Buying An Expensive House
Posted by: admin, in Buying Houses, Options
On a recent cruise when I was conducting my usual nightly Q/A session, the wife of a retired Air Force Colonel asked me how they could buy a $750,000 home in order to create some tax-free income for themselves by selling it in two years for a profit. She explained that it would be impossible for them to pay even a 10% down payment out of what remained of their savings, and even without borrowing the down payment, would be hard pressed to make payments on the unpaid balance even at today’s relatively low rates. She seemed oblivious to financing and market realities today.
I was sorely tempted to advise her to cut down her lifestyle to match her income, but one look at her long suffering husband told me that she had no intention of doing that. It also became apparent that neither she nor her husband knew very much about real estate or financing. I decided to use this situation as a platform from which I could spin off some ways to resolve the problem. Here they are in abbreviated form:
1. The easiest way to be able to afford an expensive home is to lease/Option it from an owner who no longer needs to occupy it, can’t sell it, and will rent it for a sum far less than the costs of buying it. Ideally, there will be something wrong with the house that makes it difficult to sell; and which can be remedied by the person who leases it with an Option.
What’s interesting about this approach is that the profit on sale of the property could still be tax free under IRC Section 121 for someone who isn’t on title, IF:
(a) The lease was a gross lease which required the occupant to pay all costs that an owner would have to pay including taxes and insurance, and
(b) the option price was far enough below market to remove any doubt that it would be exercised.
Under the IRS’ Doctrine of Substance Over Form, a lease and Option that conveys all the privileges and obligations of ownership is deemed a transfer of title, and as such, the lessee/Optionee has all the benefits of ownership, including the right to sell the house and claim up to $500,000 tax free.
To be continued next time.
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Buying an Expensive House Continued
I’m in the process of explaining how someone with very little to pay down, and not enough income to afford an expensive house can buy one.
Earlier I mentioned that an owner who is motivated by lack of money or by not being able to sell a house because something is wrong with it is already motivated to accept some fairly creative solutions to his problem. Fortunately, many creative solutions benefit both seller and buyer alike, so pick your side and see how everyone makes out on this next solution to the problem.
Let’s deal with using sweat equity to build equity by improving a property. I once bought a small building from a distressed parent who had converted an attractive home into a funky retail store only to have his pampered daughter quit, leaving him with a store that wasn’t quite a house, or a house that wasn’t quite a store. It had been vacant four years when I lease/Optioned it for two years. Instead of giving the owner cash, I gave him a contract which called for me to pay $1000 each month for labor and materials to fix up the house as a viable office building.
How was the owner protected if I didn’t do the work? The work was scheduled to be completed in monthly increments, and my penalty for failing to get it done, and to present bills for labor and materials totaling at least $1000 each month was to give the owner $1000 to be applied against the purchase price only if I exercised my Option to buy. At that time, If I paid him $7200, he agreed to carry back the balance of the property at 8% interest-only.
My schedule called for me to divide the building into three office suites, and to complete the project in three corresponding phases. As soon as I finished the first phase, I rented it for $600 per month and used this money to fix up the next phase. By the time my two years were up, I not only had paid for most of the repairs out of rents, but had also accumulated my $7200 down payment the same way.
Eventually, this office building was completely paid off with rents, and exchanged for a luxury free and clear home on a golf course which I could have moved into, but which I didn’t need by then.
More about this next time.
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Buying an Expensive House Continued
Last time I pointed out one way to buy an expensive home by performing repairs under a lease/Option arrangement. In my illustration I converted a retail space into a small office building, but the concept would work equally well with an expensive house that needs some TLC in order to be marketed or financed.
Now, let’s talk about the owner who is financially distressed and who can no longer afford to make payments on a personally guaranteed loan:
Before proceeding further, the house that you should be looking for is one with a large equity. This could have been created by loan amortization, additions and improvements, or appreciation; but there should be enough to entice you to make an offer that captures some of it.
In the case of financial distress, in order for you to qualify for a tax-free sale, you’ve got to take up residence in the property. That either means the current owner has to vacate, or you’ve got to work out some living arrangement in which both of you share ownership and occupancy. Let’s take these one at a time.
A friend of mine introduced me to this technique by buying half of a very large estate from a distressed heir who needed help with the payments. My friend had a complete servants’ wing of the house to himself with his own parking arrangements, entrances and exits. He was able to lock enough doors to insure his privacy. He bought his half on an Installment Contract which conveyed equitable title to him while the seller retained legal title, and his half of future profits. He could now afford the house since he only had to come up with half of the monthly payments and my friend provided the balance.
Most of the time it won’t make sense to actually move into an expensive house and share quarters with an owner who can’t afford it; but you can still buy half of it and occupy all of it while he retains ownership of his half while occupying separate quarters. This works especially well with someone who is forced to relocate because of personal needs or job requirements, and who doesn’t want to sell at a deeply discounted price.
Oddly enough, Section 121 doesn’t specify that non-related owners who occupy a residence can’t get the benefits of a tax-free sale. It does specify that an owner must have resided in, and owned, a qualifying residence for at least 730 days out of the previous 5 years; but the owner can elect out of installment sale tax treatment on the installment contract and receive all principal payments tax free; then after two years, elect out of the payment for his half when the entrepreneur sells the house. Both would get a lot of tax free cash this way.
I’m going to throw down the gauntlet to all you CPAs out there to come up with an IRC code citation or specific IRS ruling that would not allow this technique.
Stay tuned for some more ideas on buying an expensive house.
http://www.jackmillersblog.com/archives/buying-an-expensive-house-continued#more-93
