Here’s the Perfect Solution If You Want to Sell Your Investment Property and Avoid the Bank

Have you ever thought about selling or buying an investment property, but you didn’t have all your ducks in a row?

Let’s say you had bad credit at the moment, but you had the cash. Or what if the housing market was too volatile (like it is right now) and getting rid of the property would mean you got stuck with a large tax bill?

This would make it more difficult for the average investor to secure larger loans.

Thank goodness there is a little known option that could help close the gap. And it means skipping the bank altogether.

Here’s what you need to know about selling or buying real estate with a purchase money mortgage.

What is a purchase money mortgage and how does it work?

What is the difference between a purchase money mortgage and a conventional mortgage? And how does it affect your ability to sell your investment property?

A purchase money mortgage is a type of mortgage where the seller provides funds directly to the buyer at closing. This allows buyers to get financing for their down payment and closing costs without having to rely on a bank loan.

This mortgage has become increasingly popular because it eliminates the need for a bank loan. In addition, purchase money mortgages can offer borrowers lower interest rates and fees. They also allow buyers to skip the bank application process and save time.

So what are some ways to sell or buy an investment property without all your ducks in a row?

When you buy a property, you usually borrow money from a bank or other lender. This is called a conventional mortgage. If you want to sell your property, you’ll likely need to pay off the mortgage before selling. In order to get rid of the house, you’ll also need to pay back the bank.

With a purchase money mortgage, there are two main options for selling a piece of real estate. One way is to sell the property directly to another person (i.e. a private sale), and the other way is to sell the property through a real estate agent (i.e. a public sale). Each has its pros and cons. For example, a private sale might be easier to complete, but it won’t bring in as much cash as a public sale.

Purchase money mortgage pros and cons for sellers and buyers

Now let’s explore the benefits of a purchase money mortgage to both the seller and the buyer.

For the seller, these are some of the benefits.

1. The seller can get a higher sales price. By offering financing, the seller may make it easier for a buyer to qualify for the financing – thus creating a bigger pool of buyers. More buyers increases the demand for the property, which ultimately leads to a higher sales price.
2. The seller can defer their tax liability. By financing, the seller can design when they want to receive their profits by spreading their gains over a number of years. This would spread out when their capital gain taxes would be due.
3. The seller gets to receive interest payments on their note. That is money over and above the contracted sales price. The purchase money note, secured by real estate, can receive a rate of return higher than if the funds were sitting in a Certificate of Deposit or Treasury note.

For the buyer, these are some of the benefits.

1. A buyer can get into a property with a lower down payment. Lowering the down payment allows an investor to use more funds towards improving the property, thus increasing the value of the asset. This will put a new owner in a better equity position.
2. The underwriting for a buyer may be more straightforward for an installment sale compared to conventional financing.
3. The buyer can help structure the payments allowing the buyer more flexibility. They can arrange payments to help extend or payoff the debt.

An example of an installment sale…

A seller wants to sale his 10 unit building for $2 million. The seller owes $150,000 on the property, which he purchased 15 years ago for $400,000. In calculating the capital gain after an All Cash sale of $2 million, you would have to recapture any depreciation (taken annually over the years of ownership) and subtract out the cost of sale and the cost basis (cost of the property plus any improvements). Let us just say that is about $560,000—meaning your taxable capital gain would be around $1.59 million. You could owe a combined tax to the federal government and the state of up to 32% (20% Federal and 13% California) or $508,800.

If the seller sold this same property for $2 million using the installment sale method, the seller could have received, say, $500,000 up front as a down payment, and create a purchase money note for $1.5 million to be paid over 10 years. Assuming all the same numbers in the first example, the seller would only owe capital gain taxes for the money received in the year of the sale plus the recapture of any depreciation less the cost basis. The 32% combined federal and state tax in the year of the sale would only apply to about $365,932, which equals about $117,098. The seller would then receive annual cash payments of principle and interest of $85,932. You would be responsible for paying your ordinary taxes on the interest payments and a capital gain tax on any principle you received.

By using the purchase money mortgage with the installment sale, the seller was able to defer his tax liability over 10 years and received an interest payment until the note is paid. Depending on how you arranged your future payments would determine if the installment sale has a balloon payment or are level during the term of the loan. At the Brokers Tolbert & Associates, we can assist you with that.

This is just an example and your tax situation may differ. Either way, if you’re interested in using a purchase money mortgage to sell or buy your next investment property, we can work with you and your tax professional on how this type of Installment sale would affect your situation.