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Defering Capital Gains

DCapital-Gains-Taxo you remember the old lime-green travel agency at 9661 Las Tunas? You may have known the cute little old couple that ran a travel agency business out of it for 25 years or more.  Now, that building is their pension fund.

One day a few years ago, as we passed it to get our afternoon coffee, we noticed a little handwritten sign on the back door that said: FOR SALE BY OWNER, call John.

My partner needed an art studio, but we knew we would never qualify for a bank loan, but what could we lose?  I picked up the phone and called John.

The first thing I learned is that they insisted on carrying paper.  I couldn’t have enticed them with all cash offer or a juicy bank loan if I’d wanted to.  They wanted to play the role of the juicy banker.

Seller financing, selling on an installment sale basis, was a major part of their retirement plan.  They owned the property free and clear, and they wanted 20% down and would carry at 7.5%, amortized over 30 years, due in 15.

They placed a 25% pre-payment penalty on it for the first 10 years so I couldn’t pay the loan off early, because if they got paid off early, they would have a big capital gains liability, and it would defeat their reason for carrying paper in the first place.

At the time, bank CD’s were paying all of 2-3%, so the strategy made a lot of sense.

Here’s what we ended up with:

Sales price: $370,000
Down payment: $50,000
First note and deed of trust: $320,000
Interest rate: 3.75%, then 7.5%
Term:  amortized over 360, due in 180
Monthly payment:  $1,481.97 (for the first 18 months, $2,206.28 thereafter)

So, they got $50,000 down and now they get $2,206.28 every month. If they’d have sold for all cash, they’d have paid about $70,000 in capital gains, and had $300,000 to stick in a bank CD at 2.5%.  Let’s see:

Principal:         $300,000
Interest rate:        2.5%
Monthly interest:     $625

Instead they only paid about $12,000 in capital gains, had enough money left over from the down payment to pay off the remaining mortgage on their home.

Now, I’ve got the property up for sale.

I’m offering it as a sale-lease-back, because we still need to use the upstairs unit for another couple of years, but I’d like to increase my cash flow from the property.

But remember that pre-payment penalty?  And guess what?  I have no intention of paying capital gains.  So here’s the current description on my listing:

“Owner will carry. No bank financing needed. Beautiful 2-story commercial building in the heart of Temple City. Owner is looking for a sale-lease-back, intending to retain leasehold of the 2nd level for approx 3 years.  Seller must carry, terms flexible.  Open to lease option, contract for deed, or partnership in a title holding (land) trust to preserve existing tax basis and defer capital gains.”

Here’s how the deal could end up looking:

Purchase price:  $947,000
Down payment:  $150,000
Remaining amount (which ‘wraps’ the existing financing): $797,000
Interest rate: 7%
Term:  amortized over 240, due in 60
Monthly payment: $6,179.13

And out of that $150,000 down payment, I won’t pay a lick of capital gains.  That sounds kinda nice.  If you’re a property owner and you think you’re ‘stuck,’ think again.  There are so many ways to achieve the benefits you’re looking for regardless of market conditions.

Always consult with your metabolism, gustatory attorney and/or dietary counselor before visiting Cloverleaf.
Dawn Rickabaugh is a RE broker with expertise in seller financing and RE notes. www.NoteQueen.com; 626.641.3931; dawn@notequeen.com

August 17, 2009

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Dawn Rickabaugh


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