All Forum Posts by: David Collins

Generally when debt is settled for less than its face amount, the difference is considered taxable income to the obligor.

The rationale, as it applies in this case, is pretty easy to see---if Seller accepts the offer, you'll end up taking depreciation deductions on the property, and/or reducing any future sale gain, by 6K more than the total cash you actually paid for the property, when all's said and done. Taxing the note discount just evens things back up. (Although certainly not from a timing perspective: You've paying tax on 6K now, in exchange for an extra 6K of depreciation dee-ducks later.)

There are certain situations in which debt reduction is treated not as immediate taxable income, but rather as a reduction of the basis of depreciable property. That does address the timing hardship I mentioned above, but, I think these situations apply generally in the insolvency / distressed space.

Nevertheless, it's been a couple hundred years since I frolicked merrily :wink: in this area of the tax code, so definitely stand by for further opinions. Best of luck!

Good advice here already. In addition, though, keep in mind the so-called interest "tracing" and "allocation" rules. These tax rules provide that the categorization of interest expense depends on how the proceeds of the debt is used.

Thus, it's not the fact that a loan is secured by rental property that makes the interest "rental" expense, it's the fact that the loan was used to acquire the rental property. If you borrow against a rental property and use the proceeds for, say, a vacation and a new boat, the interest on the loan will not be deducted on Sch E as a rental expense. (It'll most likely be nondeductible personal interest.)

On the other side of the coin, if you get a cash advance against a credit card and use that cash to make a down payment on a rental property, then an allocable portion of your credit card interest will be "rental" interest on Sch E.

Check out IRS Publication 535 for more info.

Schedule E is used for individuals to report their real rental activity. If the property is held by an LLC, partnership, or S Corp, they'd be reporting it on Form 8825. Rental activity conducted by a C Corp is included in the corporation's basic tax return (Form 1120). Ergo, it's certainly possible that they don't file a Sch E.

What's troubling, though, is that they simply responded that they don't "file Sch E" and let it go with that. As mentioned above, they certainly report the rental activity in some manner, and their reluctance to share that data with a potential buyer raises questions.

On the other hand, if they're simply not reporting the rental activity, well, that's a whole 'nuther can of worms.

I hope that helped a bit. Good luck!

Corey, the limit that I mentioned in the second post--dealing with Code Sec 1237--doesn't relate to land contracts, but rather to developers. I only suggested that maybe it was the limit (5 lots max) that Scott had heard about. Incidentally, that provision isn't a ceiling on how many lots you can develop. It simply provides a threshold that allows small, 'one-time' development activities to use simpler and more favorable tax rules than those which apply to the 'professionals'.

Scott, a determination of "intent" usually comes down to actions and documentation. Nothing is off limits from being taken into consideration. For example, if you had paid a consultant for a rental feasibility analysis as a part of your acquisition DD, and immediately upon acqusition you began marketing efforts to some extent to acquire tenants, a court would probably find that you bought the property with a primary intention of renting it.

On the other hand, selling a call option on the property or negotiating for its resale as soon as you buy it (or even before) would make it difficult to escape a "flip" intent ruling.

Unfortunately, it's very facts and circumstances-ish. There isn't a well-defined list of things you can do to bulletproof (or absolutely sabotage) your desired tax consequence. There is, though, a large body of literature on the subject (court cases, IRS rulings, expert commentaries), and if it comes down to a critical issue involving significant bucks, it'll likely be a good investment to pay a tax pro to advise you based specifically on your particular fact set.

Best of luck with it!

Rich, that appreciation (54 to 192 in 17 y) averages out to a 7.747% annual growth, compounded annually. As you've pointed out, that overall average is just a weighted average, of sorts, of the different specific appreciation rates over different segments of the 17-year period. But that overall average is useful, at times.

Your particular ROI, based solely on the data in your post comes out to a nifty 19.18% annual ROI, with monthly compounding.

For the delight of those with a legal orientation, the usual disclaimers: (a) No expenses (rep & maint, prop tax, etc) are in the calcs. (b) I lazily assumed those rent escalators came in evenly over the rental period. (c) I assumed you paid cash for property originally--i.e., no financing. (d) And a couple of other little simplifications to make my day easier.

I'm now going to let a good single malt take the edge off the sudden awareness that I had too much time on my hands this afternoon. Cheers, all,

Oh, I can't say a word...if I had a nickel for every one of my "calculator faux pas", well, I'd need a piggy bank slightly larger than a Volkswagen.

Nope, and I'm glad you brought it up, 'cause it's a huge factor, and although I mentioned it near the end of my post (along with the "pre-tax" caveat), I'm afraid it might be overlooked.

I was just playing off of the original tenor of the thread, which looked primarily at the return generated by the property's appreciation, and I just made a couple of tweaks to those calcs.

Bringing the rent revenue stream into the mix is gonna juice up the ROI nicely. As a side note, I'd advise letting Excel (or your favorite spreadsheet weapon of choice) do the heavy lifting. That'll let you play plenty of "what if" games with assumptions regarding rent escalators, property expenses, taxes, etc.

Regards, PDC

Great discussion, gentlemen! I'm kinda late to the party (just back in town), but if I might add a couple of pennies' worth...

Using the numbers from J Scott's post, we've got the property purchased for 100K originally, and appreciating at 5% pa for 30 y, to 432K. Loan payments plus the 20K down pmt bring our total cost up to 192,800.

With that fact set, our overall ROI is (432,000 - 192,800) / 192,800 = 124.1%. Equivalently, it's the 224% calculated previously, less 1. The previous calculation didn't first deduct the cost. It's like investing 100 today, and cashing out for 110 in one year. It's true that 110 / 100 = 110%, but clearly the ROI was 10%.

Since most investments assume at least an annual compounding, we should do likewise in "annualizing" our ROI, to give us a decent apples-to-apples. And further, as J Scott points out, only 20K of the cost is paid up front, with the remainder spread linearly over 30 years.

Running those numbers, the annual ROI on this hypothetical comes in at 4.4%.

Instinct immediately says something's wrong...if the property's appreciating at 5% a year, how can the overall ROI be less? The fly in the ointment is the financing. We're assuming a cost of money at 6%, against a property that's appreciating at 5%. Borrowing 80K at 6%, and putting that cash into an investment that grows at 5% has a slight negative return effect on the overall results. Had we simply paid 100K cash up front, no financing, our ROI would have been precisely 5% per year.

But of course, this is relying solely on the appreciation as our return source. Throw in the rent income and it's a whole 'nuther game. And of course, this is all pre-tax stuff.

I'd finally add an agreement that nearly all asset classes are quoted at nominal (pre-inflation), rather than real (post-inflation) returns.

Thanks for listening, guys. Cheers!

Sec 453 certainly gives the impression of drawing a bright line for us--at first glance, anyway. That bright line gets smudged into near oblivion when one then tries to deal with the "real property held for sale to customers" portion of the definition.

That's when you get into that "intent" factor that Scott has been hearing about. If the requisite "dealer intent" is established by IRS / court, then 453 steps in with a clear and unambiguous result, as you suggest. But 453 can't come to the party in the first place until such intent is established, and that's where it comes down to a facts-and-circumstances determination.

Scott, that's why the results of your homework so far, from the experts you've consulted, indicate that it hinges significantly on that subjective intent factor.

Scott, very generally speaking, the "occasional investor" can sell property using the installment method for tax purposes (reporting gain only when and as the cash is received), whereas a "dealer" must report the entire gain in the year of the sale.

Clearly, the dentist who infrequently dabbles in property deals can get installment treatment for his gains, whereas the chap whose sole source of income is his full-time business of doing property deals is a "dealer". But in between those two obvious extremes, where's the line drawn?

There's no bright-line test which unambiguously determines whether one is a 'dealer' or not. (There is a 5-lot max rule in Code Section 1237 (h)(1) which you might be thinking about, but it relates to development activities.) The dealer-or-casual-investor is a huge facts-and-circumstances issue.

In a previous life as a tax advisor, I spent many hours sifting through numerous Tax Court cases in which this issue was debated. Bottom line is the particulars of any given situation will determine the outcome.

Best bet is to have a tax pro--one with experience in this area--advise you based on your particular situation. Next best bet: There's a boatload of 'dealer-vs-casual-investor' info on the 'net, thanks to the popularity of the issue. Many law firms and CPA houses have published articles on the topic. Peruse some of these, and you'll get a good feel for the factors that are used in making that determination.

Best of luck!

...it was early and I was full of no coffee...