Dawn Rickabaugh - Note Queen

I recently got a call from a gentleman who is selling a duplex here in Temple City, and the first words out of his mouth were,

“I want to defer capital gains without an exchange, and it says right here in your ad that you can help me do that.”

The 1031 exchange (IRC section 1031) has been one of more popular and effective strategies for deferring capital gains and depreciation recapture; however, many people just aren’t interested in exchanging one real estate headache for another. They want out of real estate altogether.

He owns his duplex free and clear, and he wants monthly retirement income. What are some of his options?

1. He could use the installment sale (IRC 453) to defer most of his capital gains if he’s willing and able to ‘carry paper’ (provide seller financing) for the buyer.
2. There is also the structured sale (Deferred Sales Trust), and the
3. Title Holding Trust System based on the Illinois land trust.

He had listed his property and received 3 offers. He accepted the highest one, but here’s the ‘catch.’ In exchange for a high offer, the buyer was asking him to take back a note (carry some financing).

The buyer was willing to put down $500,000 cash, and was asking him to carry $225,000 in a note and first deed of trust.

From an underwriting perspective, this is a great scenario if all you’re worried about is the safety of the note. With a 69% down payment, there’s some serious protective equity there.

You wouldn’t worry about potentially having to foreclose if the buyer quits making the payments . . . in fact, you might even pray for it! But he’s more concerned with wealth preservation through deferring capital gains at this point.

As it turns out, he does plan on doing a 1031 exchange into a 4-plex with that juicy $500,000 cash down payment. What he can’t figure out is what to do with that $225,000 note, which will be considered ‘boot,’ and be taxed heavily.

I suggested that he consider having the Qualified Intermediary (the exchange accommodator), be the beneficiary on the note, instead of himself. That way, the QI could sell the note, and the proceeds could then be exchanged along with the rest of the cash from the sale.

For instance, if set up favorably, I might be able to buy that $225,000 note for as much as $200,000. Yes, he’d be taking a $25,000 discount, but he would be able to save himself the capital gains on $225,000, which his accountant told him would be about $75,000.

Yuck, nasty discount, you’re thinking. Maybe, until you realize that his next best offer was $50,000 less. He’s still coming out ahead creating and selling the note by working with this buyer.

There are many excellent exit strategies above and beyond the standard CTNL (cash to new loan) and the 1031 exchange. What you’re after is the vehicle that best delivers your desired benefits.

Related Reading:

• If I Carry, What Happens if the Buyer Quits Making the Payments?
• If You’re Going to Carry Paper, Read Some Books on Seller Financing
• I Want to Sell My Note, What is it Worth?
  

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This is a post I’ve been wanting to write for a while now, because I get so many questions from investors and builders like the one you’ll see below.

When the financing machine is rusty, we need to look for ways to lubricate the system and get those creaky parts moving. We need to create liquidity one way or another. Buyers need to buy and sellers need to sell. So much of our economic activity here in the U.S. revolves around the housing market.

“Dawn-

Below is a basic synopsis of what we’re looking to do. We’re builders looking for options for buyers who do not quite fit the mold for an FHA mortgage. Please let me know if this is something that you could help us out with.

• Historical home sales over the last year have been between $149,000 and $169,000
• Lots are approximately 50 by 110.
• Homes are new construction. Brick and siding.

Buyers for this program are typically in the 540 to 620 credit scores, with stable employment histories, and debt ratios that slightly exceed FHA guidelines.

HOWEVER, these buyers are required to have a 24 month clean payment history on a previous mortgage or rental housing, previous 12 months clean payment history on any auto loan, a new housing payment not to exceed a current payment by more than 20%, and must not have had a foreclosure or repo within the past three years.

• Down payments are typically three to five percent.
• Note rates are typically eight to eleven percent.

Option 1: Builder will carry a low interest/no interest second for 20% and sell the first lien of 75%.
Option 2: Builder will sell the 95% LTV note at a 15 to 20% discount with a simultaneous closing.

Many thanks, R. M.“

Not only are builders in a pickle, but so are all the real estate investors out there who are trying to buy, rehab and flip short sales and REOs. There are some seasoning issues that sometimes make it difficult for buyers to close with conventional financing in a timely manner, if at all.

So these investors say, “OK, we’ll just sell these properties quickly offering seller financing and then sell the note right away.” The problem is that there are still seasoning issues to contend with.

A note buyer these days wants to see some seasoning. No one is that eager to buy rehab/flipper paper. Either

• the seller has to have owned the property 12 months before selling it, or
• the note needs 12 months of seasoning (at least!).

So, let’s pretend you don’t have these seasoning issues. You’ve owned your property for the last 5 years before selling and carrying paper. Most note buyers are still going to want you to receive 1-3 payments from your Payor/Buyer before they buy the note from you, even if it’s the best note out there.

So, is there any hope?

There is an investor out there who can get around the seasoning issues and do a true simultaneous close. How can they possibly do that??? No one else can touch it!

They underwrite the deal from the very beginning.

You have your prospective buyer fill out a 1003 (loan application) and have them pay for a credit report, and the investor reviews the file. Some buyers will qualify for the program, some won’t. If they do qualify, here is a sample of what an average deal might look like:

• Only owner occupied SFR’s (single family residences), and there are some parts of the country they won’t touch
  
• 5% cash down payment
• Seller carries a 10% - 15% second
• Seller creates and immediately sells an 80% - 85% first at .85 cents on the dollar
• Face interest rate on the 1st note will be somewhere between 8.5% - 10% (when 12 timely payments have been made, the buyers will most likely be able to qualify to refinance at a lower rate with the same company, and they can be working on improving their credit scores to boot).

So, here’s what some potential numbers might look like:

• Purchase Price: $100,000
• Down Payment: $5,000 (plus closing costs)
• Seller Carry Second: $10,000
• Seller Carry First: $85,000
• Proceeds From Selling First Note to Investor: $72,250

So, the seller/investor/builder walks away with $77,250 cash and a note for $10,000 that will ‘hopefully’ get paid off when the buyers refinance in a year or so.

It won’t make sense for everyone, but it is an option that’s out there if the seller can absorb the 15% discount and wait for the 2nd to pay off down the road. And even though the buyer will have what sounds like a high interest rate, most of the time they still come out ahead owning instead of renting on an ‘after tax’ basis.

Based on the above builder’s understanding that they will be holding a second for a while, it sounds like we will probably be able to put a few ’simo’ note deals together. Alternatively, if they didn’t need immediate cash, the builder could

• let the note season for a year or more and probably take much less of a discount, or
• put the property in a title holding trust.

Related Reading:

• Seller Financing is Not Stupid Financing
  
• Avoid the Pitfalls of Lease Option With an Equity Holding Trust
  
• I Want to Sell My Note, What is it Worth?
  

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Let's admit it . . . as a nation we've been partying very hard for a very long time, and now, in the midst of our collective hangover, we're looking for ways to sober up and find serenity. Who better than Bill W. and Dr. Bob to give us a hand?

1. We admitted we were powerless over the real estate market - that institutional financing had become unmanageable.

2. Came to believe that a power greater than Fannie Mae or the FDIC could restore us to sanity.

3. Made a decision to turn our will and our lives over to the care of creative financing as we understood it.

4. Made a searching and fearless moral inventory of all the options available to us.

5. Admitted to God, to ourselves and to a seller financing consultant the exact nature of our perceived limitations.

6. Were entirely ready to have God remove all these defects of consciousness.

7. Humbly asked Him to remove our fear of the unknown.

8. Made a list of all the benefits we were looking for, and the risks we wanted to avoid, and became willing to honor them all.

9. Made direct offers to extend terms wherever possible, promising to protect lenders, ourselves and others through use of the proper seller financing strategy.

10. Continued to collect the payments, and when we owed the bank, promptly paid it.

11. Sought third party administration of our note or equity holding trust, praying for relief from acceleration, and the power to avoid the due-on-sale clause.

12. Having experienced empowerment as the result of these steps, we tried to carry this message to distressed buyers and sellers everywhere, and to practice flexibility in all our affairs.

Giving people hope and peace of mind by helping them unplug and empower themselves is one of my favorite things to do. Remember:

Whether you have equity,

Good underlying financing, or

Some combination of the two,

There's a perfect seller financing plan

That's right for you!