Master Lease Option Apartment Building Purchase

30 Replies

Hi everyone, I am looking to purchase an apartment building and after much searching I have come across one in which the owner is willing to do a Master Lease Option on. Here are the terms: 

  1. Purchase price: $335,000
  2. Down payment: $70K
  3. Amortized over: Over 30 years at 5%
  4. Balloon payment in: 7 years
  5. Option to by at any time through out the 7 years. 

My question has to do with the terms, do these seem like good terms for an MLO? - The Seller wanted to sell but after finding out that they would get a huge tax bill is now willing to do a MLO but they also need a big cash infusion. Is there any thing here were I could possibly get better terms or are these already decent terms? 

Also, does anyone have any points for the Master Lease Option, my main concern has to do with the amount of money down and my exit strategy. 

No need to do a MLO. Keep the same terms in place and take title. The seller is still participating in the financing and deferring capital gains. Your job then is to perform and give the seller great service so that they won’t want the balloon in seven years.

@Neal Collins thank you for your input Neal. I don't the Seller wants to sell anymore due the increased tax liability on his part. Are you saying that if he offers owner financing (which I believe he is willing to do) he would be able to defer capital gains? How much better is that compared to a MLO in regards to taxes on the Seller's part?


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@Alex R. The seller has basically spelled out Seller Financing terms already. Taxable events are triggered when the seller receives profit from the sale. Without getting overly complicated on several different fronts, even if the seller was entering into a MLO with a downpayment, the IRS would treat that as an installment sale and if the $70k downpayment represented profit above their basis, then they would trigger a taxable event upon the receipt of the money.

If their motivation is more on the tax side of the equation, I would keep the conversation going in the same direction with the terms they have outlayed with the only difference being you take title when you give the downpayment. The rest of their equity is secured by a first position Trust Deed or mortgage on the property with monthly payments made. If they want to completely defer capital gains then they can receive interest only payments without having the loan amortize, or conversely, if they want a higher monthly payment and to spread the capital gains taxes out over many years they can amortize the loan. 

@Alex R. You already have the means to do this without the seller. Just go to a Mortgage Broker. 20% down is $67k. Then you will get 30year loan with no ballon. Also, the loan company doesn’t use your income, they use the income from the property.

@Alex R mention 1031 exchange to the current owner. Go with the financing option @Robert Herrera mentioned and have the owner find another property he can 1031 into. Depending on size of property the owner 1031's into, he may be able to avoid capital gains taxes completely and improve his cash flow as well. 

@Robert Herrera do you know of a mortgage broker that can do 20% down for a 30 year on a multi-unit apartment? Would it be possible to get their contact info. Most of what I come across is 25% down on a 20-25year AM with a 5 year balloon. 

@Alex R. I don’t know Brokers in your area but a quick google search of Mortgage Brokers should get results. How are you supposed to finance out on a ballon payment if no one will do a fully amortized loan? Just keep searching.

@Robert Herrera The seller wants to avoid capital gains and depreciation recapture taxes.  They are not going to sell if Alex comes to the table with the full purchase price.  And most commercial apartment loans are not fixed for 30 are thinking about residential financing.

@Neal Collins is spot on.  Find out the down payment the seller needs and then get them to seller finance the rest.  The seller will have to recognize a portion of the capital gain and depreciation recapture but it will be proportional to the down payment instead of the gain and recapture on the full sales price.

If you can help the seller understand this opportunity, you will have an advantage over other buyers.  If I am in the seller's shoes, I'd want to control your ability to pre-pay the loan so you don't pre-pay and then I get hit with the tax bill but that is getting granular and can be worked out in the note agreement.

@Mike Dymski  thank you for your input. That's right on, the Seller does not want to pay capital gains and recapture taxes but does need funds for other projects. The Seller wants as close to 20% down as possible and my thought was sure, since the bank will make me do 25% down, so that's a win there. Additionally, I could work it so it's on a 30 year AM at 5%  with a 7 year balloon which the Seller is fine with, which is better than the bank's 20-25 year AM @ 5%+ with 5 year balloon, a win here as well. 

The Seller's side came up with the MLO as a strategy to avoid capital gains, so essentially my same terms on a MLO which I am not particularly fond of since 20% is a big chunk for an MLO which put me at risk of loosing it if I don't exercise my option but, I'm fine with it on a purchase because of the terms. Because of this, I'd rather do Seller financing in which from what you are saying the Seller would not be hit with capital gains in one lump sum but rather over a period of time, which is the same as an MLO in that aspect but, better in that the property is mine. 

Mike and everyone else, what are your thoughts about my terms -  20% down on 30 year AM @5% with a 7 year balloon? ------ My strategy is to of course increase income, decrease expenses and refinance or sell within 2-3 years. ---- But just for security, Should I try to do away with the balloon? or ask for an extension option beyond the 7 years? or do you think a 7 balloon is fine. What have you guys seen that works? Do I have it backwards would an MLO be the way to go?

Any input would be awesome. 


Your terms look very good and I agree with your reasons for using seller financing over the MLO.

@Alex R. I can't say it enough....You have the terms for private financing laid out. There is no need to go with an MLO. Listen to @Mike Dymski as well. The other posters advising you to go with conventional loans do not understand the power of seller financing. It is so much more than interest rate, points, term and LTV. It will be THE BEST source of private money in your real estate business. Build up your track record and deliver service to your lender and they won't want a balloon payment in 7 years. Where else are they going to defer capital gains and get a 5% return with their money secured by a 1st position lien on a piece of real estate that they have owned? Show them that you have the ability to perform and you'll never even need to cash them out, even when you go to sell this property and buy another one.

@Neal Collins and @Mike Dymski ..... thanks guys, your input really helped me out. It's always nice to hear different points of view and really helps to calm the nerves. I agree with you both and will put the Seller financing in play, I'll let you know if it works out. Thanks again.

The seller will need to talk to a 1031 Exchange Accommodator even with seller financing.  You’ll want to make sure he/she does that so your desk doesn’t blow up.  I can give some recommendations if you put him in touch with me.  Good luck!

@Karen T. Can you expound on this please? There is no reason the seller would need to talk with a 1031 Exchange Accommodator except in the event that the Seller wanted to exchange into another property.

He stated the seller doesn’t want to pay capital gains taxes.  The only way to defer capital gains tax is by doing a 1031 exchange, which he can in a seller financed deal.  The seller should be speaking with his 1031 QI.  If he realizes his tax liability on the seller financed deal he could pull out of the deal.  Just because he holds the note doesn't mean anything changes on his tax on his gain, it is just handled differently.    

@Karen T. It looks like you have a background in 1031 exchanges, but I don't think we're looking at this thing in exactly the same way.

The statement "The only way to defer capital gains tax is by doing a 1031 exchange..." is entirely not true. The only way the seller will avoid depreciation recapture is by a 1031 exchange, but doing a seller financed transaction without a 1031 exchange will most definitely defer capital gains taxes as long as the seller is not receiving the principal amount back that is subject to capital gains taxes.

We work day in and day out with sellers that seek out seller financing as a means to defer capital gains and receive secure monthly income. Hardly any have participated in the financing and done a 1031 exchange simply because they do not want to buy more property, not to mention that it becomes messier due to the Qualified Intermediary needing liquid funds to close the new purchase. 

This thread is very interesting and I just wanted to jump in since I am formulating a strategy to buy fully depreciated free and clear properties from retiring landlords and thought the OP could use this as well. Formulating a marketing message for these owners that addresses capital gains and depreciation recapture was the trickiest part. From my elementary knowledge of tax law I found that the IRS can determine a MLO to be an installment sale if the terms look like an installment sale, aka there is a large down payment and combination of the lease and option equal the fair market value. A true MLO won't kick off capital gains nor depreciation recapture since it is not a sale. My strategy currently is to use a minimal down MLO where I pay all MLO closing costs and make the term of the MLO enough to cover depreciation recapture plus a bit extra (3-5 years) Then the option would be a Seller-carry deal that is 100% financed except closing costs. This means that the seller would be getting lease payments from me during the MLO in addition to a full priced interest bearing mortgage that they would be able to defer capital gains on. The key for this offer is is that I will be including long prepayment penalty terms for 10+ years so the seller can continue to benefit from deferring capital gains. I know this is not ideal from my end but this is being marketed as a retirement option and I am trying to differentiate myself from the normal investor. I'm not sure if the OP would be interested in this strategy but I wouldn't mind some input from experienced investors.
I apologize for no paragraphs, I wrote it on my phone and it took away my spacing.

Hi @Neal Collins... Once a seller sells a property and does not do a 1031, they lose that opportunity. So yes we are looking at this in different ways. Most Real Estate Investors like to preserve their option to 1031 in the future - time and time again. Then upon their death, they pass their real estate portfolio to their heirs with a step up in basis. My only input on what you state is make sure your clients are aware that while they may be spreading out their tax burden - and you could use the word defer - they are not doing the same thing as what is accomplished with the 1031 exchange strategy. In this situation of this thread, Alex stated his seller didn't want to pay his huge tax bill and therefore offered a MLO.  Alex really has to encourage his seller to be informed about his options - which is talking to a QI about a contract sale with a 1031 and go look for replacement property, or do a MLO.  I could be wrong, but I'm guessing the seller is not going to spread his tax burden out on this one with a contract sale.  It's worth a try for sure however!  

The best scenario would be the seller does a 1031 and buys another real estate investment that meets his needs so Alex can buy this property.  There are ways to do a 1031 with seller financing, I am not a QI so that is better left answered by people like @davidfoster .  There are also many options for replacement properties that I am sure could work for this seller.  

@Karen T. thank you so much for your input. The Seller in this situation is a seasoned real estate investor and as such needs the funds for another project outside of a 1031... so that takes the 1031 off the table for him. Then it just becomes a question of what is the next best option, the seller brought up the idea of an MLO for that purpose however, because of my high down payment I'm not particularly fond of an MLO for this one and after researching a bit and taking input from here, I thought that seller financing and having it taxed as an 'installment sale' might be best. Although maybe not as good as doing a 1031, I figured an installment sale would allow the Seller to spread out the tax burden over many many years, while also keeping my down-payment a bit more secure than that of an MLO.

Yes, it is just up to the seller.  He may not see it the same way that you do .... if he's a seasoned RE investor, he knows how to work the angles.  He offered a MLO for a reason is maybe the point to take away.  Sounds to me like he wants his cake and eat it too :) ... .sell it and get the equity ... but not really sell it.  lol.  Just be careful is my input for whatever it is worth.  

@Karen T. I definitely agree with you. I see it the same way; he would like the equity similar to that of a sale but, not really sell. Although I currently do not have any reservations on his intentions yet, I'm with you --- If I'm putting down 20% why put myself on an MLO; why not just go after the seller financing. With an MLO I have to worry about my performance as well as the Seller's however, with Seller financing I just have to worry about my performance and so I view it as much more secure when this amount of $ is on the line. I agree with you and will tread cautiously through this, but I'm pushing back to get it on Seller financing since it seems to me that the tax benefits between an MLO and 'installment sale' are similar and thus if that is the true reason for the Seller to suggest an MLO then it shouldn't make to much of a difference to him to go with an 'installment sale' instead and address some of my concerns. Your thoughts?

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