I bought a house for $136K on a short sale. I agreed with the previous homeowner that I would sell it back to his sister for $9K over what I bought it for, or $145K, thus netting $9000. They just sent me over the Purchase and Sale Agreement and they want to buy the house for $174K and just have me give them the rest of the money back to them ($174K-$145K = $29K). So they basically want me to show that I sold them the house for $174K and then they want me to give them $29K outside of closing.
See the problem? Yeah, me too. I would have to pay the capital gains tax on the full money ($29K+$9K = $38K) of $38K.
Is there a way to avoid this?
My thought was this, I could put the house into a trust, named after me so as not to raise any red flags for the sister’s lender. My partner would be the trustee, and I would be the beneficiary. I would sell my beneficial interest to the sister( making her the beneficiary of the same trust) for $145K. Unless they scrutinously searched title there would be no evidence of this. Then, the sister could actually buy the house herself from the land trust. The gains would be counted to her taxes not mine.
Does this make sense?
Could this work?
Is there a better way?
I understand that we will have to pay title insurance again for the transaction, however $600 is better than paying $5000 in capital gains tax, right?
Please help me, I’m a budding investor.
The Default Doctor.
I am replying to my own post.
I just got off the phone with a CPA who specializes in real estate. He said that I do not have to go through the brain damage of creating a Land trust and trying to weave in and out of hoops to make this thing work. He said that I could just give the buyer a check for the $29K that I owe them, and do it outside of closing. If I can write on the check that the money is for concessions or fix-ups related to the home(write the address on the check) then that alone is enough to satisfy the IRS.
Sorry, for making any of you read this. I hope no one is dumber from doing so.
The CPA may be right about showing the money as a fixup cost for your tax return. I believe the bigger danger is bank fraud. You probably told the lender that the owner was to get nothing or they would not have done the short sale. Besides that issue you would be in on them getting a higher mortgage than the value of the property. If they fail there could be some reprecussions that entangle you. They seem to have a history of non-payment or you would not have done a short sale. Of course everything could go right and all you do is make money.
To clarify:
The house is worth somewhere between $170 - $185K, depending on what comparables you pull. The lender will be lending a reasonable and fair amount of money for the house.
I will be selling the house and writing the check to the previous owner’s sister. I will not be giving ANY money back to the previous homeowner.
The sister is the one that will suffer if the ‘renters’ do not pay their rental payment - the bank will still get their money, she will make sure of it.
Lastly, I thank you Bud for the comments. I hope that you nor anyone else thinks that I am willing to be dishonest in order to make a buck. I believe that what I have done is perfectly legal. Being dishonest may get a person richer, but I fear HELL more than poverty.
Hey Doc. Although you figured out your situation I appreciate the fact that you posted it. I learned from it, so hopefully you don’t feel as though it was a waste.
Thanks.
I’m uncomfortable with the advice DefaultDoctor’s advice received. If the sale to the sister is truly arms-length, then $145,000 is the fair market value of the property. The IRS won’t care about the comparables if there is an arms-length transaction to show worth, which is exactly what you would have to argue. If you don’t, then the IRS is going to call it a part sale/part gift. A gift tax return would be required. I admit that the IRS doesn’t have enough time or manpower to deal with situations like this, but that’s my take.
If I was DefaultDoctor, I would say “no” to the $174,000 purchase and sale agreement. Alternatively, ask for a price increase to offset the risk of IRS audit (or possibly bank fraud as mentioned). You’re also helping the buyer artificially increase her basis in the property. That can’t help matters.
In sum, your gain should be $9,000 because the FMV sale price you agreed to was $145,000. Theoretically, if the sister sold the property a year later for $175,000, her gain should be $30,000 – not $1,000.
And certainly stay away from the land trust idea.