First-time deal between my father and I; How do we set this up?

30 Replies

My dad flipped a house that I would like to buy. He is willing to sell it to me at cost. I've been putting away about $500 a month to save for a down payment on my first investment property. Because he owns it free and clear, I'd like to set up an agreement where I pay him a small down payment, find a tenant, rent it out, and use the rental income + my current $500/savings (less a percentage for repairs/maintenace) to pay it off. I'd have it paid off way quicker than I would if I were to get a mortgage. I don't have the terminology for what we're trying to do. Would this be considered a land contract? 

He and I have only briefly discussed this idea. We need to run the numbers and meet with an attorney and an accountant regarding the contract and taxes. But we already have a potential tenant lined up who would eventually like to buy the house after renting for 2 years so we avoid the capital gains tax. 

My brain feels so scattered that I know this post will be as well. I guess the first thing I need to know is how to structure this deal so that the title and income are put in my name now allowing the 2 year clock to start ticking. 

Is there anything I'm overlooking? Is there a better way to structure this arrangement that we may be overlooking? This is a first-time thing for both my father and me, and it's very exciting!

TIA!

I suggest you put your father on the hook to co-own the property initially. That way he is still more willing to coach you until you are financially and emotionally ready to take over.  This can be a written signed note notarized that you agree to pay $500 per month or more until some point you want to buy him out.  In our area it can be a matter putting both on a Grant Deed go to court house or have a title company record for you. A note is where you specify the terms, loan amount etc.  

Seller finance is what you are looking for.

Transfer the title to your name with the agreed purchase price between you and your dad. Your dad will act as the bank.

Find an attorney to draft it up. 

You in turn will find a tenant and give the option to purchase after 2 years. Tenant pays you the purchase price, you pay the remaining principal to your dad. You keep the gain.

I agree with Simon. The easiest way to proceed is to treat this like an owner financed deal. Your father sells you the property and finances the deal. At that point you can do what you like with the property. You can rent it out, sell it, keep it, etc. I would caution you to be smart about what you do, your father might have different ideas about what he thinks you are going to do with the property, and he might take offense to you selling it after 2 years if he is selling it to you at cost. Make sure you are up front and transparent with him from the very beginning. You wouldn't want to jeopardize your relationship with your father over a miscommunication.

I also recommend speaking with your tax professional if you are concerned about capital gains. There are options available to help avoid paying capital gains.

@Sam Shueh if we both owned the house, who claims the rental income? For tax purposes, I don't want him to have to report income that isn't technically his. 

@Simon W. Thanks for spelling that out for me. Seeing it written it in simpler terms makes this feel much less overwhelming, and I feel that I can now better iterate what I'm trying to do. 

@Nicole Heasley - you can do it another way, put this property under an LLC, create an operating agreement to show ownership of the LLC between you and your dad. You can make it that you own 98-99% and your dad will not be accepting any rental income. Also state that if the property is sold, your dad will get either a flat number or % of the sale price.

Operating agreement can be anything to be honest. I would consult with an attorney though.

Update: forgot to mention that in the Operating Agreement you can state how much you paying your dad to buy out his equity from the LLC, that is if your dad wants you to pay him monthly.

@Chris StPeter He already knows my intentions to rent out and then sell the house. He obviously wanted to sell it and make a little money, but as this is his first flip, it hasn't gone as smoothly as we'd hoped, and now we're looking at potentially losing money. He's been wanting me to buy it from the beginning with the intent to keep it as a long-term rental or sell it for the appreciation, but I didn't have the 20% down payment, and he wanted his entire investment back ASAP, which would have required me to find some sort of financing. Now he's becoming more comfortable with the idea of making it back slowly over time, which gives me more options to take it over. 

Have you looked into hard money lenders? you may be able to explain the situation to a hard money lender and get one to help you.

@Chris StPeter I haven't, but wouldn't that cost me more in the long run because of interest? If I work this out solely between my father and myself, I'm looking at an interest-free payment plan. 

The benefit is to put the house in a safety net to protect you and your dad's personal assets if you are renting it out. 

Most people who start out can't put their investment property under an LLC since they have a personal mortgage on them. You have the advantage.

Plus having both you and your dad's names on the title instead of an LLC might lead to the IRS audit (even though I'm pretty sure it will be nothing, but it's just a hassle).

Again, consult with CPA and Attorney for the best setup. At least you can throw some suggestions to them now and see what they think.

Btw, I am not a CPA. I actually started out as a Property Accountant like you.

if you don't mind me asking, what is the cost of the property? This will determine if Hard Money is a good idea or not.

That's correct, you would benefit, but your father wouldn't. I'm sure he isn't flipping this house so he can take a loss. If you were to talk with a hard money lender, you might be able to get your 20% down payment covered, then finance the rest of the purchase with a traditional mortgage, and then sell the property to make a profit. Then everybody wins, your father doesn't have to take a loss and he gets his investment back, you get the property without having to worry about making payments to your father, and when you sell it, you get to make some money. 

I'm just trying to offer you some alternative ideas, since that is what you asked for in the original post.

@Chris StPeter I most definitely appreciate all suggestions; even if they don't work for my situation, it's still good knowledge to have. No, he does not want to take a loss. At this point, he's just trying to break even. I'd love to talk to a hard money lender simply to learn more about it. 

@Simon W. I believe we're at about $45 or $46k (we're in NE Ohio where you can buy decent houses for $50-$60k). Here's the Zillow listing: https://www.zillow.com/homedetails/230-Maplewood-A...

One thing where caution is advised is the issue of liability. Your father may not be exposed to liability as much as you are, whether that be in driving, in your work arena or even in your marital status for that fact. People get sued every day even by family. It's always better to put everything in writing and treat every transaction as a business. And remember, there's no way around capital gains taxes. Either short term or long term, someone is going to pay! The best you can hope to accomplish is "how much do you pay?"

@Todd White - I got a notification saying you responded to my post, but I can't see anything. 

Then I'm thinking if you can't see it, it's because I'm new to this thread and my post response needs to be validated by admin.

@Todd White It's showing up now! We plan to have a contract written up with an attorney. 

@Nicole Heasley here's another possibility: put it in LLC, get refi for 70% of the value. Give the refi money to your dad as partial payment and you slowly pay him back the remaining cost

To make things easier: say the value is $50k

You refi at 70% which makes it $35K loan (get business loan under LLC, not your personal name)

You will owe the remaining cost to your dad.

You will slowly pay him back with the rent and your current $500/savings.

Just an idea.

So your dad will pay capitol gains if he sells to you if he's owned less than 2 years.. but on a 50K house it's not a huge amount..compared to a 350K house. 

You'll owe capitol gains also if you sell before 2 years.. everyone is afraid of paying capitol gains.. but in reality it's a cost of holding a property less than the required 2 years.. a cost a flipper adds in to the sale of the house. 

I would buy this house from your dad on a long term contract for deed.. with a monthly payment of 1/2 the rent you'll be getting, and a balloon payment at the end if you can make those arrangements then fine if not don't. It's gotta be good financial plan for you both. 

You may not want to sell after the house is rented gaining income and equity you could use to leverage another purchase. 

If it doesn't work out don't worry maybe selling this outright is best thing for your dad right now.. you can always do another deal down the road.. 

Originally posted by @Deanna McCormick :

So your dad will pay capitol gains if he sells to you if he's owned less than 2 years.. but on a 50K house it's not a huge amount..compared to a 350K house. 

You'll owe capitol gains also if you sell before 2 years.. everyone is afraid of paying capitol gains.. but in reality it's a cost of holding a property less than the required 2 years.. a cost a flipper adds in to the sale of the house. 

I would buy this house from your dad on a long term contract for deed.. with a monthly payment of 1/2 the rent you'll be getting, and a balloon payment at the end if you can make those arrangements then fine if not don't. It's gotta be good financial plan for you both. 

You may not want to sell after the house is rented gaining income and equity you could use to leverage another purchase. 

If it doesn't work out don't worry maybe selling this outright is best thing for your dad right now.. you can always do another deal down the road.. 

If her dad sells it to her at cost, there shouldn't be any capital gain to get taxed on, right? It seems like Nicole is trying to take the burden off since he needs it for retirement. Then again, $50k house is not a huge amount.

@Nicole Heasley

I am a little bit wary since this transaction is done between family member.

1) If you guys decide to go the seller financing route; you guys should pick an appropriate interest rate and not 0%.
Your father should then pick up interest income from the seller-financing note.

If the note calls for 0% interest - the IRS can calculate "imputed interest" onto your dad's income.

A workaround this is for your father to gift you $14,000(annual gift exclusion for 2017) and use that to pay off the seller financing and you pay him back after all is said and done.

It should also be noted that if he sells you the property at a loss - he can't take the loss on his return.(i know you said he is selling it at cost). this is again a IRS rule related to family transactions.

Basit Siddiqi, CPA

    Originally posted by @Basit Siddiqi :

    @Nicole Heasley

    I am a little bit wary since this transaction is done between family member.

    1) If you guys decide to go the seller financing route; you guys should pick an appropriate interest rate and not 0%.
    Your father should then pick up interest income from the seller-financing note.

    If the note calls for 0% interest - the IRS can calculate "imputed interest" onto your dad's income.

    A workaround this is for your father to gift you $14,000(annual gift exclusion for 2017) and use that to pay off the seller financing and you pay him back after all is said and done.

    It should also be noted that if he sells you the property at a loss - he can't take the loss on his return.(i know you said he is selling it at cost). this is again a IRS rule related to family transactions.

    In this case, would the LLC make sense for them?

    @Nicole Heasley , ....I think you need to rethink/research the capital gains issue.

    If you live in the house 2 years as your primary residence, the capital gain is tax free ($250k per person, $500k for a couple). If it's a rental, the 2 years doesn't apply on investment property.

    If you sell in less than 1 year, the gain is taxed at ordinary income rates. If you held it for a year or more, it's long-term capital gains.

    You say "hold this house for a long-term rental" and then you say "rent to own in 2 years" for your newly found tenant????). Since there is no tax 'trigger' at 2 years, why 2 years? Maybe sell after 1 year?

    Why not keep a good rental for 30 years??? You might have a BRRRR rental on your hands.

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