I know there are risks to this, but I'm only asking about viability.

Let's say I buy a property in the United States and did a one to three year rent back to the previous owners. The sellers would live rent free for the term of the rent-back. I would buy the property at a lower price to compensate for the loss of rent. Would I need to pay taxes on the price differential (purchase price to market value)?

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    The real estate lawyer who draws up the contract would hopefully know. (Or they might charge $300 to ask a CPA...) – RonJohn Nov 18 '19 at 18:15

This depends on the taxation laws, but generally:

  1. If you have invented a trick to avoid taxes, it may be considered inappropriate by the tax authorities. Where I live, this goes as far as this: if you sell a stock and immediately buy it back to optimize your taxation, they won't accept it.

  2. Even still, taxation is typically applied to all gains: income and capital gains. If you buy the property at a lower price, you will eventually have to pay taxes on the price differential if capital gains taxation are applied where you live. Where I live, capital gains tax rate is the same as rent tax rate, so this would at most delay the taxation. The amount of taxes paid eventually would be exactly the same.

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  • What about the exemption for sale of your personal residence? Seems like you might actually be trading an exemption for tax liability in this case. – Michael Nov 19 '19 at 21:20

I don't think so, but I would check with an accountant to make sure. You will probably also want to consult with an attorney to draw up a proper lease.

Some may say that this is totally avoiding taxes, but it isn't. When you go to sell the property, your cost basis will be less and therefore you will potentially have to pay more taxes then if you had bought it at the market rate.

Initially, this looks like a far better deal for you than the sellers. Why would they agree to such a thing? Also weird situations like this are created for a reason, often times unwholesome. What happens if the property taxes or insurance increase dramatically? Does that make this a good deal? Maybe the property needs extensive renovations (like an HVAC) and this is their way of getting you to pay for it.

If this was a short term thing, I would be fine with it, but three years make it seem like a con in the making. Taking the "free rent for a discount" thing out of the picture, would you want to own this property as an investment? Often times the answer to that is "no" which gives you a reason to walk away. In the case that it is "yes" why not do a more conventional deal?

Having had some experience with this lately, there could be some issues if the sellers declare bankruptcy. If they sell you something at below market value you could be forced to repay the difference and then you would a creditor like anyone else.

If you have that much extra cash, to forego income on an investment property for three years, there are probably much better deals to be had.

It is somewhat common for owners to sell a house and then rent it back from the buyer for a few months. Most often this coincides with the end of the school year, so kids are not uprooted in the middle of a school year. Typically the transactions are atomic, the house is sold at market rate, and the rent and lease is at market rate.

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    And they might trash the place. – RonJohn Nov 18 '19 at 19:15
  • This is a theoretical question at this point. I'm just thinking about how something like this can be structured. Without going into any of their story, I have personal friends that I believe would benefit more from a lower cost of living (living rent free) for a period of time than having a lump sum equity upfront (HELOC or sale). The terms would be favorable to them. At least, I'm thinking of giving them the option. – Arfo Nov 18 '19 at 19:29
  • Yes, they would be taking on my credit risk in exchange for the possibility of more favorable/kinder terms. – Arfo Nov 18 '19 at 19:33

No. No need. This is simply you buying the house at a lower price because it is worth less. It is worth less because it has an intractable tenant that you cannot remove for 1-3 years, and cannot collect rent from, because of a previous landlord-tenant commitment that comes bundled with the property.

It would be exactly the same as if I owned a real rental property with a real tenant; the tenant paid up the rent 36 months in advance ($36,000) which I spent. Now, I am selling the house to you to continue as a rental property. Because this house is encumbered with this $36,000 obligation to the tenant, the sale price will be nominally $36,000 below normal price.

Don't worry about the IRS. They'll do fine. Your cost basis for the house is lower, so when you sell the house, your capital gains will be higher. That is when the tax man will get his due.

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