I guess the bottom line is that whether you pay the principal all at once (i.e. buy with your own cash) or in pieces (e.g. monthly mortgage payments), you don’t pay taxes on principal when you get it back.
Rehabbers and landlords might not think about this too much. Do the old-time investors you mention fit into those niches? Wrappers and paper investors do think about this since they are concerned with how much they get today, during the transaction (e.g. monthly payments), and on the back end. The back end is very dependent on the difference in loan principal build up of the wrap and the underlying loan.
You, perhaps inadvertently, bring up an interesting point about the various niches in real estate and the knowledge necessary, or unnecessary, to be successful.
A friend of mine told me not to confuse experience with expertise. Most of the old-timers I’ve met are one-trick ponies and don’t understand or recommend any other way of investing, other than their own of course. They don’t have 20 years of experience, they have 1 years experience, repeated 20 times over.
On the bright side, it’s nice to know that you don’t have to be an expert in all phases of real estate investment to make a nice living.
interesting tax free profit - Posted by michaela-ATL
Posted by michaela-ATL on April 17, 2003 at 14:22:18:
Learned something really interesting today, when it comes to ‘agreement for deed/land contract’.
Let’s say I bought a house on LC for 150k, with a present
mortgage of 120k and a 2nd mortgage to the owner of 30k.
I then sell it on a LC for 170k to a buyer, who gives me
20k down, which is taxable.
I bought it for 150k, sold it for 170k and paid taxes on the 20k profit.
What, if i gave the buyer an ‘interest only loan’? His payments are lower and I may not have any positive cashflow.
Let’s say after 10 years I owe 125k on both mortgages (i don’t have an ammortization table, so I’m only making this number up to illustrate) and the buyer refinances. The extra paid down equity (25k) is not considered income and it’s tax-free.
Of course, it doesn’t have to be an ‘interest only’ loan. I just used it to make it simple.
Just thought, that that’s an interesting strategy. This guy who talked about it buys and sells properties on LC and his CPA told him this.
The reason that the paydown on the loans is not considered income is that it isn’t income. You can’t spend it. However, all the payments to you from the buyer is interest. All of the interest payment is taxable–at your ordinary income tax rate, not at a capital gains rate.
I’m wondering if the investor was mistake about what the accountant said or if the accountant didn’t present the “rest of the story.” (apologies to Paul Harvey.)
“The extra paid down equity (25k) is not considered income and it’s tax-free.”
Hi michaela,
Unless I’m missing something, this concept applies to all transactions, not just ‘agreement for deed/land contract’. You’re building equity with todays after-tax dollars and then you’ll get it back when you sell. Why would you ever pay taxes (again!) on money that you paid in?
You only pay income taxes on your profit (i.e. difference in buy vs. sell price) and the interest income spread as you receive it.
Maybe I misunderstood your example, but to me it doesn’t appear to be unique to land contracts.
Posted by David Krulac on April 17, 2003 at 15:37:17:
instead of LC you sell on a lease option with $20K option consideration. Then the $20,000 is tax free until either the option is exercised, or the optionee defaults.
Posted by michaela-ATL on April 18, 2003 at 09:12:10:
What are you talking about? I buy on landcontract for 150k. The first mortgage is 120k and I give the seller a 2nd mortgage for 30k. Then I send 2 checks to the seller every month. One made out to him and the mortgage company, which he will need to endorse and forward on and a 2nd one for the payment on the 30k. At least, that’s how this investor has been doing it.
What’s impossible about that?
Re: interesting tax free profit - Posted by michaela-ATL
Posted by michaela-ATL on April 18, 2003 at 08:12:47:
Ron,
sorry, if i wasn’t clear. Of course it isn’t spendable at the time, that the loan is intact, BUT, if there’s a difference between the original loan amount(when you purchased it) and when the loan is paid, that money is tax-free.
Yes, the received income is taxable, but what if you gave an ‘interest only loan’, so, that there’s no ammortization? If you don’t have any positive cashflow, because you only break even, then there’s nothing to pay taxes on. Your profit comes at the end in the form of paid down equity, which is tax-free.
This was a presentation by a long-time investor and his CPA, Robert Swain, is the one,that told him about it and had to convert him, because it sounded so unreal. Robert swain is a very well regarded CPA, that specializes in Real Estate and regularly teaches courses at our local REIA.
Re: interesting tax free profit - Posted by michaela-ATL
Posted by michaela-ATL on April 18, 2003 at 08:20:57:
Andrew,
that just what it was presented with. It wouldn’t work with a lease-option, because obviously there was no transfer of property. This guy used LC and it may work better, because the loan is already older, subsequently you’re paying principal down faster.
If this is a well-known thing - then great. We had a lot of old-time investors there and it wasn’t soemthing, that was generally known or thought about here.
Posted by michaela-ATL on April 18, 2003 at 08:23:58:
David,
this is something totally different. On a lease optin you will still have to pay tazes on the profit whenever the property sells. I don’t understand the connection.
In OH at least if you buy on LC than you sent the seller one check where he keeps the profit and sends the mortgage payment on to the bank. Hence known as a wrap. Seller retains title until said contract is paid.
Using a second is a purchase money mortgage where you get the deed and are title holder making mortgage payments to former owner.
Posted by David Krulac on April 18, 2003 at 15:50:30:
if you buy on a LC, the original owner is still the deeded owner. It impossible for him to put a second mortgage on the property that he STILL owns.
I’m confused at what you’re trying to do and from the posts apparently so is everybody else.
If you pay NO interest, then the IRS imputes interest for you saying that part of the payment is interest and part is principle. Principle payments are NEVER taxed no matter whether you do a LC, LO, sub2, etc.
If you receive interest only payments they are ALWAYS taxed at ordinary rates up to 39.1%, so that’s no bargain when capital gains are 20%.
If you could please elaborate on what happens and what is supposed to be accomplished. Thanks.
Excuse me for not making myself clear the first time.
You are the lender on an “interest only loan,” if I understand you correctly. You have used that phrase twice, but if I have some misapprehension, please set me straight.
The payments from that “interest-only” loan are TAXABLE at the federal level. And, if you have an income tax in GA, probably at the state level also. The interest is taxable at your ordinary income rate. Thus, if your tax bracket is higher than your capital gains tax bracket, you pay more tax than if you had sold and taken your profit at long term capital gains rate.
Good Investing***********Ron Starr****************