Buying a house that was a recent 1031 exchange - Posted by Kevin (TulsaOK)

Posted by Kevin (TulsaOK) on May 01, 2006 at 13:16:47:

OK, the home warranty doesn’t sound as good as I originally thought, so we probably will not be going that route. Which means repairs are back in the equation.

I am getting this house on terms so I do not expect huge cashflow or boat loads of equity. These are very nice folks who are elderly and do not want to manage properties at their age. They are willing to be flexible (they told me this at one of our meetings), and they do not want to see me get hurt on this deal either. They said “If we can’t get the numbers to work, then we shouldn’t do the deal. They will just rent the houses out.” The way I figure it, the owners will be getting around 8% ROI ($1,130 Payment - $226.67 T&I = $903.33 Net = 7.9%) or ($903.33 / $137,000 Purchase Price X 12 months), so not outragious for an investment loan to an investor.

Can we avoid triggering taxes by transferring majority interest in the trust to me, and giving the owners a mortgage for $140,000 @ 6%, 30yr amortized / 5 year balloon? The trust hides the transfer, but the mortgage may trigger something.

Also, I didn’t buy this house from my neighbors because they were not offering any terms.

Any ideas? Thanks!

Buying a house that was a recent 1031 exchange - Posted by Kevin (TulsaOK)

Posted by Kevin (TulsaOK) on April 30, 2006 at 18:00:41:

Owner bought these houses using 1031 exchange about two months ago. Houses are held in seperate trusts. Can’t due a L/O or Contract for Deed due to triggering taxes. The owner says his lawyer sees no problem with us signing an agreement that will allow me to buy the properties at a future date (5 years with the option to extend). I would be included as a beneficiary in the trust to secure my interest. I mentioned 15% beneficial interest and the owner agreed. These will be rental properties for me. Has anyone ever made a deal like this? Any advice is greatly appreciated. Here are the numbers on one of the properties:

$140,000.00 Purchase price in 5 years
$147,000.00 FMV
$1,130.00 Monthly payment to owner
$1,250.00 Fair Market Rent
$ 0.00 Down Payment!!!
$162,000.00 Projected FMV in 5 years

Here’s my guess - Posted by Killer Joe

Posted by Killer Joe on May 01, 2006 at 07:43:37:


These houses will produce a negative cash flow for you. At some point in your five years of waiting for a payday it will become clear that the mathamatics of the deal were upside down to begin with, and the burden of owning these houses will take an unwanted toll on your finances.

If I hypothetically asked you the same question, but rephrased it along these lines, what would your answer to me be…

Kevin, I’m thinking of buying some houses that will leave me $120.00 a month after I pay the seller. How much of that $120.00 will I have leftover after insurance? Will that amount be enough to pay the taxes, cover any vacancies, replace the refrigerators or stoves if I have to, repair or replace a furnace, water heater, or a roof? What happens if one of my tenants trashes the place? Will that leave me enough money to cover these expenses and still leave enough profit to make it worthwhile?

I could go on, but how would you answer my question so far?


Re: Buying a house that was a recent 1031 exchange - Posted by Larry K

Posted by Larry K on April 30, 2006 at 21:18:18:

Sound like a lease option. To analyze the deal, a little more info may be helpful for others. How many house are there? What are your monthly expenses? How much (if any) of the monthly payment would be applied towards the $140,000 purchase. I would really crunch the numbers prior to making this deal. You will not be getting hardly any cash flow, no equity from debt reduction, no tax savings, and only 2% apprecation ($15K over 5 years). What am I missing?

Re: Here’s my guess - Posted by Kevin (TulsaOK)

Posted by Kevin (TulsaOK) on May 01, 2006 at 21:08:50:

Thanks for your thoughts. Insurance and taxes are covered in the $1,130 monthly paid to seller. I own or control 6 properties right now, so I’m not a newbee. The house next door to me has been very well maintained, so repairs should be minimal. As for vacancies, I’m averaging about 15 months turnover rate, so 15 x $120 = $1,800 Net. Now if I have a months vacancy, I’m still up $670 minus any repairs. During those 15 months I have presumably gained over $5,000 in equity. Even if annual repairs are 1% of the value of the house ($1,470), I’m still on the positive side in equity. The big picture is positive, not negative! I’m willing to spend penny’s to make nickels.

Re: Buying a house that was a recent 1031 exchange - Posted by Kevin (TulsaOK)

Posted by Kevin (TulsaOK) on April 30, 2006 at 22:26:49:

Thanks for pointing out that I was low on my appreciation. House should be worth more like the mid $170K’s in 5 years at 3% per year (low side). Owner will not allow a lease option due to that being considered an installment contract which is a sale in the eyes of the govt… We have agreed to split the cost of a home warranty that will cover moderate to major repairs. There are two houses involved and both are in move in condition (no repairs needed). The $140K house is right next door to my home, so I know that it has been well maintained by the original owners (30 years). As far as I know, none of the monthly payment would apply towards the principal (again, that would be an installment contract). It’s hard to say no to instant equity for $0.00, but I do realize that the longer this deal goes the less beneficial to me it is.

Re: Buying a house that was a 1031 - Posted by dealmaker

Posted by dealmaker on May 01, 2006 at 07:32:24:

I’ll add this post here as it’s getting more attention. Regardless of what you call it, it is a L/O. I’ve had those warranties, not worthless, but not worthwhile if you’re capable of any of your own repairs.

Let’s look at the possible, BIG repairs.

HVAC; yep, they’ll put in the cheapest unit, they’ll fight you on it if it’s AGE RELATED, (ie; worn out)

Roof; nope
Slab; nope
carpet; nope
painting; nope
water heater; see HVAC, above
dishwasher; they only cost $200
garbage disposer; they only cost $70
faucets; nope
garage door; nope “structural”

Not trying too hard to dissuade you, you will do what you want to do. This is just a list of what my most common repairs were over the 24+ years that I’ve been landlording and flipping.

One other thing; No investor I know "gives up much (if anything) to make a deal. On LT capital gains his max hit is 15%, so he sure isn’t giving you more than 15% I’d show the “proposal” to my CPA (mine is very conservative) and ask if he thinks the IRS might consider it a “sale”. If that happens the seller is likely to come back and ask you to do “something else” to try to help him out.

If this one is such a deal, why didn’t you buy it when your neighbors were selling?


Re: Buying a house that was a recent 1031 exchange - Posted by Larry K

Posted by Larry K on May 01, 2006 at 05:39:30:

I would be careful. Are you really getting instant equity? You are relying on the anticipated value of the house in 5 years (apprecation) but you arent purchasing with much equity. You also dont have much room with your monthly rent for declining rent, vacancies, etc