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Hi guys, my name is Taylor. I’m new to the group and have found a ton of great information through the forums. I still work a full time job in construction management around DFW Texas and have been learning for the last year and am ready to do my first deal.
I have a question on owner financing.
If a seller who has owned their home for about a year wants to move and build a new home but they sold their home with owner financing for cash flow, how would capital gains tax affect them?
Please let me know, ThanksHi Taylor
Thanks for joining the Community Forum at CashFlowDepot.
To answer your question, if the seller was occupying the house for at least 2 of the last 5 years then they will not owe any taxes on their gain if it is less than $250,000 if it is a single person or less than $500,000 if it is a married couple. This is called IRC 121 (Internal Revenue Code 121).
Some investors use this little tax code in their favor by buying a run down house then moving in while they fix it up. If they live there two years then sell the property all the profit will be TAX FREE! It’s a beautiful thing!
But… what happens if the seller has not owned the home in 2 of the last 5 years or for only 1 year?
This is the perfect opportunity for you to “sell” the owner on leasing the house to you for at least 1-2 years so they qualify for the IRC 121 so they don’t have to pay any capital gains taxes. You could lease the house with the right to sublease it to someone else. Your profit will be the spread between what you collect from your tenant and what you pay the owner (or his mortgage company). You’d also want to get an option for the mortgage balance.
You could even have the seller execute all the documents to sell you the house subject-to the mortgage but have a title company hold them in escrow.
Jackie, Thanks for the reply!
Ok, so the seller’s would get taxed on their gain even with owner financing.
As far as leases go, I didn’t think sandwich leases were allowed in Texas? Is what you’re talking about different? I know some investors set up a lease and an option for the seller’s and then just assign their position to the buyer for a fee rather than sub-leasing.
Let me know if your example is different, Thanks
You can BUY a house with a lease option in Texas.. Then you could rent it out without an option. A sandwich lease is perfectly legal in Texas.
In Texas, the problems come with you lease option the house to your buyer. It is considered an executory contract and has a lot of rules like, the buyers option consideration ( earnest money) cannot be non-refundable and you need to give the buyers the deed to the house within 6 months. Other reporting rules too which all make a lease option in Texas not an attractive thing to do.
Sure there are some ways around it by assigning your position. But if the buyers quit paying the sellers will come after you for putting them in to a bad situation. If the sellers are receiving payments from the buyers but the sellers don’t pay the underlying mortgage payments (assuming there are payments), then the buyers will come after you for putting then in a foreclosure situation even though they paid on time. It is better to stay in the middle to make sure everyone does the right thing.
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