I. Introduction: My name is Paul Hodge
A. Qualifications: I am a Certified Public Account with degrees in Accounting and Finance from the University of Texas A&M.
B. Experience: I have worked as a Controller and CFO for over twelve years at a variety of companies. I started my CPA practice five years ago and I have grown it into a successful business operating in both Houston and Dallas. I am a RICH Club Gold Business Member and a real estate investor with twenty four single family properties.
C. Subject Matter – Owner Financed Sales/Installment Sales
II. Owner financed Sales – Installment Sales
A. What is an owner financed sale/ Installment sale
1. Simply an installment sale is a situation where the seller of a property agrees to accept payments on the purchase of the property.
2. The IRS defines an installment sale as the sale of property where the seller receives at least one payment after the tax year of the sale.
3. What most people understand an installment sale to be is where the seller of the property offers to provide the financing for the buyer by agreeing to accept a series of scheduled payments. You are the BANK
B. Why would you want to sale your real estate through owner financing
1. You can sell your property for more money
a) Since you are usually dealing with buyers that cannot get normal financing then your property is a premium
b) You can usually mark the property up 10% for owner financed sales
2. You can sell your home quicker
a) By offering owner financing you have a unique investment among a large group of interested buyers.
b) Just by putting a sign in front yard indicating owner financing can draw several offers the first week
3. You can create a stream of income
a) For those investors wanting a steady stream of income but not wanting the hassle of renting this is a good option
b) Vacant land is a good example where the stream of income from an installment sale could be much higher than renting the property
4. You can defer Taxes
a) You can defer capital gains and depreciation recapture: I will discuss how to do that later in the lecture
b) The only tax you should be paying is on the interest earned
5. You have greater investment leverage
a) You can earn money on the taxes you defer
b) This can increase your interest earned by as much as 20% to 30%
Example After Tax Installment Sale
Sale Amount $100,000 $100,000
Adjusted Basis $ 20,000 $ 20,000
Capital Gain $ 80,000 $ 80,000
Net Proceeds $100,000 $100,000
Taxes $ 25,000 $ 0
Amount Invested $ 75,000 $100,000
Yearly Income 10% $ 7,500 $ 10,000
Net Yearly Adv. $ 0 $ 2,500
6. One final reason to do owner financing is because it is easy to understand. You do not have to be an attorney or CPA to understand an installment sale.
C. New rules regarding owner financed sales “The Safe Act”
1. The Safe Act: On July 30, 2008, President George W. Bush signed into law the Secure and Fair Enforcement for Mortgage Licensing Act, commonly referred to as the SAFE Act. Contained within the federal statute was a requirement that all states enact uniform legislation implementing the SAFE Act within one year. In Texas, this was done during the 2009 legislative session.
2. Owner financing will require you to obtain a RMLO license: What is that?
a) Residential Mortgage Loan Originator’s license
b) This is basically loan officer’s license
3. The exceptions to the rule are:
a) Selling your personal residence
b) Selling to family members
4. Dates to Remember:
a) June 1, 2010 Owner financing died June 16, 2010
b) Owner refinancing live again until August 31, 2010
III. The mechanics behind owner financed sales
A. How to structure an owner financed deal
1. First get a significant Down-payment
a) This should be between 10% to 30%
b) This will be the first filter to eliminate prospective buyers
2. You dictate the terms, You are the Bank
a) Interest Rate – more than a typical bank rate
c) Escrow – Insurance and taxes
d) The above will determine your payment
e) Sold As Is
f) Points at closing
g) You can also reduce the real estate agents commission (It is your show)
B. Rules behind lease to purchase contracts - HB 1823
1. Try and keep it under 180 days - there was no new legislation for these contracts
2. At 180 days to three years the agreement is considered to be an executory contract. The following are the most demanding of the new rules.
a) You must give adequate notice before taking action on late paying tenant/buyer
b) Maintaining clear title except for Purchase Money First Mortgages. Disclosure of liens must be made prior to signing and the Buyer/Tenant must be given access to Seller/Landlord's financial institution and account information.
c) Severe penalties can occur if you do not follow all the rules
C. Using outside sources to help with your sale
1. As with any restriction the government comes up with on doing business, the market finds the loophole
2. One of the RICH clubs major vendors and my client Prime Loan Services has found the loop hole around having to get an RMLO. The process is:
a) Prime Loan Services acts as the bank for the purchaser and they produce the note, personal guarantee and the Deed of Trust
b) At closingPrime Loan Services funds the note for the purchase
c) Then you the seller purchase the note from Prime Loan Services
d) At this time you have sold your investment without having to get the RMLO
IV. Tax Strategies for Installment Sales
A. Defer taxable profit
1. The IRS allows you to pay taxes on a pro-rata portion of your profits as you receive the cash
2. You have the ability to defer capital gains and the recapture of depreciation until the end of the note
3. Interest only notes can defer taxes indefinitely
B. Getting the Bank involved
1. You can use the note itself as collateral and get all of your money without paying any taxes
2. A wrap around mortgage will do the same
A. Risk of Foreclosure : Your buyer defaults on the note and you have to go through the process of foreclosing on them. This could take several months.
B. Risk of Early Pay-off : Your buyer could pay you off early and now you will need to catch up on the taxes owed and you have lost your stream of investment income. It is time for a new plan.
C. Risk of Property Deterioration : The new owner will let the property condition go down or worse they may tear the place up. This is why it is so important to screen potential buyers.
D. Risk of Decreasing Property Value: The property value may decrease below the mortgage amount
A. Owner financing can be a very useful tool in your real estate investing. It does sometimes though make sense to sell a property for cash and pay the tax on the profit. Make sure that an installment sale is right for you and your property.
B. Since the laws are always changing please work with a real estate agent that is familiar with owner financing. It is just as important to screen a potential buyer as it is a potential tenant. Remember until that buyer makes that last payment to you it is still your property.
C. Always consult a Tax Professional (CPA) for advice about your own tax situation. Everyone’s tax circumstances are different and a good CPA will pay for them selves in saving you time and money. Plan for your taxes and keep more of what you make, because it’s not what you make, but what you keep that matters.