Seller reluctant due to gains tax
Hello,
I am trying to purchase a building, but the seller is reluctant because of the tax consequences for him.
We agree that the building is worth about $700,000, and I'd be willing to pay (almost) that. But, he doesn't want to sell because his basis is very low and he'd be hit with a big tax bill.
Can anyone suggest a method to reduce his tax liability or in some other way leave me with control of the bldg? My MO/plan is to hold and develop the property.
Thank you,
Joseph
Although not familiar with it ...I believe he can do a 1031 exchange to ease the taxes he'd be hit with. You maybe able to research 1031 exchanges here on TCI or other sites on the net but it maybe best to speak with an experience 1031 exch. real estate broker.
I hope that helps. [ Edited by Terilyn on Date 05/04/2003 ]
A properly structured 1031 like-kind exchange will defer capital gains taxes indefinitely.
If the seller wants to divest himself of investment property, an installment sale won't reduce the liability, but, it will spread out the tax hit over the life of his owner financed loan.
Quote:josephnyc wrote:
Hello,
I am trying to purchase a building, but the seller is reluctant because of the tax consequences for him.
We agree that the building is worth about $700,000, and I'd be willing to pay (almost) that. But, he doesn't want to sell because his basis is very low and he'd be hit with a big tax bill.
Can anyone suggest a method to reduce his tax liability or in some other way leave me with control of the bldg? My MO/plan is to hold and develop the property.
Thank you,
Joseph
Joseph:
As others have mentioned, a 1031 exchange would allow the seller to rollover his gains into another property tax-deferred. However, he may not be so keen on having to find another property to purchase.
Here is one situation that may work. Have the owner contribute the property to an LLC with you and he as the members of the LLC. You can give him a preferred equity interest that pays X% per year to him for his equity, whereas you get all of the common interests in the LLC (thus giving you all the upward appreciation). The preferred equity interest in the LLC would be similar to preferred stock in a corporation and would look like an installment note, but be treated as equity (not debt) for tax purposes. However, you CANNOT secure the preferred equity interest against the property like you can a mortgage. Otherwise the IRS may treat the transaction as a sale of the building on an installment note (in substance, since they will be disregarding the form of the transaction).
This is more complicated than other types of straight forward transactions. However, it will reduce your risk and may increase your returns. Talk to your attorney about my suggestion and ask him to structure the transaction to avoid: (1) the "disguised sale" partnership tax rules in Internal Revenue Code Section 707, (2) the Substance over Form Doctrine for equity versus debt, (3) the installment sale rules, and (4) the dealer property rules. Trying to explain all the issues involved here would be too complicated and require too great a space for posting.
I have done these deals and other creative structuring methods for my clients. They work if done correctly.
Hope that helps,
Taxjunkie
P.S. Rather than trying to tell the seller how to do my suggestion above, have your attorney draft a proposal for you discussing the transaction and how it can be a win-win deal for both. That will give you some credibility. The seller will likely have his CPA or attorney review your advisors memo. When you start getting advisors involved, your costs go up, but I have found that more sellers are willing to go along with these creative proposals because their advisors have said that it will not be adverse to the seller, which is what you are trying to convince the seller of anyway. (The seller will never believe you saying it will not cause a tax problem, but if his or her tax advisor says your structure works, the seller will listen to their advisor)
Both the seller and I are aware of the possibility of a 1031 exchange, but I would think it best to leave the finding of a replacement investment to the seller and his broker.
The other suggestions about structuring the deal are new to me. I will definetly bring them up with my attorney.
One quick question: Won't something like that make a lending institution stay far away from this deal?
Thanks to everyone for the help!
Joseph
Quote:
On 2003-05-05 05:58, josephnyc wrote:
The other suggestions about structuring the deal are new to me. I will definetly bring them up with my attorney.
One quick question: Won't something like that make a lending institution stay far away from this deal?
Joseph
A: No. The LLC would be getting the loan. Banks are use to entities getting loans for development deals. I have used LLCs many times for my developer clients in similar situations.
Taxjunkie
Wow, that sounds powerful.
I still don't see how it will solve the problems
Owner sells property to LLC that he has preferred shares in but that I have all common shares.
Bank takes mortgage in name of LLC in the amount of $X.
Owner wants $X+$Y, and I'm willing to provide $Y and let him take $X out of LLC in exchange for his shares.
How is this not treated like a sale of his interests, with the capital gains associated with is?
Perhaps my structure is off -- how can the Owner walk away with his money?
Thanks,
Joseph