Seller-Financed Note Holder Asking For CASH NOW!

Buying & Selling Real Estate
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Seller-Financed Note Holder Asking For CASH NOW!

Matt InouyePro Member
Investor · Irvine, CA · Member since 2014 · 73 posts · 24 votes

Hey BP Community.

A few months ago (pre-COVID-19) one of my seller-financed note holders approached me and asked if I could accelerate the payoff of the note even though the note/contract still had many years left before being due.  I am wanting to help the guy out... but due to the number of financed properties in my name, I am unable to straight up refinance the note holder out with a Fannie/Freddie loan.

I recall on several podcasts that some buyers have purchase their seller-financed notes at a discount.  However, instead of buying at a discount and incurring a tax liability on the portion of cancelled debt, has anyone done a "price reduction after purchase" to amend their purchase price after the fact.  

From what I can gather, it is allowed by the IRS (publication 4681), but its not a free lunch.  Instead of getting taxed as ordinary income on the cancelled debt, your cost basis on the property is lowered by the amount of debt "forgiven".  It still seems to make sense to do it this way as capital gains are taxed at 15% (vs. 30%+ for ordinary income) and I wont incur the tax liability until property is sold.

I am most concerned on how to actually perform this action and if there are any hidden pitfalls I should consider prior moving forward.  If anyone has ever done this particular type of transaction, I would greatly appreciate the insight.

Thanks in advance for your input and stay safe everyone!

Aloha,

Matthew Inouye

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  • Mitch Messer
    Lender · Playa del Carmen, México · Member since 2014 · 2k+ posts · 1k+ votes
    6y

    Hey @Matt Inouye, it's late in the day (and it has been a long one), so maybe I'm missing a few steps here, but...

    Your note holder has an asset in his possession (your note) that he could choose to sell at any time. There are professional note buyers and brokers out there that purchase this kind of debt all the time.

    You wouldn't be the buyer for this note; you're the payor/maker. You need a third-party note buyer.

    Yes, these note buyers will be looking for a discount, but that's the cost of converting an income stream back into cash ahead of the agreed payment schedule. Your seller should be prepared for that reality.

    So, while you could certainly help by introducing your seller to note buyers, I don't know that there's much more you should be doing in this situation.

    I certainly would not be trying to retroactively adjust the purchase price.

    What am I missing?

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  • Matt InouyePro Member
    OP
    Investor · Irvine, CA · Member since 2014 · 73 posts · 24 votes
    6y

    Hey @Mitch Messer

    Thanks for the response and clarifying questions.  Yes, I am the Payor and yes the note owner has entertained several offers from professional note buyers.  As you had mentioned there is a discount the note buyers expect which the note owner doesn't want to accept at this point (hence his approaching me).

    At this point I am trying go figure out a win-win where he gets more than what note buyers will pay and I get a discount on my unpaid principle owed and a full reconveyance of the property. 

    The piece I am trying to figure out is how to navigate the discount portion of the note which for me as the payor would be treated as cancellation of debt income (which is taxable).

    That's why I am investigating the "price reduction after purchase" method as a means to achieve the win-win without me getting hosed on taxes.

    Any particular reason you personally wouldn't pursue the price reduction path?  Was there a bad experience in the past when you did this or did it create a lot of accounting headaches after the fact?

    Thanks,

    Matt

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  • Mitch Messer
    Lender · Playa del Carmen, México · Member since 2014 · 2k+ posts · 1k+ votes
    6y

    @Matt Inouye It feels like this note holder is trying to turn his problem (not wanting to abide by the agreed-upon terms of the note) into your problem!

    If you're willing to take it on, spending your valuable time and resources to do so, then no worries.

    But, I'm not quite that accommodating, particularly when there's a well-established, viable and superior solution. This is business.

    And I'm also not seeing the win for you here.

    For one thing, if you do this it sets a very dangerous precedent for future deals and other sellers.

    And also, you have to ask yourself whether this is the kind of seller you want to be doing business with. He's basically reneging on the financing.

    Worse still, I'd be shocked if, after this is all over, he'll be the least bit appreciative of the hard work you put in to get it done.

    If the roles were reversed and you needed him to eat 50% of the note value on a short sale, how hard would you expect him to be working to solve your problem?

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