Advice on Real Estate Sale Strategy

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Topic Author
eagerinvester
Posts: 12
Joined: Sun Mar 03, 2019 6:43 pm

Advice on Real Estate Sale Strategy

Post by eagerinvester » Sat Sep 14, 2019 5:21 pm

Hi Boglehead community,
I’m looking for a gut check to see if I missed anything regarding the sale of my parents’ investment property.

My father bought an investment property in 2007 for $380k. It had been a strong rental property but needs a large amount of TLC, and he and my mom had planned to sell this property to me and my husband essentially at cost ($380k plus about $200k in improvements) once he had a chance to rehab it. We had planned to live in it for 2 years, and then turn around and sell, knowing we could exclude up to $500k in profit from capital gains taxes. The house next door with a mirrored floor plan and updated finishes sold in May for about $1M.

Unfortunately my father passed away in June before any improvements were made and the property will be going into a trust that my mom will have access to, along with a handful of other investment properties that were in his name. This particular investment property was appraised at $675k at the time of his death, which I believe becomes the new stepped up basis should my mom choose to sell.

My mom has committed to rehabbing the property with my help, but we are now trying to figure out if it would be better for her to sell it herself once it’s done and give me a piece of the profit, or continue with the original plan of selling to me after the improvements have been made. The rehabbed property is eligible for a 10 year tax abatement which we will apply for.

Assuming we can sell the property next year for a similar amount to the house next door ($1M) and receive the tax abatement:

Scenario A - Mom sells it herself for $1M:
Mom is in it for $580k ($380k purchase price plus $200k improvements). She has a stepped up basis of $675k. She sells for $1M, for a profit of $420k and $125k in capital gains ($1M - $675k - $200k), so tax bill of $18,750 at (15%)
Mom recoups her $580k, takes $18750 to cover capital gains taxes, and remaining ~$400k goes to me and my husband.

Scenario B - Mom sells it to me and my husband for $580k and we then sell 2 years later for $1M:
I assumed she’d have to file a gift tax return for $95k since we are purchasing below the appraised price. Assume I will take out a 7 year balloon mortgage with 20% down to buy from her with 3% interest. After 2 years, we sell for $1M. I’m in it for roughly $550k (mortgage payments and the remaining mortgage balance). We pay no real estate taxes due to the tax abatement. We end up with a profit of $447k tax free since we are under the 500k capital gains threshold.

I understand I’m making quite a few assumptions here, such as our ability to sell for $1M in both scenarios, mortgage rates, etc. Am I missing anything major here? Does the fact that properties are in a trust instead of my moms name change anything? We are planning on consulting our accountant as well, but I wanted to do a quick gut check to make sure I’m not missing any major tax levers here. Thank you for any advice or assistance you can provide.

Olemiss540
Posts: 1137
Joined: Fri Aug 18, 2017 8:46 pm

Re: Advice on Real Estate Sale Strategy

Post by Olemiss540 » Sat Sep 14, 2019 9:13 pm

I dont understand why you and your husband get any "profit" out of this deal?
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.

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unclescrooge
Posts: 3997
Joined: Thu Jun 07, 2012 7:00 pm

Re: Advice on Real Estate Sale Strategy

Post by unclescrooge » Sat Sep 14, 2019 9:57 pm

eagerinvester wrote:
Sat Sep 14, 2019 5:21 pm
Hi Boglehead community,
I’m looking for a gut check to see if I missed anything regarding the sale of my parents’ investment property.

My father bought an investment property in 2007 for $380k. It had been a strong rental property but needs a large amount of TLC, and he and my mom had planned to sell this property to me and my husband essentially at cost ($380k plus about $200k in improvements) once he had a chance to rehab it. We had planned to live in it for 2 years, and then turn around and sell, knowing we could exclude up to $500k in profit from capital gains taxes. The house next door with a mirrored floor plan and updated finishes sold in May for about $1M.

Unfortunately my father passed away in June before any improvements were made and the property will be going into a trust that my mom will have access to, along with a handful of other investment properties that were in his name. This particular investment property was appraised at $675k at the time of his death, which I believe becomes the new stepped up basis should my mom choose to sell.

My mom has committed to rehabbing the property with my help, but we are now trying to figure out if it would be better for her to sell it herself once it’s done and give me a piece of the profit, or continue with the original plan of selling to me after the improvements have been made. The rehabbed property is eligible for a 10 year tax abatement which we will apply for.

Assuming we can sell the property next year for a similar amount to the house next door ($1M) and receive the tax abatement:

Scenario A - Mom sells it herself for $1M:
Mom is in it for $580k ($380k purchase price plus $200k improvements). She has a stepped up basis of $675k. She sells for $1M, for a profit of $420k and $125k in capital gains ($1M - $675k - $200k), so tax bill of $18,750 at (15%)
Mom recoups her $580k, takes $18750 to cover capital gains taxes, and remaining ~$400k goes to me and my husband.

Scenario B - Mom sells it to me and my husband for $580k and we then sell 2 years later for $1M:
I assumed she’d have to file a gift tax return for $95k since we are purchasing below the appraised price. Assume I will take out a 7 year balloon mortgage with 20% down to buy from her with 3% interest. After 2 years, we sell for $1M. I’m in it for roughly $550k (mortgage payments and the remaining mortgage balance). We pay no real estate taxes due to the tax abatement. We end up with a profit of $447k tax free since we are under the 500k capital gains threshold.

I understand I’m making quite a few assumptions here, such as our ability to sell for $1M in both scenarios, mortgage rates, etc. Am I missing anything major here? Does the fact that properties are in a trust instead of my moms name change anything? We are planning on consulting our accountant as well, but I wanted to do a quick gut check to make sure I’m not missing any major tax levers here. Thank you for any advice or assistance you can provide.
You're over thinking this.

Your mom sells you the house for $600,000.

You take out a mortgage and give her the money.

She pays no tax on this.

You then do whatever you feel like.

Topic Author
eagerinvester
Posts: 12
Joined: Sun Mar 03, 2019 6:43 pm

Re: Advice on Real Estate Sale Strategy

Post by eagerinvester » Sat Sep 14, 2019 10:27 pm

Olemiss540 wrote:
Sat Sep 14, 2019 9:13 pm
I dont understand why you and your husband get any "profit" out of this deal?
Profit may not be the right word here. My father wanted to gift the proceeds to us. Call it whatever you will. We have no intention of staying in the home long term. When he was alive, his cost basis would have been lower so it made sense to sell it to us at cost and we would then resell. My mom now has a stepped up basis with his passing, so we are figuring out if it still makes sense to buy, wait two years, and then sell, or just sell now. That’s all.

SuzBanyan
Posts: 275
Joined: Thu Jun 02, 2016 11:20 am

Re: Advice on Real Estate Sale Strategy

Post by SuzBanyan » Sun Sep 15, 2019 8:43 am

eagerinvester wrote:
Sat Sep 14, 2019 10:27 pm
Olemiss540 wrote:
Sat Sep 14, 2019 9:13 pm
I dont understand why you and your husband get any "profit" out of this deal?
Profit may not be the right word here. My father wanted to gift the proceeds to us. Call it whatever you will. We have no intention of staying in the home long term. When he was alive, his cost basis would have been lower so it made sense to sell it to us at cost and we would then resell. My mom now has a stepped up basis with his passing, so we are figuring out if it still makes sense to buy, wait two years, and then sell, or just sell now. That’s all.
First, my condolences on the loss of your father.

Second, make sure that the basis in the property now owned by your Mom through a Trust was stepped up in its entirety. That would be the case if your Dad was the sole owner before his death or if the property was co-owned and your parents live in a community property state.

If there was a full step up in basis, then there is no benefit to selling the property to you to live in. Your Mom would have no tax consequences from a prompt sale. Your plan for the property before your father passed didn’t fully account for all the tax issues due to the planned below market sale and need for depreciation recapture, but those issues disappear with a full step up in basis.

Then, the real question is whether your Mom should spend $200K on repairs before selling. Unless she is guaranteed to capture an additional $325K by spending $200k, it probably makes no sense to pour that much money (and time) in. With real estate, there is never a guarantee like that. Have your Mom spend enough on repairs to get the property sold and call it a day.

Finally, although your Dad may have intended to make a substantial gift to you, it doesn’t sound like he did so through his estate. Recognize that your Mom may need some time to come to terms with being a widow before she can face making any gift to you.

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LilyFleur
Posts: 751
Joined: Fri Mar 02, 2018 10:36 pm

Re: Advice on Real Estate Sale Strategy

Post by LilyFleur » Sun Sep 15, 2019 10:18 pm

Is this your father's trust, and your mother is now the trustee? Who are the beneficiaries of the trust?
I would check this very carefully, but I would think it likely that trustees have a fiduciary duty to the trust which includes selling property at fair market value. A trust is a legal entity, with specific legal protections and rules. It may not matter what your father intended you to have from this property; what matters is how the trust is written. There are legal liabilities to the trustee if actions are taken which violate the terms of the trust.

Topic Author
eagerinvester
Posts: 12
Joined: Sun Mar 03, 2019 6:43 pm

Re: Advice on Real Estate Sale Strategy

Post by eagerinvester » Wed Sep 18, 2019 6:45 am

All great points and feedback, thank you. There have been a few more issues that have come up in wading through all of this and it’s feeling more and more like my mom should just put the property on the open market. We will consult with her attorney and accountant, and others if needed but this seems the simplest way to go. We will deal with everything else later. Thanks to you all for your collective wisdom.

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