Land sale with note

[TAX4US]

OK Here's what we got. TP loans to A 35k and holds land as collateral. A pays for 4 years and defaults. TP takes land 2012 and sells for 26k in 2014.( A still owed TP 26k). Land had a FMV of 30k at time of foreclousure in 2012.



Futher research shows that TP DID NOT REPORT interest as income. This all took place between 2008 and 2012 except for the sale.



How would you report this transaction due to the interest not being reported? Your thoughts.

[ATSMAN]

There are 2 issues here in my opinion.

The interest on the loan not being reported and the foreclosure sale.

If the tax years are still open he could amend the returns and report the income, pay the tax and interest associated with it. Is there a mortgage note? You will need the details.

At the time of foreclosure the basis for the taxpayer is the balance on the note, plus expenses like legal fees etc. associated with the foreclosure proceedings and subsequent sale of the land. The gain or loss would be sale price minus the basis.

[TAX4US]

There was interest on the note. TP just never bothered to report it in all the closed years. tp did receive those payments. Yikes what kind of animal have I discovered when all questions are asked?

[Burke]

Looks like the only issue for past years is reporting the interest which should have been reported. Simply file amended returns for those years. Then report the gain or loss on the sale in the current year. If your client was owed $26K and he sold the land for $26K, then he should have a loss based on expense of sale and/or foreclosing on the property, as ATSMAN says.

[Lion]

A tax year is only "closed" to receiving a refund, and maybe to being audited if substantial underreporting, fraud, etc., are not present. I don't think a year is ever closed to reporting MORE income. Get the client' returns corrected/amended so the sale will be reported correctly also.

(Does Form 3115 have a method to report all the interest at once?)

[Roland Slugg]

I would advise the lender to report nothing.

He loaned someone $35k. He got back $9k over four years then took the collateral and sold it for $26k, so he came out even ... no gain, no loss. IMO it was even reasonable to NOT report any of the $9k payments he received in the early years as interest, but to treat it all as principal instead, because of the uncertainty of full repayment.

Telling this guy that he should file a bunch of amended returns is what is NOT reasonable. Besides, at least three and probably all four years in which he received that $9k are now closed years. This is a sleeping dog. Don't wake it up.

[ATSMAN]

Roland, If as a tax adviser you put that recommendation in writing and then the taxpayer is audited it will hurt you real bad!

I would recommend that he amend prior returns and pay the tax and interest on the interest income. I am assuming the borrower deducted that interest expense? If he does not follow through at least it can't come to haunt me. You got to CYA these days my friend.