Tracking Note Income (capital gain from sale or income)

[Daria B.]

I have been investing in notes since 2017 and it's been a pretty simple process. Several people in my area invest with a JV that manages the ins/outs and have had good results. We have had numerous discussions in our group about how to track income and what does that really mean.

Recently we had a note that was paid off so in essence it wasn't a sale - or was it? This is the first time a note was paid off by the borrower. 

We have had notes that truly were a sale and profited from what we originally funded to that of the sale and payments in-between that were what we gained as income.

I realize there are many levels to tracking and what is considered income (eg. capital gain, payments that are both principal and interest and is interest really only considered income where the principal is the capital investment). And then there is the discounted rate at which the CPA considers - not part of this topic.

To keep this very simple in terms of discussion: 

1-how do you track your profit when a note is paid off? Is it the same as a sale? 

For instance, you invest/fund to purchase a note at $60k for which the UPB is $120. If you sell after a couple years of payments for $75k then profit is anything over that initial $60k cost (sands any other expenses/fees just keep it simple). But if the borrower pays off the $120 (likely less since payments being made for a few years reduce the UPB), it's still greater than the initial $60k so do you consider that like a sale and just caulk it up to capital gain?

Just trying to keep this as a simple example - I realize there are a lot of moving parts to this.

[Chris Seveney]

@Daria B. To start I am not a CPA or attorney but the way my books are handled:

If a note is paid off or sold to another investor - mine are tracked the same. You have X amount of money spent on the note and Y amount of income. The delta is your profit and loss (which in my business notes are considered interest and taxed as ordinary income). 

So in your example you bought it for $60k and they paid you $125k off - you profited $65k. Also something to consider is if you bought it for $60k while they are paying, the interest you are making is also taxed. Some people think you do not start paying taxes until you are paid off - which the equivalent would be buying a $100k rental and collecting $1000 a month in rent and thinking that $1000 is not taxable. Of course it is - its income.