Case Studies: Deposit to Purchase

Deposit to Purchase

A client had just concluded making an acquisition of a business and after two years of renting the facility from the former owner, he was desirous of buying the property and creating a platform for making his occupancy costs more predictable.  The problem was that in accomplishing the initial purchase of the business, the balance sheet had been leveraged beyond what conventional lenders might consider a reasonable margin of safety.  Worse, the client did not have the necessary down payment to seek conventional or alternative mortgage financing.  A solution was identified whereby our client would enter into an agreement to buy the property on a deferred basis and instead of making his earlier rent payments, they would take the form of a non-refundable deposit against the purchase price.  By way of example, if the property was appraised at $1 million, the deposit to buy would be $8,333/month.  At the end of the first year, a deposit of $100,000 would have been completed or 10% of the agreed upon price.  Our client had the option of continuing to extend the deposit for an additional year before seeking financing.  Thus, the purchase price would have been $1.1 million ($100,000 of which would have already been deposited) and at the end of the second year he would have accumulated $200,000 in aggregate deposits or roughly 18% of the agreed upon price ($200,000/$1,100,000).  The seller did not have to declare the deposits as income since they were merely non-refundable deposits and the buyer (our client) did not have to expense the payments as rent, thereby increasing his earnings and reducing the leverage incurred from the initial purchase of the business on a more accelerated basis.  When the deposit to buy strategy was completed, the seller of the property recognized the transaction as a capital gain and not ordinary income, thereby significantly lowering his tax burden.  The result was a win-win for both buyer and seller.