I just negotiated a deal with the owner to buy his house which he used as a rental property for past 8 years since he bought the house. The verbal cost of buying was finalised for 245,000. No contract has been signed as yet. After talking to my friends, i asked the owner to make a contract for 250,000 and give me back $5,000 as closing costs. this will help me in getting loan on 250,000. However, the owner says that if he does that, he will have to pay capital gains tax and income tax on the extra 5,000, and so he refuses to do so, or else he says that he can pay me 3,000 instead of 5,000 to offset the cost of taxes.
Cant he show the extra 5,000 as his selling cost and not have to pay tax on it? Is there any way that I can convince him to do so. It will help me in getting a loan on higher amont and that money I can use for minor renovations.

“No contract has been signed as yet. After talking to my friends, i asked the owner to make a contract for 250,000 and give me back $5,000 as closing costs. this will help me in getting loan on 250,000. However, the owner says that if he does that, he will have to pay capital gains tax and income tax on the extra 5,000,”----> If you lie on your real estate loan application, it's mortgage fraud. Even tiny white lies constitute mortgage fraud. It is a big deal. So-called "creative financing" went out in the 1970s, along with bell bottoms. If the lender subsequently discovers any part of your loan application is false, not only can it demand immediate full payment of your loan but you could pay six-figure fines, find FBI ringing your doorbell and / or go to jail. The FBI defines mortgage fraud as "any material misstatement, misrepresentation or omission relied upon by an underwriter or lender to fund, purchase or insure a loan." If you have two purchase contracts and send the false contract with the higher sales price to the lender in hopes of obtaining a higher appraisal, it's mortgage fraud. If you strike a deal with a home seller to give you a big wad of cash or to slip a check across the closing table, say, to pay for a new roof, and if the lender doesn't know about it -- because it's not disclosed in the purchase contract nor addendum nor your estimated closing statement -- it's mortgage fraud. On the sale of the rental home, he will be required to pay tax at the capital gain rate for the excess amount. If his total income (including capital gain income) places him in the ten or fifteen percent tax brackets, then, he doesn’t need to pay any LTCG tax on his LTCG of $5K.However, as long as his marginal tax rate is 25% or higher then, he needs to pay LTCG tax of $750; $5K*15%.
“and so he refuses to do so, or else he says that he can pay me 3,000 instead of 5,000 to offset the cost of taxes.”---->As described above, the cost of the LTCG taxes is $750. Then he needs to pay you the remaining $4,250($5K-$750) after the LTCG tax, NOT $3K.
“Cant he show the extra 5,000 as his selling cost and not have to pay tax on it?”-----> As the sale of his main home is reported on Sch D/Form 8949/Form 4797(the proceeds will be reported to him on form 1099-S and he needs to enter the gross sale price of the rental home on line 20 under the column for Property A and on line13 of 1040.)showing the gain reported , he needs to pay LTCG tax on the gain ,the excess of the amount realized over the adjusted basis of the property.
“ Is there any way that I can convince him to do so. It will help me in getting a loan on higher amont and that money I can use for minor renovations?”----->As described above. I guess you need to consult with real estate professional for more accurate information in detail for legitimate transaction for yur goal.

Thankyou for the info. I actually meant to have this type of arrangement in a proper contract legally and show 5000 as the closing cost bore by the seller. Any way, I think it is not worth it if I have to pay tax on it.

Thank you for the clarification

" I actually meant to have this type of arrangement in a proper contract legally and show 5000 as the closing cost bore by the seller"--->Correct; in that case, the transactioncan be legitimate.

Then as desribed previoulsly, the seller 'd b subject to LTCG tax on the 45K additonal capital gain as long as the seller's tax bracket is hihger than 15% for 2012.

I think you are correct. But i think there is no point in paying 750$ to get 5000 more as loan if we are not very hard pressed.

"But i think there is no point in paying 750$ to get 5000 more as loan if we are not very hard pressed."-->Corret I mean $750 is LTCG tax. Not tax to get an additinal loan of $5K ,OK???

Oh yes. That's clear. Thanks a lot