5 Myths About Selling A Minneapolis Duplex On A Contract For Deed

When I consult with long-term Minneapolis and St Paul duplex, triplex and fourplex owners thinking selling, we talk about taxes.

Specifically, capital gains tax and depreciation recapture.  The toll can be substantial for many housing providers who’ve owned for decades.

Most don’t want another property, not even a hands-off investment like a Delaware Statutory Trust is an option for some owners. Most, however, want to cash out with as few tax consequences as possible.

Another way to do that is to sell the property on a contract for deed. This suggestion often terrifies people, which surprises me. It’s usually because they don’t truly understand it.

A contract-for-deed is simply an installment contract, where the buyer pays the seller a monthly payment rather than making that payment to a bank.

Common misconceptions about a contract for deed include:

1. The buyer doesn’t give the seller a down payment. The terms of a contract for deed are negotiated between a buyer and seller. This is advantageous to a seller, as it provides an opportunity to strategize with a tax professional about offsetting gains and depreciation recapture. In my opinion, it is always a good idea to get a big enough down payment to make it painful for the buyer to lose.
2. It’s risky. The seller can and should do not only a credit check, but also ask for a financial statement from the buyer. A contract for deed does not necessarily mean the buyer has bad credit, nor that they don’t have any money. The seller can decide their minimum criteria and decline to carry the note if that threshold isn’t met.
3. The seller is paid over 30 years. While the loan is typically amortized over 30 years in order to make the payments realistic and affordable for the buyer, the seller rarely has to hold it that long; unless, of course, they choose to. Most contracts for deed have a balloon payment a few years down the road, at which time the buyer agrees pay off their obligation with the seller by refinancing with a bank.
4. The buyers will default and the seller will get the property back. If a buyer has a significant financial interest in the property, odds are they will take care of it. And as a contract is whatever two people agree to, the seller can stipulate that no major repairs above a certain dollar amount are performed without their prior consent.
5. It’s a legal hassle to get it back if the buyer defaults. If a buyer defaults on payments or doesn’t meet other contract obligations, the seller can foreclose by simply giving the buyer 60 days notice.

I’m not an accountant, but the advantages to sell on a contract for deed include:

• Spread capital gains tax and depreciation recapture over time. Capital gains taxes are paid on the principal of the payments above and beyond the adjusted basis. Contracts can be structured in a manner that allows the seller to cash out at an optimal date and time for their tax obligations.
• Mortgage interest is taxed as ordinary income. The state of Minnesota allows sellers to charge up to 8% interest on contracts they carry. The interest paid is taxes as ordinary income, which is at a lower rate than capital gains or depreciation recapture. This allows the seller to pocket more money than they may have in a traditional sale.
• The seller continues to have monthly income, with none of the work.

If you’ve owned your duplex a long time, but are afraid selling it may cause you to lose too much money through taxes, give me a call. There may be a way, and a buyer, that can help you have the best of both worlds.