Need advice on possibly botched JV

31 Replies

Hi all, I am also new to the forum. Looking for some advice as to how to proceed.

In 2012 I partnered up and bought a triplex to rent . We went 65% for him and 35% for me on the ownership and rent split as I was still young and didn't know any better. We were still living with our folks at the time so our 5 year plan was to live in 2 units and rent out 1 unit until we saved enough to move out and rent all 3 units. 

 Long story short, my wife and I tried to buy a new home but unexpectedly were denied a mortgage approval because although the property was split 65% to 35%, I am still liable for 100% of the loan but only 35% of the rent. What would be the best way to proceed? Sell the property, or keep? What would you do? 

also FYI, We bought the triplex for 780k with 40k down. Recently has been appraised for 1.4m. 

Any insight, would be much appreciated. 

@Wayne Brooks   this sounds like Vancouver or Toronto appreciation.. I am not sure the Canadians have the same tax treatment  they might though.. 

sounds like a great deal for this guy though.. 

Originally posted by @Hai Loc :
@Jay Hinrichs

Capital gains will eat the appreciation alive.. Prices in Toronto certainly doubled since 2012..

In the US if this person owner occupied it 2 of the last 5 years  he could shelter 500k his 35% of  1/3 of the gain 

since its a tri plex and he only lived in one unit..  Cap gain rate when I invested in CA  for me a US citizen was 25% is that still the same rate for a Canadian.. and also do you have the 1031  free exchange method we have in the US .. well not free but you can roll up tax DEFERRED to another property but only the portion that was not owner occupied and it has to be an investment property not a home.  Since there is no tax up to 500k on owner occ anyway.. if that all makes sense.

Yes I do live in toronto. Not 100% sure how capital gains work but @Hai Loc we were looking to buy in the 800k range. By refi the rental and pay cash, do you mean use the equity? 

If I have this right, you invested ~275K (35% of 780K). IF you net out $1.4M on the sale, there is ~ 600K of capital gain which will be taxed 150K (25%) of which you will be responsible for ~50K for a profit of $157K; approaching 60% after tax profit over 6 years.

So, you invested ~$275K and will get out $432K ($275K + $157K); over 50% of your target purchase of $800K. Don't know of a bank that would turn you down on less then 50% LTV on a primary residence. Alternatively, do a 75% LTV (Still a slam dunk) and use the remaining $100K to remodel to your tastes, accelerate retirement savings, do a bit traveling, etc (or any combination).

As always, check with an accountant especially as sounds like your first time dealing with these issues. These are life issues and not stuff you want to make a mistake with.

@Jay Hinrichs - Canada does NOT have an equivalent of a US 1031 exchange (wish we did!). It simply does not exist and you owe taxes in the year that your sell. Hence why Canadians should not do 1031's in the US; Canadian taxes would still have to be paid 'now' and that creates other problems down the road.

Oren

@Edward Rueca Yes no way you can buy $800k house with equity.. You can try going to a mortgage broker who can restructure your current loan with the income property and obtain a new loan for primary residence.. tricky part is you will likely not have a trailing 12 rental history which is what the lender would want to see.. You can ask if a broker can help with that. If not you might have to rent for the meantime to have some rental income history.. But I think you can find a lender out there who can do it but at an interest rate that is not desirable. If you need help I can reach out to a few people..
@Jay Hinrichs In Canada only 50% of your Capital gains will be taxed.. So if your tax rate whether personal or corporate is 40% you will be taxed 20% of the total gain.. We sadly do not have 1031 exchange or a $500,000 blanket for capital gains. My uncle lives in LA and told me about this last month.. There is a fine line between capital gains and business income as a real estate professional licensed and unlicensed in Ontario and if you have a good enough accounting firm backing you, you can get away with business income being taxed vs capital gain on disposal of property.

@Hai Loc Thanks for the prompt responses very informative. If you were in my situation, would you sell? It seems like if we sell, we can afford a principle residence with a basement renter, as well as investing in a separate rental property perhaps somewhere more affordable , think Windsor, London etc. Once I educate myself a bit more, I would like to pursue rental investment properties using Buy and Hold strategy. 

@Edward Rueca Ok I am using hypothetical numbers here. After closing costs you are at $1.3M your debt should be around $700k so you net $600k.. you get 35% which comes out to just over $200k. For argument sake you deduct $50k for capital gains and now you are down to $150k.. this is not 20% down for an $800k home which is what I recommend to avoid CMHC.. What would I do? Pride of ownership is a beautiful thing. You gained huge on this play even after tax. Whatever you choose is not a right or wrong decision.. I would buy a primary residence and this answer is purely based on your situation.. bc I already own my home and have income properties. I don't think your property is in downtown based on the value unless it is a retrofitted triplex from a 2 storey + basement home. The downtown rental market right now is sizzling. The longer millenials cannot afford housing the more heated the rental market will be for years..

I wouldn't call your JV botched necessarily. The fact that you made the move in the first place, got your foot in the door and now you have equity! I would talk to an accountant about the capital gains you may have to pay if you sell. That will help to understand what your next move could be and how much money you'll have to work with. Does your partner want to sell the building or will he buy you out? Are you still living in one of the units? If it were me, I would sell so that I could buy the house with my wife. If you put 20% down, so 160K, you'll probably still have 65K left from the sale of the triplex, by my quick calculations. Then you could use the remaining profit to reinvest in a cooler market where you don't need as much capital. I like the basement suite idea, it works for me and has cut my amortization in half. I have a suite in my primary residence as well as one in a rental house I own.

@Michael Fedun Thanks for the response. My partner also wanted to move at the 5 year mark but was turned down for a mortgage. Yes we are both still living in 2 separate units of the property. I am drifting more towards selling as well but also trying to determine what the pros are for keeping it. Is there a penalty for selling prior to the end of a mortgage term?

@Edward Rueca Yes, there would most likely be a penalty for ending the term early. Lender's can have different policies but it is typical to pay a penalty fee for the remainder of the term. You would find that information in your mortgage documents. Unless you are going to purchase another property at the same time, then depending on the mortgage agreement, you can transfer or also known as porting the mortgage. Porting the mortgage is great because you will continue the term at the same rate, which is probably lower than what the rates are today. Not all lenders allow porting so you'll have to ask or read the mortgage documents. There may also be bridge financing available to you, which allows you to use the current equity in your property as a down payment for the new home. Once the current property sells, the bridge loan is cleared with the proceeds of the sale.

@Oren K. Jay was talking about section 121 which is 250k single / 500k married capital gain exemption if you owned your personal residence 2+ out of 5 years A 1031 is a like in kind tax free exchange of rental property. Two very different things Not sure if Canada has either equivalency

Sell and each do your own thing with the capital. Bravo on that appreciation! I don't think there is 1031 tax deferred exchange in canada but talk to a local tax attorney see what ideas he has. 

@Steve B. In Canada, simply put, you do not have to pay capital gains on the sale of your primary residence. There are stipulations like the time you have lived in the property, etc. Flippers have tried to skirt paying capital gains buy living in the property for a year however, from what I understand, the government is cracking down on that. If the property is not your primary residence then you will have to pay capital gains tax on 50% of the profit, at your personal income tax rate. Example to keep numbers simple: buy at 400k, sell at 600K = 200K gain minus selling cost and maybe rehab cost of 100K = $100k profit, 50K is taxed at say 25% (depending on your personal income tax rate) so you pay 12.5k in taxes and keep 87.5K

Originally posted by @Steve B. :
@Oren K. Jay was talking about section 121 which is 250k single / 500k married capital gain exemption if you owned your personal residence 2+ out of 5 years

A 1031 is a like in kind tax free exchange of rental property. Two very different things

Not sure if Canada has either equivalency

Steve:

Things are a little different in Canada, here you do not pay capital gains on the sale of your primary residence.   In the OPs case, he is using one unit (say 1/3) of the property as his primary residence.   If they were to sell the building, he would not pay capital gains on that portion of the sale.  Similarly, his partner would not pay capital gains on the portion of the building constituting his primary residence.

@Edward Rueca From what I understand, you would pay capital gains on 2/3 of the property since you only live in 1/3. So you would pay capital gains tax on 50% of 2/3 of the profit of 35% of the building. It's getting messy, but I think that's how it would work. Again, better info would come from an accountant. I don't think family is considered.

One further note of caution being the JV arrangement. Whose name is the property in; yours, jointly with his, in a company that both of you pay 'rent' to? Each one may have implications regarding taxes. For example, if it is only in your name, I don't think he can claim it a primary residence.

I will emphasis again that getting advice from the non-professionals on BP is good for education but absolutely NOT a basis to make final decisions. You are dealing with hundreds of thousands of $, so spending a few $ on proper advice on issues that you do not have experience with is well spent.

Oren