Owner Financing (family)?

[masscredit]

I'm exploring ways to purchase a house that belonged to a relative that passed away a few months ago. It's currently in her daughter's name and she's going to be looking to sell it soon.  I'm renting it for now. I have about $15K in tax liens (3 liens) and a lot of my income is expensed so my bottom line number doesn't show what I actually make. Those are 4 strikes against getting a mortgage from a bank.  I really like the house and I'd be paying the same amount as a mortgage so I rather buy that instead.  I'm running some numbers and will be putting together a proposal to see if she might do the financing for 20 years. Hopefully at zero interest.  I would be paying her like I'd be paying a bank. I'd be responsible for taxes, the water bill, trash ect... The only thing she will be doing is collecting money. A couple of benefits for her at - 

As far as I know there won't be any capital gains tax. I believe it can just be written up as a quit claim deed at the end to transfer it to me (thats how she received it). That would save about $40K-$50K.

And the septic would have to be replaced before the house is sold to someone else. That usually runs at least $10K-$15. 

Maybe I'm wrong but I see some financial benefits to this instead of selling it to someone else. I'd want legal documents drawn up to spell out what would happen. 

I've had a number of mortgages in the past but have no experience with something like this. Wondering if anyone else has and can give me a little guidance.

Thank you

[rynocity]

1) She still has to pay capital gains.  There might be tax benefits for her since she only has to pay tax on the installments she received that year.  But she will still be responsible for the full amount of capital gains over the course of the mortgage.  If you try to write the sale for less than the actual purchase price you might avoid the cap gains, but you put yourself at tremendous risk by not having the true terms of sale recorded.

2) Pay interest.  You can negotiate a low interest rate, but 0% is going to cause problems. First, the IRS doesn't like 0% interest loans, imputed interest would probably apply and she will have to pay tax on the interest she should have been charging you.  Also it might look like you are taking advantage of this woman to outsiders.  If you are borrowing money, you need to pay interest.  If she gives you a 0% loan she's losing money,she could put it in a interest bearing account or loan it to someone else at interest.  At today's rates she's losing over 40k on a 100k sales price!

3) If you think you're going to get an amazing deal on this, I'd reset your expectations.  She's going to need a lawyer for this, and the lawyer should advise her to have the property appraised first and should urge her to consider selling on the open market.  Sure, the property needs a septic system, but that's what price concessions are for.  Surely you are expecting a discount because of the septic issues, so how does your offer help the seller?  Your offer is only valuable because it's a little easier in the short term because it will speed up the sale.  But in the long term the seller has to worry about you making the payments on time, foreclosing if you can't, etc.    

I just don't see much upside for the seller here, and a lot of downsides.  The seller is accepting a big upfront risk here unless you have a substantial down payment.  Let say she agress to owner finance and while living there some large expense pops up, something like dry wells, failing septic, roof failure etc.  If you don't have the savings to cover this expense you might be forced to stop making the payments so you can pay rent at an alternate location.  Now the seller is really screwed.  They have to pay to foreclose to get back a broken house.

[StartingOver10]

In addition to the well thought out points above, you OP will also need an attorney.

One of the points you mention is a Quit Claim deed, you do not want a Quit Claim deed. It is truly the weakest form of ownership. In simple terms anyone can quit claim their ownership, if any, to anyone else. I could quit claim my ownership interest in the Sears Tower - but I don't have any ownership in the Sears Tower so what I am quit claiming is nothing. 

You want a warranty deed or some similar type deed (Special Warranty Deed for example).  This means you are going to have to have an attorney involved anyway to run title to make sure that there are no liens and on the property now. Do some research yourself, but definitely get an attorney involved so you can get an idea of your responsibility and the seller's responsibilities and to get clear title and to draw the note and mortgage if there is private financing.

[masscredit]

Thanks for the replies! I guess I have to do some research. I wasn't thinking that the IRS has to be involved. Like if I have a trailer or lawn mower for sale. It's my business if I sell them. If it was an actual mortgage through a bank then there would be a paper trail so that's something that should be reported. Paying interest would change my numbers. We all know how much more that adds to a mortgage. I'll have to figure it a few different ways. I was planning on doing this through an attorney if it happens. That way we know that it's all written up correctly. 

I'm guessing that total owner financing isn't something that's common? I've read about the rent to own proceedure. That requires the renter to put down a decent down payment and be able to secure a mortgage within a set number of years. 

A little info that I found about a quitclaim deed -

A quitclaim deed is a legal instrument which is used to transfer interest in real property, the entity transferring their interest is called the grantor, and when the quitclaim deed is properly completed and executed it transfers any interest the grantor has in the property to a recipient, called the grantee. The owner/grantor terminates (“quits”) any right and claim to the property, thereby allowing the right or claim to transfer to the recipient/grantee.

Unlike most other property deeds, a quitclaim deed contains no title covenant and thus, offers the grantee no warranty as to the status of the property title the grantee is entitled only to whatever interest the grantor actually possesses at the time the transfer occurs. This means that the grantor does not guarantee that he or she actually owns any interest in the property at the time of the transfer, or if he or she does own an interest, that the title is free and clear. It is therefore possible for a grantee to receive no actual interest, and – because a quitclaim deed offers no warranty – have no legal recourse to recover any losses. Further, if the grantor should acquire the property at a later date, the grantee is not entitled to take possession, because the grantee can only receive the interest the grantor held at the time the transfer occurred. In contrast, other deeds often used for real estate sales (called grant deeds or warranty deeds, depending on the jurisdiction) contain warranties from the grantor to the grantee that the title is clear and/or that the grantor has not placed any encumbrance against the title.

Because of this lack of warranty, quitclaim deeds are most often used to transfer property between family members, as gifts, placing personal property into a business entity (and vice versa) or in other special or unique circumstances. Quitclaim deeds are rarely used to transfer property from seller to buyer in a traditional property sale; in most cases, the grantor and grantee have an existing relationship, or the grantor and grantee are the same person

[StartingOver10]

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@masscredit wrote:

Thanks for the replies! I guess I have to do some research. I wasn't thinking that the IRS has to be involved. Like if I have a trailer or lawn mower for sale. It's my business if I sell them. If it was an actual mortgage through a bank then there would be a paper trail so that's something that should be reported. Paying interest would change my numbers. We all know how much more that adds to a mortgage. I'll have to figure it a few different ways. I was planning on doing this through an attorney if it happens. That way we know that it's all written up correctly. 

I'm guessing that total owner financing isn't something that's common? I've read about the rent to own proceedure. That requires the renter to put down a decent down payment and be able to secure a mortgage within a set number of years. 

A little info that I found about a quitclaim deed -

A quitclaim deed is a legal instrument which is used to transfer interest in real property, the entity transferring their interest is called the grantor, and when the quitclaim deed is properly completed and executed it transfers any interest the grantor has in the property to a recipient, called the grantee. The owner/grantor terminates (“quits”) any right and claim to the property, thereby allowing the right or claim to transfer to the recipient/grantee.

Unlike most other property deeds, a quitclaim deed contains no title covenant and thus, offers the grantee no warranty as to the status of the property title the grantee is entitled only to whatever interest the grantor actually possesses at the time the transfer occurs. This means that the grantor does not guarantee that he or she actually owns any interest in the property at the time of the transfer, or if he or she does own an interest, that the title is free and clear. It is therefore possible for a grantee to receive no actual interest, and – because a quitclaim deed offers no warranty – have no legal recourse to recover any losses. Further, if the grantor should acquire the property at a later date, the grantee is not entitled to take possession, because the grantee can only receive the interest the grantor held at the time the transfer occurred. In contrast, other deeds often used for real estate sales (called grant deeds or warranty deeds, depending on the jurisdiction) contain warranties from the grantor to the grantee that the title is clear and/or that the grantor has not placed any encumbrance against the title.

Because of this lack of warranty, quitclaim deeds are most often used to transfer property between family members, as gifts, placing personal property into a business entity (and vice versa) or in other special or unique circumstances. Quitclaim deeds are rarely used to transfer property from seller to buyer in a traditional property sale; in most cases, the grantor and grantee have an existing relationship, or the grantor and grantee are the same person

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^^^This was my point. Naturally the info you found is much more compreshensive. Despite the subsequent paragraph stating quit claim deeds are used to transfer between family members, I would NOT do it with a quit calim deed. Speak to your attorney about the pros and cons.

There are sellers that do own property free and clear and sell with seller financing. However, not zero percent interest. There are some guidelines even with seller financing due to the Dodd Frank act. Again, your attorney would be a good resource for this information.

[coterotie]

I'll weigh in on the tax angles.

When you receive property through an inheritance you receive what is called a "stepped up" basis.  Meaning you only pay tax on the increased value since the date of the inheritance.  So let's say the property appraised for 100,000 for estate purposes.  Was transferred to Jane Doe on January 1, 2013.  She sells the property for $105,000 on January 2, 2013.  She has to pay short term capital gains taxes on $5,000.  If she sells for $95,000 then she is may be entitlted to a loss depending on certain circumstatnces.  If sold for 100,000 then no tax is due.  In the case of an instalment sale, then the tax liability is pro-rated over the life of the installment useing the holding period rules in effect at the date of the sale.

If you have a tax lien it will attach to the property as soon as transferred, so be aware that they can seize the property and sell it to pay the taxes.  Again some of the rules are state dependent, but be aware of that possiblity.

With your history with the IRS, I would be wary of anything that wasn't to the letter, eg. your 0% rates, quit claim deed, lack of a "paperwork trail,"  they will definitely scruitinize stuff you do whether you tell them about it or not.

you have some more research to do on this, but it is do able with the proper planning.

[masscredit]

The property belonged to my grandmother. She transferred it to her daughter about 20 years ago. That might have been to make life easier after she passed. She hung around for a long time after that. Don't know if that would factor the same way as if she received it in an inheritance. 

As for my tax liens, I'm staying away from actually owning property until they go away. The big one will reach the status of limitations in a few years. The other two will follow soon after. I might even pay those at some point. 

[Revelate]

To add to the tax conundrum, the IRS will take a piece out of the hide out of anyone who makes a below market loan, and there are very limited options for a 0% loan and they are spelled out.  If there's no paperwork, the seller is doing it wrong - no recourse and no defense, and "Aw Shucks" isn't the defense you want against the IRS.

http://apps.irs.gov/app/picklist/list/federalRates.html

That's the market rates as deemed by the IRS, below that you get to go through hoops to be on the up and up.

There are some interest free loans you can make, but they cap out at 100K and the restrictions there are non-trivial; easier at 50K and of course the IRS doesn't care if it falls underneath the Gift line, but realistically there's only so much house you can make on any of those 3 options.

[ezdriver]

Private mortgages, along with a lien, are still generally recorded in the public files like any other mortgage and lien. If a lender [private, family, etc.] don't record a mortgage, they are accepting a lot of risks.

[coterotie]

The "basis" in the property was established at the date of transfer.  So let's say on that date, 20 years ago, the property was worth 50,000.   You execute a contract to purchase for $100,000 today.  The owner would owe taxes on $50,000 of gains.  UNLESS, they can prove they spent money on upgrades etc.  OR if they occupied the home as their primary residence in 2 of the last 5 years.  Usual income limitations etc. apply.  As noted above, for an inheritance the basis is established at time of death/transfer to estate or trust. 

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@masscredit wrote:

The property belonged to my grandmother. She transferred it to her daughter about 20 years ago. That might have been to make life easier after she passed. She hung around for a long time after that. Don't know if that would factor the same way as if she received it in an inheritance. 

As for my tax liens, I'm staying away from actually owning property until they go away. The big one will reach the status of limitations in a few years. The other two will follow soon after. I might even pay those at some point. 

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As to the tax liens, hopefully you have done your homework, as actions taken by you can extend the SOL or even put it in deferment for years at a time.  The IRS can even file an unenforceable extension just to mess with you.