Buy “Seller Gets a New 1st Mortgage” then Sub2 Purchase
Buy “Seller Gets a New 1st Mortgage” then Sub2 Purchase
Cash-Out Refinance + Subject-To Acquisition + Land Trust
This advanced strategy combines three powerful techniques: a cash-out refinance, a subject-to acquisition, and a land trust structure. The seller pulls equity out of the property through a new first mortgage, then sells the property subject-to that loan. The result is a win-win: the seller walks away with tax-free cash, and the investor acquires a property with built-in financing at favorable terms.
How the Strategy Works
The strategy unfolds in three phases:
| Phase | Action | Result |
|---|---|---|
| Phase 1: Cash-Out Refinance | Seller refinances the property, pulling out equity at 60-80% LTV | Seller receives tax-free cash; new first mortgage in place |
| Phase 2: Subject-To Purchase | Investor purchases the property subject-to the new loan | Investor takes control with minimal cash down |
| Phase 3: Land Trust | Property is placed into a land trust | Privacy protection + potential due-on-sale mitigation |
Phase 1: Seller Gets a New 1st Mortgage
Understanding Loan-to-Value (LTV)
Loan-to-Value (LTV) is the ratio between the mortgage’s principal balance and the property’s appraised value. For example, a $100,000 property with an $80,000 mortgage has an LTV of 80% [citation:3].
Cash-Out Refinance Limits for Investment Properties
For investment properties, conventional lenders typically cap cash-out refinances at 75% LTV for single-family homes. Some lenders allow up to 80% for well-qualified borrowers, but 75% is the practical ceiling for most investors [citation:14].
| Property Type | Maximum LTV (Conventional) | DSCR/Portfolio Lenders |
|---|---|---|
| 1-Unit Investment | 75% | 75-80% |
| 2-4 Unit Investment | 70% | 70-75% |
Sources: Fannie Mae Eligibility Matrix, Valley West Mortgage [citation:9][citation:14]
Example: Seller’s Cash-Out
Property Value: $300,000
Existing Mortgage Balance: $120,000
Seller’s Equity: $180,000
New First Mortgage at 75% LTV: $225,000
Cash to Seller After Payoff: $105,000 (minus closing costs)
Why the Seller’s Cash Is Not Taxed
A cash-out refinance is treated as debt restructuring, not income. The IRS considers the cash you receive to be a loan, not taxable income. Even if you receive $50,000, $100,000, or more in cash back, this money should not be counted as income from the IRS’s point of view [citation:2][citation:8].
Key distinction: This is not a sale. The seller is borrowing against equity, not realizing a gain. The cash is tax-free because it’s a loan that must be repaid [citation:13].
Why this matters for the seller: If the seller sold traditionally, they would owe capital gains tax on their profit. By refinancing first, they extract cash tax-free, then sell subject-to. The refinance is a loan — not a taxable event.
Phase 2: Investor Buys Subject-To
After the seller completes the cash-out refinance, the investor purchases the property subject-to the new first mortgage. The loan remains in the seller’s name, but the investor takes control and makes the payments [citation:10].
Why This Structure Benefits Both Parties
| Party | Benefit |
|---|---|
| Seller | Walks away with tax-free cash; relieved of property management; avoids traditional sale |
| Investor | Acquires property with built-in financing; no bank qualification; low cash down |
Key Consideration: Seller Remains Liable
In a subject-to deal, the original borrower remains liable on the loan. If the investor defaults, the seller’s credit is damaged. The seller must understand and accept this risk. This is why the strategy works best with motivated sellers who need cash and are willing to accept the ongoing liability for a period of time.
Phase 3: Land Trust Structure
Once the subject-to purchase is complete, the property is placed into a land trust. This provides two key benefits: privacy and potential due-on-sale protection.
How the Land Trust Works
- Trustee holds legal title to the property
- Investor is the beneficiary (the true owner, not disclosed in public records)
- Seller assigns their beneficial interest to the investor
Due-on-Sale Protection Under Garn-St. Germain
The Garn-St. Germain Act (12 USC 1701j-3) prohibits lenders from enforcing due-on-sale clauses in certain situations, including transfers into an inter vivos trust where the borrower remains a beneficiary [citation:6][citation:12].
By placing the property into a land trust where the seller remains a beneficiary (initially), the transfer may not trigger the due-on-sale clause. The land trust provides the best available mitigation of due-on-sale risk.
⚠️ Important Caveat: While the land trust provides mitigation, it does not eliminate the risk entirely. The lender could still call the loan if it discovers the transfer. Always consult a real estate attorney before using this strategy.
Full Example: Putting It All Together
| Step | Action | Numbers |
|---|---|---|
| 1 | Property appraised value | $300,000 |
| 2 | Existing mortgage balance | $120,000 |
| 3 | New first mortgage at 75% LTV | $225,000 |
| 4 | Cash to seller after payoff | $105,000 (tax-free) |
| 5 | Investor purchases subject-to | Takes over $225,000 loan |
| 6 | Property placed in land trust | Privacy + due-on-sale mitigation |
| 7 | Investor’s cash out of pocket | Minimal (option fee/earnest money) |
Key Benefits
- Seller gets tax-free cash: Cash-out refinance proceeds are treated as a loan, not income [citation:2][citation:8]
- Investor gets built-in financing: Takes over an existing loan with no bank qualification
- Low cash requirement: Investor needs only minimal funds to close
- Privacy protection: Land trust hides ownership from public records
- Due-on-sale mitigation: Garn-St. Germain Act provides protection for transfers into trusts [citation:6]
- Preserves favorable rates: If the new mortgage has a good rate, the investor keeps it
⚠️ Risk Warnings
Seller Remains Liable: The original borrower remains on the loan. If the investor defaults, the seller’s credit is damaged.
Due-on-Sale Risk: While the land trust provides mitigation, the lender could still call the loan if it discovers the transfer.
Lender Scrutiny: Some lenders actively monitor for subject-to transactions. Increased scrutiny may lead to enforcement actions.
Legal Compliance: Subject-to transactions and land trusts are regulated differently by state. Always work with a local attorney.
Tax Implications: While cash-out proceeds are not taxable, the seller may face tax consequences on the subsequent subject-to sale. Consult a CPA.
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Disclaimer: This page is for educational and informational purposes only. It does not constitute legal, financial, or tax advice. This strategy involves complex legal, tax, and financial considerations. Always consult a licensed real estate attorney, CPA, and financial advisor before entering into any transaction.
