Key Tax Benefits for Your Next Seller Finance Deal

Dan Austin: [0:00] Hey there. Welcome back to another episode of the collecting keys real estate investing podcast. The podcast where we teach you how to make massive income, not just passive income, because who doesn't like a lot of money all at once. Today's a Friday Focus episode, which means you have me as your host, Dan Austin, on a solo episode. Happy Friday. Happy Black Friday, I believe. This episode will launch the day after Thanksgiving. I hope your day is going well. My day literally started out like shit. Went upstairs, changed my son's diaper, didn't realize there was poop in it. Somehow, it rolled out onto the floor, and then I walked all over his bedroom with poop on my foot, and I kept thinking that he smelled really bad. Walked all the way down the stairs, poop everywhere. So literally, it's been a shitty day so far, but it's gonna get better from here. It can only go up. Right? Anyhow, today, I wanted to talk a little bit about some of the tactical nuances around seller finance deals, in particular, the tax discussion. I wanna do that because we talked a little bit about it on the episode that's gonna drop next week, our Wednesday episode with me, Mike, and Dylan. And we've been getting some questions in the scale community Slack, which if you're not familiar, the scale community is our coaching group. We have a Slack channel. We all chat about real estate stuff and help each other do better.

Dan Austin: [1:18] If you wanna know more about that, you can go to collectingkeys.com/scale. Anyways, there's a few things that people get wrong with seller finance, but the main one is around the benefits to the seller, and people just willy nilly say, oh, it's going to reduce your taxes, seller, you don't have this big capital gains tax. Well, yes and no to that, and the really, the meat and potatoes of that is there's really two parts of the tax discussion, and you need to know these, because you could potentially be putting the seller in a bad spot, and we kinda talk about some of the stories in the next Wednesday episode. And really what it comes down to is the first part that most people don't even know, is what's called depreciation recapture. So depreciation recapture is when you've had a rental property. This doesn't like play into, like, if it's a primary residence, because you can't depreciate your primary residence. But if this is a rental property, maybe it's a tired landlord list, older individual, retired, and they just wanna finally sell their the last rental property or one of their rental properties. It doesn't matter. When you have a rental property, if you take straight line depreciation, you take whatever asset value minus the land. So say you paid a 150,000 for it, tax records say the land's worth 50, so the actual house is worth a 100,000.

Dan Austin: [2:41] You take that 100,000, you divide it by twenty seven point five, which is twenty seven point five years because that's what the government says your house should last, and then each year, you depreciate a little bit. So say you're buying a house from a guy who owned it for thirty years. He owns it outright, and he depreciated that $100,000 value down to zero. Essentially, every year, took us a little bit depreciation to reduce his tax liability. And so according to the government, the house is worth zero. He depreciated 100,000. Maybe the house is worth, you know, 200,000 now. So basically, that $100,000 of depreciation he took over the last twenty seven and a half years, he has to pay 25% of that back, and he has to pay that back the year he sells it on his taxes. So essentially, he's going to have a $25,000 tax bill on that recapture. That's important to know, because a lot of times when you're talking to sellers, people I hear this all the time. They they say, oh, well, you're going to reduce your income. You're only gonna be getting a little bit of your principal back every single year, so that'll keep your taxable income lower, meaning you won't actually have to maybe bump up into the higher tax record. Yes. However, there's the caveat that they will have to pay their depreciation recapture all in year one. So that is a bummer, and you have to make sure that they know that, so that you're not selling them a false bill of goods.

Dan Austin: [4:04] But they're gonna have to pay it regardless whenever they sell this property, so it just needs to fit them. The next piece to this is the capital gains, and this is where the benefits overstated by a lot of folks trying to pitch seller financing. It's still a benefit, it still exists, and some of these tired landlords, these old dudes especially, they're just like, I don't wanna pay any more taxes than I have to, and so they the teeny teeny little bit that might help them to not pay taxes, they're a 100% all in on this. But if you think about it, so they have the same property. They had they bought it for a 100,000. It's now worth 200,000. Their capital gains is between that 100,000 and the 200,000. So they have a $100,000 capital gains. So if they were to sell the property, all get you paid cash for it, they they just got a big $200,000 check, they would pay the $25,000 in depreciation recapture, and then they would have to pay the capital gains on that other $100,000 of value increase. Now they can pay 0% capital gains, 15% capital gains, or 20% capital gains. And those are each individually based on their actual income for the year. And I don't know what those tax brackets are. I don't know what the income levels are for those, but you can think about most people in America are paying a 15% capital gains. So if they sold at year one, another $15,000 goes to capital gains. Now if you spread that over a longer period of time, essentially, what they can do is only pay a little bit of tax.

Dan Austin: [5:41] Right? So say you do a principal payment of, $500 each month, $6,000 a year, they're going to just pay the capital gains on that $6,000 for that year. And in the event that they have multiple properties they're selling or maybe they have an income coming in, this could keep them below the 15% or below the 20%. So it could save them it could save them potentially 15 to 20% or 5% even between that 1520% tax bracket. So that's where the capital gains savings comes in. The government gets their money no matter what. Right? However, how much they get can be determined by how much income they get from the sale of this property in each year. So that's a huge advantage. Now the third advantage, which you may run into is is for the retired folks that are on Medicare for their health care. Now if you the the challenge I've ran into this with landlords. We bought a place we bought two houses from a guy who was like 80 years old, and he was hell bent on not paying any more capital gains than he had to, and not increasing his income. So we actually did an interest only loan with him on these two properties, or sorry, principal only, no interest, because he didn't want the income from that. But what he was really concerned about was his taxes going up or his taxable income, his modified what do they call it? Modified adjusted gross income or something like that going up because then he would have to pay more in Medicare premiums.

Dan Austin: [7:09] And as you get older, one thing that's, like guaranteed is your medical care is going to cost more and more money, because you're gonna need more and more medical care to stay alive. I googled this, don't take this for a fact, but it looks like if you are married, a income above $206,000, you have to pay higher premiums for Medicare Part b and Part d. I don't know what any of those, like, Part b and Part d means, but I do know, basically, you you essentially have to start paying piece or, like, certain portions of that medical cost, and that can be significant, especially if you have medical issues. So for some sellers, this is a really big deal. Right? So if they're gonna have a huge gain, maybe that's pushes them over that $206,000 or whatever, you may wanna talk to them and say, hey, we could do seller financing to keep your adjusted income below that. And this also means that like a big high interest payment each year may not be good for them, especially if they're already like you know, drawn on Social Security, and they've got a four zero one k they draw on, and maybe a pension that they get, so they're like doing okay. But getting a bunch of interest payment, because interest payments are considered, you know, income, might push them over that, and then they might have to start paying certain percentages higher on their Medicare. And that's a big deal, like I said, for some of these folks. That's a good advantage that applies to some people.

Dan Austin: [8:29] Now, you have a distressed landlord that has no money, realistically, they're probably not going to break into these thresholds anyways, and seller financing may or may not be good for them. They want the recurring income, it could be fantastic and great for them. If they just need the money now, you may need to a cash offer might be better. So just to kinda summarize the the three pieces here, keep in mind, and when you're diving into these offers and you're trying to align the benefits to your seller, you've got depreciation recapture, and you're not gonna know exactly what that is, unless you talk to their accountant, or their accountant, you can look at their taxes. It's not a big deal, you don't need to know that, like detail what their situation is, but you should definitely talk to them about that. If you can have that conversation or get that information on your accountant, great. But that depreciation recapture is important, because they have to repay 25 percent of that, whatever they depreciate on that property. And then you have the capital gains piece, which we discussed, which is the any gain above what they paid for the property, or any gain above their actual asset value. Because if you put a new roof on it, that that would actually increase the the the property value on the book value. So anything above whatever you've done to it and and whatever you've capitalized, you're gonna have to pay capital gains on it.

Dan Austin: [9:37] So you could spread that out over a longer period of time, keep their income lower, so that they're not in a higher capital gains tax bracket moving from 0% to 15%, or 15% to 20%. And then lastly, if they are retired, the Medicare piece can play a pivotal role in it, and it does come up more often than you think if your seller is over 65. So something to think about. Those are the three things. You're gonna hear us talk a little bit about this in the Wednesday show next week, so I hope this kinda preps you for it, and gets you kinda around the understanding of what we're talking about when it comes to taxes. The last thing I'll say just on the seller finance piece or any creative finances, and I'm always a big pro to this, it needs to make sense for your seller. Don't get them wrapped up and tied up into a long term situation with you, or whoever you assign this to, if it doesn't make sense for them. Otherwise, you're just doing them injustice, and it just makes everybody look bad in this industry. So do the right thing for your sellers, and make sure what you're pitching aligns with them, and isn't just in the best interest of you, because that's just shitty business, and you're a shitty person if that's what you're doing. Anyways, hope you have a less shitty Friday than I did, and have a great weekend, and we'll catch you all next week.

Dan Austin: [10:45] See you.