 2015 · 2k+ posts · 1k+ votes
9y
the seller needs the cash for a replacement property of equal or higher value.The offer of a 0% loan would be a greater benefit to you .
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Adam R.
OP
Investor · bristol, RI · Member since 2017 · 52 posts · 19 votes
9y
Agree on the 0% part, but doesn't the 50% down payment allow the seller to buy a more expensive property via 1031 instead of waiting for the money to trickle in if I only put 20% down?
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
9y
@Adam R., you're heading the right direction. But 50% may not be enough to benefit him. It all depends.
In order for him to defer all tax he must purchase at least as much as his net sale. And he must use all of the proceeds of the sale in the next purchase. Proceeds include both cash and cash equivalents (the note).
This is the problem. If he only reinvests the cash he has taken boot in the amount of the note and that will be taxable to him. Yes as it comes in but still taxable.
However, if he can replace the 50% note that is in his exchange account with cash from any other source then he could still do a complete exchange and offer owner financing to you.
Easy example - The property is for sale 100K. You give him 50K cash and a note for 50k. Both go into his exchange. He has to buy 100K in real estate and spend 50K in cash and 50K in a note to do that. Offering an unseasoned note to a 3rd party as part of a purchase is tough. But if he were to replace the note with 50K of cash then his exchange acct. has 100K in cash and he can complete his exchange.
Meanwhile outside the exchange he has a note from you that is now non-taxable except for the interest which sounds like would be 0.
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Adam R.
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Investor · bristol, RI · Member since 2017 · 52 posts · 19 votes
9y
Thanks for the education. One more question. In your example, what if the seller only intends to use the initial proceeds(my 50% down payment) as his down payment on the next property. For instance could use the $50k as 25% down on a $200k property. Can he do that with 1031?
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Khalil Bachir
Pompano Beach, FL · Member since 2017 · 36 posts · 6 votes
9y
Thanks for the lesson Dave. I was familiar with the 1031, but you broke it down in a way that applies in the real world .
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
9y
Thanks for the shout out @Khalil Bachir.
@Adam R., unless he uses both the 50K in cash and the 50K note (or cash he exchanges for the note) he will incur a taxable event.
If he only uses your 50K as a down payment, even though he is buying more than what he sold, he is taking the note out of the exchange and the IRS says that is a taking of profit so it would be taxable.
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Adam R.
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Investor · bristol, RI · Member since 2017 · 52 posts · 19 votes
9y
Thanks @dave foster . Appreciate the timely advice as I am sending over my offer tonight. I gave him 2 options. The one above and a more traditional seller financing structured deal. Based on your info, he likely won't bite.
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Sam Shueh
Real Estate Agent · Cupertino, CA · Member since 2016 · 4k+ posts · 1k+ votes
9y
Suggest you get hard money.
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Tan Mehedi
Engineer · Douglasville, GA · Member since 2016 · 90 posts · 31 votes
9y
Dave Foster excellent example. That is what I called idiot proof explanation. Adam R. You should look for hard money and use Brandon's BRRRR to refinance the house after some time
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Jeff StephensPro Member
Rental Property Investor · Portland, OR · Member since 2017 · 101 posts · 78 votes
9y
@Adam R.: In my experience, people who want to do seller financing fall into one of two categories
1. They have their eye on a new property they want to buy, and have to sell something they currently own to buy it
2. They want to sell their current property, and just don't want to pay the tax on the gain now.
Do you know which of these two categories your seller falls into? Knowing this will help you make a more useful proposal. If the seller is in the second category (and many of them are!), then you can propose an installment sale structure (where you make a downpayment and then payments over time), which--if structured correctly--can also help them greatly defer much of their gain. Of course, every seller's situation is different (their goals, their basis in the property, their gain, etc.) so you have to evaluate it on a case-by-case basis, but this general idea is very powerful. In my experience, many sellers simply do not realize that a well-structured installment sale can be a viable alternative to a 1031 exchange. Once educated on this, they can find it very attractive.
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Adam R.
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Investor · bristol, RI · Member since 2017 · 52 posts · 19 votes
9y
Update on this offer. Seller didn't accept either offer. I now have a P&S to sign, but having trouble with the financing. The property has 2 lots and the traditional lenders won't lend on 1 of the lots. My counter is to do 2 P&S(I.e. One for each property) and get a lender to finance one and I'll come up with the funds for the other. My 1031 question is, this gets the seller his cash all upfront, but in 2 transactions. How does that impact the seller?
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
9y
@Adam R., Going to one buyer at one closing table like that It is possible to combine those so it is functionally acts as one exchange. The lender will want a separate settlement statement for the leveraged property but it can be done. The key is to work with the closer.
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Thomas RutkowskiPro Member
Financial Advisor · Boynton Beach, FL · Member since 2015 · 834 posts · 798 votes
9y
A good solution for you would be to talk to the seller about using a Monetized Installment Sale instead of a 1031 exchange. This would allow him to defer the taxes on the sale. In a monetized installment sale you defer the taxes by selling on an installment contract (seller financing) through an intermediary. The monetization loan lets him walk away from the closing with cash that can be used for any purpose.
Your seller can still finance you, have the cash to do his next deal, and defer the capital gains for 30 years: win-win-win. Happy to explain further. PM me if you'd like more details.
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Patrick L.
Real Estate Investor · Saint Petersburg, FL · Member since 2013 · 1k+ posts · 951 votes
9y
Originally posted by @Adam R.:
I am trying to finalize terms on a seller financed deal. The seller wants to do a 1031 exchange and has reservations about seller financing understandably so. I'm considering offering a large down payment(maybe 50%), then no monthly payments, and a balloon payment for the balance due at 5 years. Effectively it would be a 0% loan. Would this structure help the seller from a 1031 perspective?
Your 0% loan would be terrible for the seller tax wise. If the interest rate is too low (or 0) the IRS will charge an imputed rate to the person holding the note (I believe it's around 3%) and they will be taxed on that theoretical interest as income (even though they received nothing). Also no monthly payments is a pretty odd arrangement. More fair terms would be interest only at a reasonable rate with a balloon.
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