Turbo Charging Your Real Estate Acquisitions With Discounted Notes

by | BiggerPockets.com

The following acquisition strategy can be put into play whether you’re a flipper, long term investor, even a spec builder.

Heck, wanna buy the lot on which you’re gonna build your dream home? This will work for ya big time. The first part of the recipe is to own a discounted note, secured by real estate. Seriously though, you can begin by makin’ a deal with a seller before you actually have one. I know, cuz I’ve seen me do it. ๐Ÿ˜‰

The Basics

What you’ll be doin’ is taking advantage of your discount.

Sometimes you’ll get full credit for the note’s balance, sometimes you won’t. But I’ve never been forced to transfer title at my purchase price. I’ve always received more credit for the note than I paid โ€” which is the idea, right? (Captain Obvious rollin’ his eyes.) It sounds a lot more complicated than it is, though tryin’ this using the DIY approach will, in my opinion, end up becoming a life lesson.

Let’s say you own a note with a balance of $100,000 for which you paid $60,000. Using the note as full or partial payment of the purchase price is the goal. Though I’ve known seasoned investors who’ve agreed to take what they had into it, what went unsaid was the years they may’ve held the note making thousands a year in payments. However, most times you’ll be able to get credit exceeding your initial capital output. Make sense?

Related: How To Leverage Credit Cards To Create A Cash Cushion In Real Estate

A Caveat

If you do indeed succeed in buyin’ some real estate using a discounted note, understand there will many times be tax consequences.

For example, if I paid $X for a note and traded it for face value, which was $30,000 over $X, that difference would be subject, at least most of the time, to taxation. Sometimes it would be at ordinary tax rates, but most of the time it would be under the more attractive capital gains rates. There are strategies we can use to either reduce those taxes or avoid them altogether.

A Tax Strategy I’ve Often Used

For example, several times I’ve avoided a taxable event completely by using the note itself as collateral for a new note carried back by the seller.

Related: Key Concepts to Consider When Starting to Invest in Real Estate Notes

The seller does their own due diligence to ensure their own security. This also works in the seller’s favor tax wise. It allows them to claim installment sale treatment to the extent they carried back a note. Many believe when a seller carries back some of the purchase price in the form of a note that it must be secured by the subject property itself.

Wrong installment sale breath. In fact, in my experience it doesn’t hafta be secured at all, though I’ve only been able to execute that once. ๐Ÿ™‚

Simply have the seller carry back all or a portion of the sales price evidenced by a newly created note. That note will then be secured by the secured note you already own.

When the seller’s note is ultimately paid in full, your note is then released as a security instrument, and you still own the note. Nice, eh? In that scenario you either paid no taxes on the payments you received from your discounted notes, or very little. The reason is the offset of interest payments made by you on the seller carry back note. You made use of the principle of hypothecation. ย Make sense?

You can make use of this strategy in many ways, both mechanically and tax wise. The bottom line benefit most of the time is the ability to save cash. Many times the owner of a fixer will prefer getting a note they perceive as a better deal for them down the road, than a lower cash amount now.

Also, older sellers often look at note income very favorably. Transactions for them can be structured such that any tax liabilities can be spread out over several years. This works especially well when, for whatever reason, their primary residence or investment property presents a tax problem by taking any or too much cash in the year of sale. You can be of real benefit and service to them by presenting this option.

In Conclusion

I’ve had a few times when the seller literally couldn’t sell in that year in the traditional way, but loved what their tax accountant had to say about our proposal. In the end, investors with the ability to acquire discounted notes secured by real estate, can create some pretty nice equity positions for themselves if done correctly and with the right professionals advising them.ย 

This doesn’t in any way touch on all the strategies you can implement with discounted notes when investing in real estate. But it’s a dang good start, right?

How didย you begin investing in notes?

Be sure to leave your comments below!

About Author

Jeff Brown

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.


  1. โ€œ When the seller’s note is ultimately paid in full, your note is then released
    as a security instrument, and you still own the note. In that scenario you
    either paid no taxes on the payments you received from your discounted notes,
    or very little. The reason is the offset of interest payments made by you
    on the seller carry back note. โ€œ

    I will have to re-read this twice to fully understanding technique.

    My interest was peak over 10 years ago via a late night guru television show.
    Regard very nice article.

    • That was my take too when I first learned of it, back in the day, Ramon. But once you become comfortable with all the different possibilities, a whole new world opens up. For me it was just short of finding the key to the vault. ๐Ÿ˜‰

  2. Dennis Lanni on

    Jeff the big question/ secret sauce is… where to find the discounted note that really is worth more than the note balance in a normal town (San Diego, Sacramento, not Timbuktu).

  3. Dennis Lanni on

    Sorry about my writing I’m from Texas and I’m dyslexic. The whole strategy begins with purchasing a note for 60 cents on the dollar, easier said than done. Why work when I can just buy notes ๐Ÿ™‚

    • No doubt, Dennis, but here’s the thing. When you’re still working, and retirement is down the road, you don’t need the income. In fact, you’re makin’ enough to have the money to buy notes and real estate. Why not buy both, use them synergistically to make all the good stuff happen sooner, rather than later? Then, when it does happen, you not only have income from real estate AND notes, but you have another page or two of options on your menu.

  4. If you buy, sell, or trade bank notes within an IRA, self-directed IRA, or check book IRA it is not a taxable event until you make distributions. Therefore, if you are buying notes as a long-term investment and have no intentions of receiving income you can utilize the self-directed IRA strategy to avoid a taxable event. In addition, if the IRA is a ROTH then the initial funding cash is taxed, not the dividends. Therefore distributions received at age 59.5 (or five years less in some occasions) are tax free. Keep in mind however, that annual funding limits for a ROTH are much less than a traditional IRA.

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