I am working on a deal to eventually acquire four properties. The seller is planning on holding the current mortgages on the properties and I am going to make principal and interest payments on the difference from the mortgage balance and the purchase price. At set dates in future years, I will refinance the mortgages into my name. This can be done via a land contract, although the seller would be responsible for paying taxes on depreciation recapture for all four properties in the year the land contract was signed. Since this is a no money down situation, we are trying to defer the payment of taxes. My idea, although I am not sure if it will work, is the following. Create a S-Corp or LLC and contribute some of my own property and have the seller contribute her property to the S-Corp or LLC. Then, I will buy the interest in the S-Corp or LLC from the seller in the form of a note payable. The seller would have a realized gain of the difference from the adjusted basis and the purchase price. Because the sale was for the interest in the business and not the actual asset, there will therefore not be any depreciation recapture in the year of the sale. Also, as no money is actually being exchanged, the principal received from the note payable will be treated as installment sale income and be taxed at the capital gains rate of 15%, while the interest income will be reported as interest income. The possible problem is whether I can deduct the interest paid on the note payable. I believe that it would technically be considered investment interest expense, therefore limiting the deduction to the extent of your investment earnings (ex. dividends, interest income, etc…). I don’t plan on having alternative investment earnings as the majority of my capital is in real estate. When I buy the seller’s interest in the business, I will receive a step up in the basis of the S-Corp or LLC to the extent of the purchase price of the properties. This would then allow me to start depreciating those properties with the new basis over 27.5 years. I am also not sure how I can refinance the mortgages that were quit claimed into the S-Corp or LLC. Usually Banks don’t allow LLC’s to have mortgages solely in their name, so the property usually is quit claimed out of the LLC and then refinanced. The problem is that after the seller is bought out, the seller will not have an interest in the property of the S-Corp or LLC, so how could this be done; or will it not be a problem? PLease let me know if I have the right idea on this! Please let me know if I am forgetting anything! Please let me know if there are any other ways that I can help defer the payment of taxes for the seller (not interested in a 1031 since the seller does not want to acquire any additional property)!
Sounds like you need a good real estate atty.
One thing I can hopefully help you with is this. The seller cannot be a member of the LLC unless you get a VERY specific operating agreement in place that removes them as a member at some point in time when this whole thing is done.
The reason being is that members cannot generally be released from an LLC, especially without an operating agreement, without disolving the LLC in whole. That’s one of the things in the LLC that keeps anyone that might get a judgement against the LLC from removing your controlling interest, or from another member forcing you out.
The one drawback is that you can’t buy a member out, they can’t voluntarily remove themselves, etc. Unless there are specific provisions within the operating agreement that allows them to do so.
You really need a good atty, especially if you want to use an LLC. The operating agreement would need to be very specific on how and when the seller would or could be released.
you have correctly identified the two major hurdles:
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the contribution of the seller’s property without the bank’s approval will probably muck up any subsequent transaction
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your interest on the purchase of the entity is investment interest.
previous poster’s advice to find a good atty is right on the money.
You’ll need an opinion from 2 people. The first is an attorney who deals in partnership law to draft an operating agreement that does what you want. The second is a tax expert (CPA, attorney, or EA) who focuses or has vast experience with business sales. It is possible to reach your goals. The question is doing it in the most tax efficient way.