Author Topic: Seller financing of undeveloped land  (Read 607 times)

Paul der Krake

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Seller financing of undeveloped land
« on: October 08, 2020, 07:16:13 PM »
There is a piece of land thatís owned by 3 related family members. Relative #1 is in their late 80s, relatives #2 and #3 are in their 60s. The local government has expressed interest in buying it to build a school on it. The land has been in the family for decades. The basis is so low that each relative would walk away with 7 figures of capital gains, which means a huge tax liability. None of the relatives are sophisticated investors. They are unlikely to go fishing in the opportunity zone pond or do clever 1031 exchanges.

One way around the huge tax bite is seller financing, paying capital gains slowly at capital gains rates, and ordinary income rates on whatever interest is charged.

The two main risks that I could identify are:
Credit risk: is the municipality willing and able to make the payments?
Legislative risk: do capital gains rates remain low(er) for the length of the installment sale?

Intuitively, it would make sense to sell ďas fast as possibleĒ with a short loan duration, but not so short that the tax hit would be too burdensome.


Question #1: are installment sales something local governments even do? If so, how to assess the credit risk? This is not Detroit, but public finances arenít exactly stellar anywhere these days.

Question #2: letís say the local government is willing to play ball and everyone agrees on a loan length of 5 years, at 3%. Does the remainder of the note pass to the estate of relative #1 if they were to die before the 5 years? Where does the money go while the estate is being sorted out? What happens to the basis?

Question #3: the municipality, for whatever reason, reneges on the contract. But now thereís a school on the land. What happens then?

Question #4: what else do they need to think about? Any other avenues to get this done?

Yes I know, they should talk to CPA(s) and estate attorney(s) to get good advice. Call this preliminary research if you will.





Mr. Green

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Re: Seller financing of undeveloped land
« Reply #1 on: October 08, 2020, 11:16:29 PM »
Do some research on a structured sale. It's essentially a sale where the proceeds go into a trust and are paid out over time, like an installment sale. The advantages over an installment sale are the buyer gets to take immediate possession of the property (it's just a normal sale to them) and the seller doesn't have to worry about the buyer's ability to pay over multiple years. The cons are the trust costs a little money to set up and maintain and they're an uncommon vehicle so finding companies that will act as the third party to set up the trust takes a little legwork. You dictate the terms of the trust so the payout can be over any period of time. We considered this a few years back for a property sale.

SndcxxJ

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Re: Seller financing of undeveloped land
« Reply #2 on: October 09, 2020, 07:38:01 AM »
I engage in seller financing and private money often both as lender and borrower.  I often encourage older retired folks to consider seller financing as it can provide stable income and delay some capital gains tax.  I feel I can address some of your questions, but I've never worked with a municipality so my experience is limited to private individuals.
Question 1:
Often with seller financing, as well as hard money loans, it's all about the property and less about the buyer.  Get a sizable down payment (20-30% preferably, which will be taxed), and if the city defaults you get the property back with any improvements they made.  I would even consider a lower down payment if the city is going to invest significant improvements to the property right away (assuming this is an undeveloped plot of land).
Question 2:
The note is an asset so the note itself will be passed on by trust or will or whatever.  I believe the income while the estate is being figured out is also part of the estate so will continue to be deposited into the late family members account until the account and the note is dispersed.  Double-check with an accountant, but I would assume the note's "basis" would be stepped up to current value and the capital gains tax would be avoided and only estate taxes would be considered (which if the estate is valued less than about $11 million the estate pays nothing, whereby avoiding those capital gains taxes entirely)
Question 3:
Say the city builds a school and then stops paying, you foreclose, get the land back and the school comes along wit it.  Now you can sell it again, this time with a school on it, earning potentially much more.
Question 4:
Assuming they don't want to pay the taxes, and assuming they will continue to want to have the money invested, I would say the loan term would be more like amortized for 30 years, but due in 5.  That way, in 5 years, you can update the interest rate or request the entire balance.  Hopefully the city wants to continue with the note and hopefully interest rates are favorable in 5 years.  I once bought a multifamily property from a retired person with this method almost 20 years ago, we update the interest rate every 5 years, he has spread his capital gains taxes out over at least 20 years and has had a steady monthly interest payment, I own the property and make money by running it and have never had to pay (or qualify for) a loan, which on large multifamily property can easily run $20k and is done every 5 or so years.
I don't know if a city would want to get involved with this stuff, but as long as the sellers don't need the entire balance then seller financing should definitely be considered.

Fishindude

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Re: Seller financing of undeveloped land
« Reply #3 on: October 09, 2020, 07:57:38 AM »

Question #1: are installment sales something local governments even do? If so, how to assess the credit risk? This is not Detroit, but public finances arenít exactly stellar anywhere these days.
This could be a great deal for all parties, just need to get everyone together and start talking about what the deal might look like.

Question #2: letís say the local government is willing to play ball and everyone agrees on a loan length of 5 years, at 3%. Does the remainder of the note pass to the estate of relative #1 if they were to die before the 5 years? Where does the money go while the estate is being sorted out? What happens to the basis?
I would think each person would have a designated place the payments would go to in event of their death and have it written into the contract.   Also, think a 3% interest rate is too low for somethign like this, 5-6% would make a lot more sense to me as the seller.

Question #3: the municipality, for whatever reason, reneges on the contract. But now thereís a school on the land. What happens then?
This would be almost unheard of.  A municipality is about the most solid customer you could ask for.   Regardless, any good lawyer will include terms in the contract that explains what happens in event of a default.

Question #4: what else do they need to think about? Any other avenues to get this done?
First order of business is sitting down with all parties and see if something like this would even be considered.

Yes I know, they should talk to CPA(s) and estate attorney(s) to get good advice. Call this preliminary research if you will.

Paul der Krake

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Re: Seller financing of undeveloped land
« Reply #4 on: October 09, 2020, 06:16:23 PM »
Do some research on a structured sale. It's essentially a sale where the proceeds go into a trust and are paid out over time, like an installment sale. The advantages over an installment sale are the buyer gets to take immediate possession of the property (it's just a normal sale to them) and the seller doesn't have to worry about the buyer's ability to pay over multiple years. The cons are the trust costs a little money to set up and maintain and they're an uncommon vehicle so finding companies that will act as the third party to set up the trust takes a little legwork. You dictate the terms of the trust so the payout can be over any period of time. We considered this a few years back for a property sale.
Obviously the proceeds and tax savings need to be large enough to offset the admin overhead. Was the trust cost the only reason you passed on this option? I read up on this a bit and it seems almost too good to be true.

Paul der Krake

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Re: Seller financing of undeveloped land
« Reply #5 on: October 09, 2020, 06:18:56 PM »
Assuming they don't want to pay the taxes, and assuming they will continue to want to have the money invested, I would say the loan term would be more like amortized for 30 years, but due in 5.  That way, in 5 years, you can update the interest rate or request the entire balance.  Hopefully the city wants to continue with the note and hopefully interest rates are favorable in 5 years.  I once bought a multifamily property from a retired person with this method almost 20 years ago, we update the interest rate every 5 years, he has spread his capital gains taxes out over at least 20 years and has had a steady monthly interest payment, I own the property and make money by running it and have never had to pay (or qualify for) a loan, which on large multifamily property can easily run $20k and is done every 5 or so years.
Oh wow that is clever, it didn't even occur to me that you could decouple amortization and payments. That opens a lot of options.

Mr. Green

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Re: Seller financing of undeveloped land
« Reply #6 on: October 10, 2020, 04:07:18 PM »
Do some research on a structured sale. It's essentially a sale where the proceeds go into a trust and are paid out over time, like an installment sale. The advantages over an installment sale are the buyer gets to take immediate possession of the property (it's just a normal sale to them) and the seller doesn't have to worry about the buyer's ability to pay over multiple years. The cons are the trust costs a little money to set up and maintain and they're an uncommon vehicle so finding companies that will act as the third party to set up the trust takes a little legwork. You dictate the terms of the trust so the payout can be over any period of time. We considered this a few years back for a property sale.
Obviously the proceeds and tax savings need to be large enough to offset the admin overhead. Was the trust cost the only reason you passed on this option? I read up on this a bit and it seems almost too good to be true.
We only passed on it because it would lock in our income for the period of time we elected to set the trust to payout. We were FIREing and weren't sure what our income situation would look like over the next few years. We were using the ACA so having so much income each year, determined years in advance, could potentially come back and bite us.

I did the math of lump sum sale and invest vs. the structured sale and they were very close, using average market returns of course. Had our life circumstances been a bit different at the time I would have done the structured sale.