Your Client, a real estate agent named Mr. Chump, has asked you to assess the tax implications
Question:
Your Client, a real estate agent named Mr. Chump, has asked you to assess the tax implications of a proposed real estate transaction.
A - Alternative I: Mr. Chump is looking to sell real property with a FMV of $600,000, subject to a mortgage of $200,000, and with an adjusted tax basis of $100,000. The Buyer he is negotiating with will agree to assume the mortgage, plus provide a note in the amount of $350,000 payable over 5 years, along with a cash down payment in the amount of $50,000. Assume the first payment of the note is made in the year of sale.
B: Alternative II (Wrap Mortgage): Assume the same facts as above, but instead of the Buyer assuming the mortgage, the Buyer provides Mr. Chump with a note in the amount of $550,000. Mr. Chump will retain the obligation under the mortgage.
Under each Alternative calculate the following:
1. Amount and Gain realized by Mr. Chump.
2. Calculate the amount of gain Mr. Chump would recognize in Year 1 and Year 2.
3. List the advantages/disadvantages of the use of a wrap mortgage under Alternative II (both tax & commercial). Assume the interest rate on the underlying mortgage is 3% and the proposed rate on the installment note is 8%, comment on the spread and the risk of incremental leverage.
4. Comment on how the potential for an income tax rate increase could influence the use of Seller-Financing.