Structuring a wrap-around note when the seller still owes money on the underlying loan

Question

Take a mixed-use building where the seller would sell tomorrow if the buyer could get a loan. The buyer is self-employed two years, and most banks want three, so owner financing comes up. The seller still owes about $180k on a commercial note at 4.9% with a due-on-sale clause in it. The structure that gets discussed most is a wrap: the buyer signs a note to the seller for, say, $420k at 8%, the seller keeps paying the $180k underlying note out of the buyer's payments and keeps the spread. The spread looks attractive on paper. The real exposure is sitting between two obligations with an underlying lender who could call the loan if the transfer is noticed. The practical exposure depends heavily on whether the underlying lender is actively monitoring for transfers, which many do not do proactively unless a tax record or insurance change flags it. An all-inclusive deed of trust does not eliminate that risk, it mainly clarifies the payment mechanics and lien priority rather than curing the due-on-sale exposure. On the tax side, installment sale treatment when part of what is being collected also services someone else's debt is a real complication worth a CPA's specific attention before the note is signed, since the seller's basis and gain recognition on a wrap do not work exactly like a simple owner-carry note.

Rena Expert · Accepted Answer

A wrap doesn't remove the due-on-sale clause, it just puts a second layer of paper on top of it. Your lender's right to accelerate on transfer of title comes from your loan documents, and whether it's enforceable and how it's enforced depends on your state and on the specific language, so that clause needs a real read by an attorney before you price anything. An all-inclusive deed of trust is a documentation tool that describes the wrap and says the buyer's payments cover the senior debt. It doesn't bind your lender to anything.

On exposure, the thing that actually bites is timing. If the lender accelerates, you owe $180k on demand and your income is a buyer paying you monthly over years. That mismatch is the risk, not the spread. People handle it by holding reserves, by getting the senior lender's written consent, or by refinancing into something assumable first. Ask your lender in writing what they'd do on a transfer. Some commercial lenders will consent for a fee and a rate bump.

On the tax side, an installment sale reports gain as principal comes in, and the mortgage you leave in place gets treated as part of the consideration. If the debt you're relieved of exceeds your basis, you can recognize gain in year one whether or not cash showed up, which surprises sellers on wraps specifically. That calculation is a CPA job with your actual basis numbers in front of them.

The part you haven't raised: servicing. Don't take his payment into your personal account and pay the bank yourself. Use a third-party servicer that pays the senior lien first and shows both sides a ledger. If you ever end up in front of a judge, that ledger is most of your case.

dpatel_re · Answer

The spread math on those numbers is $420k at 8% against $180k at 4.9%, which is roughly $2,800 less $1,000 a month before taxes and insurance, so call it $1,800 of gross monthly on paper. Underwrite it against the acceleration scenario instead. If you had to produce $180k inside 30 days, where does it come from? If the answer is selling the note at a discount to a buyer who will price it at 12 or 14, that $1,800 spread was borrowed against a bad exit.

gregpowell66 · Answer

Two years self-employed becomes three years eventually. Ask what his path off your note actually looks like before you build a wrap around him. On the building side, watch who is carrying casualty. On a wrap you have a senior lender who wants to be named on the policy and a buyer who now owns the property and controls whether the roof gets fixed. A common failure is the insurance requirement in the senior note getting ignored because everyone assumes the new owner handled it. Then the policy lapses and the lender has a default reason that has nothing to do with the transfer.

Structuring a wrap-around note when the seller still owes money on the underlying loan

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