Vendor-take-back Mortgages, Tax Benefits? Options

[betrina]

It is my understanding that vendor-take-back mortgages give the seller of the property some tax advantatges becasue they don't have to declare all their capital gains in the year that they sell the property. Can anyone give me more details on the tax benefits of carrying a portion of the mortgage?

Also, I have a vendor who is looking to liquidate approximately 30 properties over the next few years. Any tax tips I can pass along to him?

Thanks,

Trina Burgess
780-435-9286
Fairview, Alberta

This post has been edited by betrina: Sep 10 2007, 02:17 PM

[DonCampbell]

A vendor who provides a vendor take back mortgage can, withthe help of an accountant, elect' (CRA Term) to defer the tax due on this amount up to either the length of the VTB or 5 years whichever is shortest.

If there are payments made during the VTB period, these must be declared in the year in which they receive the payments.

The income tax (capital gains) deferal is only available on the amount of the VTB, not the complete amount.

The vendor, especially with the size of this portfolio, should make sure he is speaking directly with a real estate specific accountant in order to maximize his benefits and deductions. If he has taken depreciation on the property while owning it, he will have to recapture these deductions upon sale and could surprise him/her with the size of the tax bill, thus making the VTB even more attractive.

[heslopg]

It is my understanding that vendor-take-back mortgages give the seller of the property some tax advantatges becasue they don't have to declare all their capital gains in the year that they sell the property. Can anyone give me more details on the tax benefits of carrying a portion of the mortgage?

Also, I have a vendor who is looking to liquidate approximately 30 properties over the next year or so. Any tax tips I can pass along to him?

Thanks,

Trina Burgess
780-435-9286
Fairview, Alberta

I'm not sure if this tax advantage with specifically apply to a VTB. I believe there is a very good tax case to be made for the vendor (particularly vendor with large equity and large capital gain) to sell the property to you on an Agreement of Sale....commonly refered to as a 'Wrap". Basicaly (if you aren't familiar) you would complete a purchase agreement with the vendor where he retains title and you make a downpayment and then payments at an agreed interest rate for a period of time, at the end of which you re-finance the property and buy him our (I've sold this way).

This works particularly well for investors who are selling rental property they've owned for a LONG period of time, have 100% equity and have HUGE capital gain issues to deal with.

Example:

• $100,000 propety...originally purchased for $25,000
  • If sold cash the vendor will realize a 75,000 gain...50% ($37,500) will be added to his income for the year the deal closes...about 50% ($18,750) if which will likely be paid in tax...thus net spendable cash of $56,250+$25,000=81,250.
• Your purchase property from him on an Agreement of Sale (WRAP) contract for $100,000 with $20,000 down (sample amount)
  • Vendor finances the property with standard mortgage of 75% ($75,000)...all of which goes in his jeans today...plus your $20,000 downpayment.
  • You make payments on $80,000 to him, he makes payments on $75,000 to bank and keeps the interest on the $5,000 difference.
  • Vendor works with his accountant and declares the capital gain income over five years income tax....$15,000 per year, half of which is subject to tax...$7,500. $7,500 per year added to his annual income for the next five years, rather than $37,500 in one year will no-doubt make a HUGE difference in the tax bill for the average vendor...plus he has $80,000 cash (in this example) to spend almost exactly the same as before....and five years of interest income.

Use this concept as a starting point and start getting creative. I have the CCRA publications on my computer...would post them but can't figure out how...send me a message and I'll be glad to send them to you.

Glenn A. Heslop
GlennAlan Homes

[RussellWestcott]

Howdy all, you may want to read this article written by my accountant.

Click here to read this artice by Navaz Murji

When it comes to talking about taxes, it is always best not to 'swim alone' and talk to your personal accountant

[heslopg]

Howdy all, you may want to read this article written by my accountant.

Click here to read this artice by Navaz Murji

When it comes to talking about taxes, it is always best not to 'swim alone' and talk to your personal accountant

Right on Russell. Thanks for the article.

There were two things I intended to write but forgot:

1. Think through the pros & cons of VTB vs. WRAP. My thoughts were that the tax advantages for the vendor provided lots of incentive to the vendor to pursue a WRAP vs. a traditional sale. This means one-less mortgage for you to qualify for...I would work to sync the WRAP buy-out date with the vendor's mortgage term.
2. Find the CCRA publications (IT152R3 & Capital Gains Guide) and take them to your accountant BEFORE you negotiate a deal. I doubt that most tax-accountants are aware of this, it will be important to have your accountant understand this ahead of time, as you may need to get him to expain it to the vendor's accountant....remember your accountant's chat will mean more than our explaination

Thanks again Russell.

Glenn.

[Guest_MarkGarrett_*]

One other suggestion on the VTB is to have the vendor use an RSP Mortgage (1st or 2nd).

How that would work is that on sale, the vendor now has a lot of captial... if they have room in their RRSP account, they can make a contribution (and at tax time receive a tax refund).

You close with 25% down, then the vendor makes their contribution and places an RRSP 2nd mortgage on the property.

If you use TD Waterhouse, you can set it up so it is a balloon payment. Thereby achieving a higher LTV without affecting cash flow.

Again, always consult an expert in both tax and legal questions but we have done this quite successfully.

Good luck.

[betrina]

The vendor I am working with talked to his accountant about carrying a portion of the down payment. His accountant advised him that he is crazy to be selling right now - he should just hold on to the properties, and if he does sell them not to do the VTB because it can be very difficult to get your money out on a 2nd mortgage if the buyer defaults.

So this one isn't going to be as easy as it first appeared. Any advice?

[BHoward]

The vendor I am working with talked to his accountant about carrying a portion of the down payment. His accountant advised him that he is crazy to be selling right now - he should just hold on to the properties, and if he does sell them not to do the VTB because it can be very difficult to get your money out on a 2nd mortgage if the buyer defaults.

So this one isn't going to be as easy as it first appeared. Any advice?

Hi Betrina,
Your vendor has his team of 'trusted experts'. His accountant in one of them ... and you maybe another. His accountant is probably risk adverse ... and will not listen to creative 'out of the box' ideas/solutions. However, his accounant recommended against selling - I assume - because he thinks the market will continue to increase. (...smart accountant).

You have an opportunity to learn the 'real deal' ... become the expert ... then do you best in explaining it to the vendor.

Provide the vendor with the information on tax advantages of giving a VTB. (If the vendor is selling because he is afraid the market will go flat ... or decrease in price ... he may never be comfortable giving a VTB.)
Explain LTV (Loan to Value) ... he's at little risk if the 1st and 2nd mortage is at less than 85%.

Give him the information.

You will have the information for another potential vendor - if he decides to 'side' with the accountant.

Also, if this guy is planning to sell 30 properties in next few years ... he should see a tax lawyer. (Depending on his situation ... he may want to set up a family trust. He could save substantial amounts on tax.) Richie Mill Law office in Edmonton can help him understand if he may want to do a 'corporate restructuing'. My accountant recommended JR MacDonald at Vogel & Company in Calgary ... 403-255-2636.
Bryon

[grhutchings]

Howdy all, you may want to read this article written by my accountant.

Click here to read this artice by Navaz Murji

When it comes to talking about taxes, it is always best not to 'swim alone' and talk to your personal accountant


Russell.

Thanks for the article. Fantastic information. I greatly appreciate knowing that when I come into my REIN backoffice I can always find information on whatever topic I am looking for.

You guys are awesome.

George Hutchings
www.sellmeyourhomefast.com
Hutchings Investments