Author Topic: Help me think through: Buying then leaseback to parents  (Read 1426 times)

Aphalite

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Help me think through: Buying then leaseback to parents
« on: March 16, 2016, 12:41:17 PM »
Hi all,

Would love to get some thoughts on an idea I'm currently thinking through - am sure not the first time this question has been asked in this forum but I haven't had any luck after 15 minutes of searching

My parents have a paid off house (current market value probably around $250k) and are near their retirement years. They plan on leaving everything to me when they pass. The house makes up a little under 50% of their total networth, so I was trying to think of ways they might unlock the equity and earn a higher yield/appreciation rate on it. A reverse mortgage is too expensive.

My idea: I purchase the home from them using a second mortgage (classifying as an investment property), then had them pay enough rent monthly to offset the mortgage+P&I (My wife and I are in a higher tax bracket), invested the equity (no cap taxes on the sale since under 500k gain), they would only need to get around 5%+ on the equity in order to break even on a 3.75%-4% mortgage, after accounting for origination/closing fees, right? I'm not worried about losing the step up basis on the house since it's already been stepped up once on the sale and the equity purchased with the proceeds will eventually have its own step up basis.

Risks:
-Taxes on dividends from the invested equity (15% now or 0% whenever parents retire, assuming Sanders doesn't win office and get to implement his policies)
-Losses on the invested equity from unwise investments
-Origination fees/lawyer fees/appraisal fees on initial transaction will eat into initial calculations on return
-Tax laws that I might not be aware of prohibiting these type of transactions? Although everything I read states as long as it's FMV and fair market rents there's not a problem
-Higher debt to income ratio for me (currently primary mortgage is at 11% of income, adding this will probably result in about 20% DTI)
-Related to point above, increased leverage for overall family picture
-If I ever wanted to buy investment properties, this transaction will put a damper on my ability to secure additional conventional financing

Pros:
-Unlock 250k equity (maybe less after accounting for "down payment" credits)
-5% is a low bar to have to reach on investment, 4% yield + 1% appreciation is all that's needed
-Taking a second mortgage out on parents' home is essentially shorting the dollar, which is something I would not mind doing (banking on mean reversion here)
-Tax savings from mortgage interest/property tax/insurance and possibly depreciation

I know I have a LOT of holes in my thinking right now (just thought of it this morning as my mind was wandering, so definitely not a polished idea), can you guys point out all the things I haven't thought of yet?

Leftover questions (will edit as more comes to mind):
1) Would it be prudent to raise rents higher and employ depreciation offset for further tax savings? Or would the net effect of that just be me stupidly lowering my cost basis in the "investment property" for no reason? (since the rents are coming from my parents' pockets and does not need to be taxed in the first place)

« Last Edit: March 16, 2016, 12:43:38 PM by Aphalite »

soupcxan

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Re: Help me think through: Buying then leaseback to parents
« Reply #1 on: March 17, 2016, 07:51:50 AM »
Without running specific numbers on both you and your parents' taxes, your plan seems to add a lot of complexity, transactions fees, and potentially more taxes by shifting untaxed "free" rent from your parents' return to your return where the rental income will be taxed at a higher rate (except to the extent you can offset it with deductions). Also the property tax bill could increase sharply if they sell to you - often times ptax is capped for retired people but that goes away if the property is sold.

If your end goal is simply to increase leverage and invest, then your parents can do that by taking out a regular mortgage or HELOC on their property, investing those proceeds, making the payments themselves, and deducting the interest on their own return. You don't need to be involved at all. I think that is going to be simpler and more tax-efficient in the long run.

But I would add there is no free lunch - using debt to invest (aka buying on margin) increases your risk.

Not sure what you mean by shorting the dollar - guessing you are in a different country than your parents?