selling a rental house after 23 years
Elderly friends have sold a house that they have owned for 23 years, not as a primary residence and have depreciated on their income taxes as well. They are not interested in a 1031. What are their choices with the capital gain? If I were to use them as an investor, would that avoid capital gain and how would it need to be done?
IF SO...I purchased property from them 10 years ago on a land contract. I am considering buying another piece of property from them, 
any creative way to incoporate that?
MRIhomes,
Please give us a chronology of events. Did you purchase the property 10 years ago on a land contract, or are you planning to purchase today and back date the contract?
Is the property you "purchased" the same rental property the sellers owned for 23 years? Did they just sell it, or was it sold 10 years ago?[ Edited by DaveT on Date 04/01/2003 ]
This is not the same property.
I have built my home on the property purchased 10 years ago, paying them on a 15 year land contract.
The rental property they have sold now is to their daughter who has now obtained financing from a mortgage company, closing soon. They now will realize the capital gain.
They own another separate piece of vacant property that I would like to buy now.
I was wondering if there was any way of them using their capital gain as an investor to me. (some what as a hard money loan but long term) on my real estate investments.
Far fetched maybe, but wondering if a small amount of the money they loaned me could be used as a down payment toward my purchase of their vacant land.
Sorry about the confusion, I hope this helps.
MRIhomes:
. This will lower your risk, but on liquidation of the project, they get the first dollars out that represent the value of the land that was contributed plus their return. You get all the profit above that amount. That saves you from having to take the risk on a hard money loan, but gives you essentially the same result. That also eliminates your need to come up with a down payment on the land. One word of caution though. You will need to set up the LLC correctly. This is not a "do-it-yourself" LLC project. I would suggest you contact a business/tax attorney that is familiar with drafting more detailed LLC documents with the proper tax provisions to avoid some bad tax consequences if not done properly.
You have asked a couple of different questions, so I will try to answer each separately.
"The rental property they have sold now is to their daughter who has now obtained financing from a mortgage company, closing soon. They now will realize the capital gain."
If they get cash in the deal, they will have to pay capital gains tax on the amount of the gain. Depending on your state tax rates, that means they will net, at most, only 80% of the proceeds they receive. However, they still might be willing to invest with you as a lender.
You might want to suggest to them to talk to their tax advisor to discuss the adverse consequences of Internal Revenue Code Section 1239 before completing the sale. Your facts are not entirely clear whether Section 1239 applies here, but since they are selling to a "related party" and the property will be depreciable to the daughter (I don't think you said whether or not the daughter was going to use the property as an investment property or her residence), their capital gain could be converted into ORDINARY INCOME, meaning the gain will be taxed at rates higher than 20%! (Maybe as high as 38.6%). Most laymen are not aware of this tax consequence, so just bring the issue up and let them discuss it with their tax advisor.
In any case, there is a strategy you could suggest, but it may take some explaining and discussion with their tax advisor. If the daughter formed a LLC with her parents, with the parents contributing the property to the LLC and the daughter refinancing the property in the LLC's name. Now here comes the complicated part. The LLC can use the cash to invest in other properties or lend it to you, but it cannot distribute it to H&W otherwise there will be a "deemed sale." It's called a disguised sale and it triggers a tax as if they sold the property.
After the daughter has been a member in the LLC for at least 7 years, the LLC can distribute her share of the value of the LLC to her as a distribution in kind (i.e., a distribution of the property). That is generally going to be a nontaxable distribution. H&W are left with the LLC with the cash in it. That is the general concept. You will have to work out the economics to fit your situation.
The big advantage here is that the LLC will help H&W in their estate planning and also avoid capital gains on the refinanced cash.
"They own another separate piece of vacant property that I would like to buy now."
What do you plan on doing with the vacant land? Build a house? If so, you may want to enter into an LLC with them and have them contribute the land to the LLC and you contribute your services (building the house). Give them a preferred interest in the LLC so it is treated as equity but looks like a loan (i.e., they get the first 6% cumulative returns as "interest"
Good luck. Let me know how it works out.
Taxjunkie
Thanks for the advise. I will let them know
Quote:Far fetched maybe, but wondering if a small amount of the money they loaned me could be used as a down payment toward my purchase of their vacant land.
This is done all the time. It is called seller financing.