Structuring a deal from family as a owner financing

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Structuring a deal from family as a owner financing

Jacob Scholes
Investor · Hyrum, UT · Member since 2016 · 18 posts · 7 votes

I'm looking into purchasing a duplex from my parents. I had been looking into buying it from them next year on VA loan, and they would do a 1031 exchange to buy a new property..

since we have an uncertain future with interest rates and the election i'd like to purchase sooner.

My parents mentioned we could look into owner financing by doing a cash out refinance and putting my name on the loan and paying them our downpayment separately. We would refinance in the future to get the loan in our name alone.

This would give them more time than allowed if they had to do a 1031 exchange because it has been hard to find deals in utah right now.

Would they have to pay any taxes on the equity they finance out of the deal?

Has anyone else done something similar or can offer any advice?

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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
5y

Hi @Jacob Scholes, 

The sale of the property from your parents to you would be considered a related party transaction.  You would need to hold the property for at least two (2) years in order to allow them to successfully structure a 1031 Exchange transaction.  

You could certainly buy the property from your parents and structure seller financing (seller carry back note).  They would recognize and pay tax on any cash received by them this year.  The rest of the taxable gain would be deferred over the term of the seller carry back note.  There are many ways to structure this so make sure they meet with their tax advisor first.  

This is a pretty common structure for those that do not want to reinvest in other real estate through a 1031 Exchange and do not want to get hit with taxes all in the same year.  It is important for your parents to understand that the sale of the property to you triggers their taxable gain.  The taxable gain is merely being deferred over the term of the seller carry back note.  If they want to indefinitely defer their taxable gain they should look at a 1031 Exchange. 

Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    5y

    Hi @Jacob Scholes, 

    The sale of the property from your parents to you would be considered a related party transaction.  You would need to hold the property for at least two (2) years in order to allow them to successfully structure a 1031 Exchange transaction.  

    You could certainly buy the property from your parents and structure seller financing (seller carry back note).  They would recognize and pay tax on any cash received by them this year.  The rest of the taxable gain would be deferred over the term of the seller carry back note.  There are many ways to structure this so make sure they meet with their tax advisor first.  

    This is a pretty common structure for those that do not want to reinvest in other real estate through a 1031 Exchange and do not want to get hit with taxes all in the same year.  It is important for your parents to understand that the sale of the property to you triggers their taxable gain.  The taxable gain is merely being deferred over the term of the seller carry back note.  If they want to indefinitely defer their taxable gain they should look at a 1031 Exchange. 

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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  • Daniel DietzPro Member
    Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
    5y

    @Bill Exeter thanks for your great explanation as usual :-)

    I wondered if you, or others, could chime in on how 'depreciation recapture' is taxed in a 'seller carry'? I have read conflicting things - both that ALL of that is due at time of sale (or at least on that years taxes), and others say it is spread out proportionally like the capital gains tax as the note is paid off over the years.

    The reason I ask is that I have heard quite a few times where sellers 'were surprised by the taxes due that first year', and in some cases they did not get enough down payment to even cover that.

    Thanks, Dan Dietz

    [email protected]608-524-4899
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  • Jacob Scholes
    OP
    Investor · Hyrum, UT · Member since 2016 · 18 posts · 7 votes
    5y

    Thanks for the reply @Bill Exeter ! I am also interested in @Daniel Dietz question. Also if my parents stayed on as part owners would they be hit with the tax bill or could they wait and do the 1031 exchange when I refinance and finish buying them out?

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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    5y

    Hi @Daniel Dietz, 

    It depends (that is my favorite answer!) on the type of depreciation taken (e.g., straight line, MACRS, ACRS, Double Declining Balance, etc.).  Generally, the accelerated depreciation methods are recaptured in the year of sale and the straight line method is deferred.  There are a lot of moving parts here that can influence the answer, so discussing the issue with tax counsel BEFORE moving forward is critical. 

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    5y

    Hi @Jacob Scholes, 

    Your parents would be treated as selling part of the property and holding part of the property if the sold just a portion of it to you.  This means they would trigger part of their taxable gain.  

    1031 Exchanges are difficult when a seller carry back note is involved.  They can be done, but the note does complicate the 1031 Exchange.  

    It would likely be better to obtain long-term traditional financing today so that you can lock in low borrowing costs and buy out your parents so that they can structure a 1031 Exchange.  

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
    WebsiteView Page
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