What benefits are there for Seller on seller financing?
Rental Property Investor · Bellingham, WA · Member since 2018 · 17 posts · 4 votes
So I recently reached out to a laundry mat because I heard they might want to sell. I’m more interested in the real estate it sits on primarily because it has corner building that I could open up another coffee shop. My wife and I currently own 3 coffee drive thrus but 2 are on leased land, my 3rd is An owner contract.
The older lady who owned the laundry mat called me back and said they just want to sell the laundry mat business and not the property. But then she went on to express they actually do want to sell the property but they don’t want to because of capital gains. I didn’t have an answer for her about that but this Covid time has left me time to catch up on dozens and dozens of podcasts and I keep hearing how seller financing can actually help the seller because it alleviates or defers or some of the capital gains. Can anyone help me understand the way that works so I can approach them again with a clear way to help them out and hopefully help myself in the process.
Thanks
@Jeremy Hawkinson yes, the seller financing doesn't eliminate any capital gains tax at all. It simply defers the capital gains payments over the life of the seller financed structure.
The capital gains percentage is not determined buy how much gain is collected, it is determined based on how much the owners earn as earned income in the form of adjusted gross income. So if their is adjusted gross income put's them in the 20% tax bracket for long term capital gains, then that is how much they would pay on their net gain compared to their original basis in the property (how much they paid for the property originally).
Check out bank rate for examples of this:
https://www.bankrate.com/investing/long-term-capital-gains-tax/
Keep in mind, this isn't the only capital gains they would pay, the tax code also permits a gain on recapture tax which is a flat 25% rate regardless of anyone income earned. This 25% rate is paid on all of the depreciation the owners took on the property since they owned it.
For example, Let's say for simplicity purposes, they purchased the property for $100,000 30 years ago and they are selling it today for $200,000. They would pay 20% on the difference between the two ($200,000 - $100,000 = $100,000 long term gain on appreciation X 20% = $20,000 tax on appreciation) assuming they are in the 20% tax bracket. Let's also say that since the owned the property for 30 years they fully depreciated the property from $100,000 to $0. They would pay the 25% on depreciation as well ($100,000 - $0.00 = $100,000 gain from depreciation X 25% = $25,000 tax on depreciation). Therefor their total capital gains tax would be $45,000 ($20,000 + $25,000 = $45,000). This however, does not include any net investment tax (typically 3.8% if they meet an income threshold) and state capital gain tax (varies by state).
In the case of seller financing, they would owe the $45,000 over the course of how long you amortize the seller financing terms.To keep it simple, if you amortize the $200,000 over 10 years without interest (again for simplicity) then you would pay them $20,000 every year and they would pay $4,500 in capital gain every year ($45,000/10 years = $4,500). Keep in mind, they would also pay taxes on any interest they collect as well.
Hope this helps.
James Storey, CCIM
Seller financing will help alleviate the capital gain burden by not making it due all up front in the tax year the property is sold. As an installment sale, as seller financing is considered, the capital gains will be due over the amount of years the property is paid back in the financing structure. I.e. a little bit at a time relative to the amount of the payments.
In the end, seller financing simply defers the capital gain payments in increments over many years instead of all at once.
James Storey, CCIM
If they generally speaking have enough cash and income to live off of, but they don't want to run the business any more, I'm speculating they are getting in their later years and just aren't up for the business aspect any more. They would like to see if they can cash that in. Why not as opposed to just closing shop. No capital gains tax there as far as I know, just other taxes. Now for the property... if they are old, they may be looking to pass it on to their kids. When they pass away, if the property isn't worth millions of dollars, the kids will get it completely tax free and they can sell it if they like with no capital gains tax.. Hard to come in and compete with that aspect.
So I recently reached out to a laundry mat because I heard they might want to sell. I’m more interested in the real estate it sits on primarily because it has corner building that I could open up another coffee shop. My wife and I currently own 3 coffee drive thrus but 2 are on leased land, my 3rd is An owner contract.
The older lady who owned the laundry mat called me back and said they just want to sell the laundry mat business and not the property. But then she went on to express they actually do want to sell the property but they don’t want to because of capital gains. I didn’t have an answer for her about that but this Covid time has left me time to catch up on dozens and dozens of podcasts and I keep hearing how seller financing can actually help the seller because it alleviates or defers or some of the capital gains. Can anyone help me understand the way that works so I can approach them again with a clear way to help them out and hopefully help myself in the process.
Thanks
There are two aspects: 1. She is tired of running the laundry mat. 2: She doesn't want capital gains by selling.
Your offer should be to either do seller financing for a monthly amount that suits both of you and a term that is longer than their expected lifetime.
Or, you could do a renewable lease option, which allows for you to exercise the option upon her death at which time her heirs will inherit the property tax free and you can pay them the option amount.
They make more money than if they relied on the Buyer getting the financing since the seller will now get all the interest on the financing in addition to the principle.
They should also save more money in taxes due to the seller financing income coming in instalments.
What about a 1031 exchange? They can take gain and roll it into a triple net investment for the same type of annual cash from from installment sale and exit their old business cleanly.
@Ronald Rohde. I think that’s a great idea if they’re looking to invest their money again. ButI’m not sure that these people are Investors per se. At least from my initial conversation they are not looking to pull money out so they can invest in something else. I think they happen to buy a nice piece of property 30 years ago, And now they are looking to cash out. 
So if I’m understanding the rest of you correctly it sounds like it does not eliminate any taxes, just spreads them out over a li my we period of time vs all at once. Does that sound about right? Or are they actually taxed less because the percentage of tax taken out on a smaller amount is less than a larger amount? (For example...keep numbers simple and just spit balling here, if they have capital gains of 100k maybe they get taxed at 20% so they owe 20k. Where as if they owner finance and collect 20k per year for 5 years at 10%, they would only pay 10k). All numbers used for example only...I have no idea what taxes are.
@Jeremy Hawkinson yes, the seller financing doesn't eliminate any capital gains tax at all. It simply defers the capital gains payments over the life of the seller financed structure.
The capital gains percentage is not determined buy how much gain is collected, it is determined based on how much the owners earn as earned income in the form of adjusted gross income. So if their is adjusted gross income put's them in the 20% tax bracket for long term capital gains, then that is how much they would pay on their net gain compared to their original basis in the property (how much they paid for the property originally).
Check out bank rate for examples of this:
https://www.bankrate.com/investing/long-term-capital-gains-tax/
Keep in mind, this isn't the only capital gains they would pay, the tax code also permits a gain on recapture tax which is a flat 25% rate regardless of anyone income earned. This 25% rate is paid on all of the depreciation the owners took on the property since they owned it.
For example, Let's say for simplicity purposes, they purchased the property for $100,000 30 years ago and they are selling it today for $200,000. They would pay 20% on the difference between the two ($200,000 - $100,000 = $100,000 long term gain on appreciation X 20% = $20,000 tax on appreciation) assuming they are in the 20% tax bracket. Let's also say that since the owned the property for 30 years they fully depreciated the property from $100,000 to $0. They would pay the 25% on depreciation as well ($100,000 - $0.00 = $100,000 gain from depreciation X 25% = $25,000 tax on depreciation). Therefor their total capital gains tax would be $45,000 ($20,000 + $25,000 = $45,000). This however, does not include any net investment tax (typically 3.8% if they meet an income threshold) and state capital gain tax (varies by state).
In the case of seller financing, they would owe the $45,000 over the course of how long you amortize the seller financing terms.To keep it simple, if you amortize the $200,000 over 10 years without interest (again for simplicity) then you would pay them $20,000 every year and they would pay $4,500 in capital gain every year ($45,000/10 years = $4,500). Keep in mind, they would also pay taxes on any interest they collect as well.
Hope this helps.
James Storey, CCIM
Yes depreciation recaptured gain on Section 1250 is limited to depreciation above the MCRS straight line method and is taxed as ordinary income. On the other hand unrecaptured gain (in this seller finance example) on section 1250 permits a maximum 25% tax on depreciation taken on the life of the property. This article has a good explanation in more detail.
https://www.taxcpe.com/blogs/news/recaptured-and-unrecaptured-real-estate-rental-section-1250-gain
It might be just be a knee jerk reaction by them (no one "Wants To" pay tax), and with the ever changing tax code, their viewpoint might be based on the 1976 IRS code, or something one of them picked up in 1973 watching Louis Rukeyser.
Knowing the current Capital Gains Code and how it works as well as OWC payments (loophole others have mentioned above) might help you convince them sell.
In a nutshell, it might be easy to change their mind (IF) you yourself understand the realities of it, and then have them run it by their CPA to make sure it's what they want.
If "The CPA Realities of it" are not what they want--they will probably not budge (at this time), although an option to purchase might not be out of the question (for a kicker fee of X$), if that's what you want.
Louis Rukeyser 1973: https://www.youtube.com/watch?v=9_5jPv6dL58
Good Luck!
Oh thanks. So, there recaptured depreciation and UNrecaptured depreciation. Hmmm. Thanks so much
@Ronald Rohde. I think that’s a great idea if they’re looking to invest their money again. ButI’m not sure that these people are Investors per se. At least from my initial conversation they are not looking to pull money out so they can invest in something else. I think they happen to buy a nice piece of property 30 years ago, And now they are looking to cash out. 
Then they have to pay tax. Tell them its an honor to pay taxes, shows they made a lot of gain! If they don't maintain it, that business will crumble...Interest rates are at all time low pushing asset prices to all time high, they won't sell for such a good price again...
@Jeremy Hawkinson Have you asked what their goals are with the proceeds? That has always helped me guide the seller-financing offers. Helps humanize what they are looking for to see if you can find a win-win.
@Zach Quick I have not. The original conversation what about selling the business only. I didn’t really see any way around it that they would want to sell real estate. But as I’m listening to podcasts and remembering our conversation, I was hoping to reach out to them again with a little more insight it to How I may be able to help them.