Selling a rental to current tenants with seller financing

7 Replies

Really quick scenario...

I have a home we purchased in 2009 for $123K cash, rehabbed it and have been renting since 2010 for $600/mo cash flow. Seller's market in Wenatchee, WA and can list to sell at $250K. My current tenants want to buy it, but can only qualify for $180K. Can I work a deal where they get a loan for $180K and we do some sort of personal financing between us that they pay back the difference of $170K (so we continue to cash flow about $500/mo)? If so, would we only pay capital gains on the $57K ($180K-$123K)? Actually, we would probably put into 1031 since we can buy two houses out of state for $185K. Thanks for any insights!

Oops,I made a mistake in my numbers. Our buyers would get a loan for $180K from a bank and we would seller finance the balance of $70K (not $170K). This way we could take the $180K to invest in two houses out of state (probably through a 1031)and still be getting income from the seller financing. Does this deal look OK or am I missing something?

Conventional lenders won't allow a borrowed down payment, so what you are proposing may be tough. What about carrying the note and collecting payments that way?

I see a lot of problems here. Why sell it to a buyer, in a seller's market no less, who can't afford it? Also, if the market is that good it sounds like you're currently renting below market rent. I realize that rents almost always trail sales but it reads as if you're way off.

You didn't mention your rehab costs, so based on your numbers your gain is even less than the $57K. 

You also should have some depreciation recapture, right?

If your tenant can afford the total nut on both mortgages why can't he afford a higher rent? Or for that matter why can't he qualify for a full loan?

How are you planning on reporting this on your tax forms? Both this year and in coming years as you report the interest and repayment of principle on the second? This seems highly problematic to me.

Howdy @Susan Grinde .  Looks like we're neighbors!

I would just do a lease with option to buy at market value.  Give them 24 months or so to exercise and buy when they're ready.  Will keep your cash-flow going and limit your maintenance headaches.   I usually ask for 3% as option consideration.

I share others' anxiety about the weirdness of the $70k on the side as far as tax reporting and just the fact that they can't qualify for a reason.   Hopefully they have cars and phones and clothes they can't afford like normal renters and will correct their consumeristic behavior, allowing them to qualify within 24 months.

This could potentially cause you problems in a 1031 ... doing seller financing is tricky. It has to be worth it to you and in this case it doesn't sound like it would be.

@Susan Grinde , If you do not replace the amount of the note in your exchange account it becomes taxable.  You could still do an exchange but you would pay tax on the $70K and shelter the remaining $63Kish of profit.

If you have access to outside funds you can "buy" the note out of the exchange and replace it with cash.  Then you can complete a full 1031 and have the note outside the exchange and the revenue will be tax free except for the interest on the note.

I would not bother consider selling to tenants unless they qualified for the entire purchase with bank financing. You are basically trying to finance a deal that is destined to fail. You are not doing your tenants any favours getting them farther into debt than they can afford. 

You could do the lease option and then when they default you would have their deposit but that is not exactly honest.

Do not do it, it is a recipe for failure.

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