Pushing Dirt

Believe it or not, seller-held financing has benefits for both parties.

One of the biggest advantages for the seller is that holding paper equates to an installment sale, which is a mechanism for deferring capital gains tax. The seller only pays capital gains tax as the principal balance is paid down. An interest-only seller-held note offers the greatest opportunity for savings as no principal is paid down during the term of the note.

This tax benefit is so compelling that a vehicle called a Deferred Sales Trust has been developed to take advantage of the installment sales rules to allow sellers to defer taxes without holding paper. Refer to http://likekind.org for more details.

The benefits for the buyer are fairly apparent: the seller might be the only source available to finance a particular project, or may offer better terms including higher leverage, a lower rate, or a longer amortization. A buyer can potentially, when permitted by the lender with the first trust, to secure a second mortgage from the seller to garner even greater leverage. While the seller may want to qualify the prospective borrower, the process of securing the loan is likely going to be less painful.

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With the days of 80% interest only financing long behind us, look to seller-held financing to get deals done in 2009. I’ve already concluded several transactions successfully in the last six months involving a seller held second trust. The financing in some cases is secured by a second position in the property, but lenders in the first position don’t always allow for this. In these cases a second mortgage might be guaranteed personally by the borrower or else other collateral might be offered

I’m regularly telling my clients that without some seller held financing, their buildings just won’t get sold. And sellers are opting to take the bulk of their money now, and some of it later, and facing the risk of default, rather than facing the risk of riding the market down further.

The biggest risk is of course the risk of default. On the plus side, you’ll be earning a return on your loan, and you’ll be deferring capital gains on the paper you held, paying it as the principal is paid down.

You can of course sell the note to a third party though expect to take a healthy haircut - in this climate cash is king.

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