How to record my owner financed note?

Question

I wholesaled a property and charged an assignment fee of $5800.

I took back a note and my buyer is paying me $300/mo a month until the note is paid off.

My bookkeeper is having a very hard time how to record this in Quickbooks?

How does she enter the "$5800" upfront as an "assignment fee", for example.

Then, when we get the $300/mo, how is that recorded?

Thanks

Rob

Kory Reynolds · Answer

Haha - I 100% agree with this - from a practical standpoint, this is how 99% of clients operate, and it works great. What I outlined is answering your question from a technical standpoint as that is how it was posted, but from the practical side this all takes more time that may not necessarily add any value to your day to day operations unless you are someone who just wants things "right". Out of hundreds of real estate clients, I think I have 3 that go to these lengths AND do it accurately. If you can't do it accurately, go as simple as possible and lay the trail for your tax accountant to true things up at year end.

Michael Plaks · Answer

@Robert L. Leave it to an East Coast accountant to complicate things... @Kory Reynolds :)Down here in Texas we prefer simplicity. First, forget the accrual method if you value your sanity. Stick with the cash method. Under cash method, you record income as actually received and expenses as actually paid.Your "took back a note" on a wholesale deal is unclear. Are you saying that, instead of the entire $5,800 paid at closing, you only collected a portion of your assignment fee, and the rest is paid as monthly payments? If yes, then you simply record whatever you collected as income, and you can ignore the note for all practical purposes. Under cash method, the note does not really exist. No more than a promised future salary that has not been paid yet.As to your actual note, you can burden your bookkeeper with a monthly task of breaking out each payment into components: principal return, realized gain, Sec 1245 recapture, Sec 1250 recapture and interest - as Kory suggested. Far more practical is to record your monthly payments as 100% realized gain (or 100% anything else, like interest) and then let your tax accountant make an annual adjusting journal entry to split it properly.

Kory Reynolds · Answer

@Robert L. - Anytime! No compensation of any kind - this is what the forums are for! Your initial entry is almost correct - the entire $39k would not go to the deferred gain, as a portion of the gain would be recognized. For tax purposes this would be an installment sale (assuming this is not a flip), and you would be able to recognize the gain over time. For the purposes of this example I'll assume the purchase price of $55k was entirely to 1250/capital gain property - no personal property (furniture/equipment). You would look at the ratio of your basis to the total proceeds, and apply that to the gain. IE your gain on the sale is $39k, divided by the sales price of $55k, you get a ratio of 70.9091%. On that initial downpayment of $10k, multiplied by this ratio, it means that about $7100 is recognized gain. Meaning that you would record your $32k deferred gain, and $7k of gain income.As the payments come in you would apply this ratio to the PRINCIPAL amount received (not interest) to determine how much income should be recognized. The result entry would be a debit to cash, credit interest income, credit note receivable, then to recognize the gain a debit to the deferred gain, and a credit to recognized gain income.So to answer your question - not 86%, but 70.9% is the ratio used, which is also applied to the downpayment (the flaw in your current logic). Note that there are rules where if any of the gain is 1245 property (personal property / equipment / furniture), that gain is recognized entirely in the year of the sale and is not a part of the installment sale ratio calculation. Also note that if the sale is as a flipper, this would not be eligible for the IRS installment sale method as the installment sale is not eligible for ordinary income property. With the deferred revenue rules currently in place, for a flip you could potentially delay recognition for up to a year, but you don't get anywhere near as good as treatment as you do with the installment method.

Kory Reynolds · Answer

You would record an asset "Assignment Fee Receivable" for a debit of $5800, then a credit to revenue of "Assignment Fee Revenue." As the money is received each month, the effective journal entry would be a debit to cash, and a credit to the Assignment Fee Receivable account. Note that for tax purposes, if you are cash basis, you only need to pay tax on the amount of the fee received in the current year. I would make sure your tax accountant is aware of this and accounts for it properly so you don't end up paying tax on money you haven't yet received. If you are accrual basis, you are allowed to defer revenue up to one year when reported correctly, so you would report the amount actually collected in 2019 as taxable in 2019, and the balance would be taxable in 2020, even though it sounds like amounts will be collected past that date.

Kory Reynolds · Answer

If your tax accountant does it correctly, there would be a 'book to tax' adjustment at tax time to recognize the difference between the cash method and accrual methods of accounting, so you would not be taxed on the full $5,800 even if you recorded it in Revenue. This is very common so people can record what is owed to them and what they have earned for their own book records, even if they have not yet collected it and do not owe tax on it yet. You are correct that instead of Revenue you could put it in a "deferred revenue" liability account, but this would not change the tax impact. If it was put into a deferred revenue account, the initial entry would be a Credit to Deferred Revenue, Debit to the Receivable. When the money was received it would be effectively a four line entry - debit cash, credit receivable, debit deferred revenue, credit revenue.

Robert L. · Answer

@Kory Reynolds, @Michael Plaks, We're still not clear on what the cash entries should look like (sorry). In summary: Cost of property: $29k (13 years ago) Sold for $55k: a) New buyer's down payment - $10k b) New buyer's remaining mortgage note- $45k New buyer's monthly payment - $394/mo (Prin/Int)Accumulated Depreciation - $13k What would the journal entries be to record the sale of this property to remove it from the books using cash method? What does it mean when you say: have the accountant "true things up at the end of the year"?Rob

Robert L. · Answer

I would love to book it the cash method. Can you show me the journal entries I would need to book for sale of the property with installment payments? I am not sure how to remove the property from the book in the cash method for owner financed property. We do use the cash method. Thank you!

Robert L. · Answer

Thank you Kory...that actually helped her out a lot!I really appreciate your time and would like to compensate you for your time somehow!There's another owner financed situation but for a house that I sold personally. She doesn't know how to record this one because it is different than this assignment fee.My house sold for $55k and buyer put a $10k down payment.The other $45k was taken back as a note which he has already started making payments of principal and interest.Is this the correct way to record the original entry of the owner financed property:Debit cash - $10k (down payment)Debit Notes Receivable - $45k (remaining mortgage note)Debit Accumulated Depreciated - $13kCredit Cost of property - $29k (my original purchase priceCredit Deferred Gain = $39k QUESTION: Is the deferred gain above correct? Is this a liability account or a contra account to the notes receivable? Then, when the monthly payments arrive, record it this way below. I am not sure how to record for the deferred gain each month. Is it 86% (39K/45K) of $20? Thanks in advance for your help!Debit Cash - $394 (monthly payment PI)Credit Notes Receivable - $20 (assuming this is the principal)Credit Interest Income - $374 (interest portion of payment)Debit Deferred Gain ???Credit Realized Gain ???Thank you again!Rob

Robert L. · Answer

Thanks Kory!If she credits the "Assignment Fee Revenue" the full $5800, isn't that considered income so that the full $5800 will be taxed and will be reported? If she records it as revenue, then that means she already go the money, right? Is there another account like some deferred type of account to record the $300 that comes each month so that only that received amounts are taxed. She doesn't know how to record the installment amounts.