Defaulted Installment Sale and Seller's available net loss

[MichaelDi09]

I have a client, a Partnership, that had sold a Residential Apartment Building in 2010, for $1,300,00.00 , under an installment agreement. Buyer made payments thru Feb 2015, upon which a fire heavily damaged the Bldg.

Buyer had no Insurance on Bldg. Buyer Died in June 2015.
No further payments have been rec'd since May 2015.

Current balance on Seller-Mortgage is $979,000.00 .

Client sued Estate of Buyer for the Balance of Mortgage but Estate has no money or Assets. Court ruled in 11/26/16 , FMV of Apt Bldg at $276,000.00

Partnership Paid transfer tax of $ 2100.00, in 3/2016 and took back Property(Apt Bldg)

Ok, my question is , what Capital gains or Losses does the Partnership have, regarding this defaulted Installment Sale ?

And as a follow up, What would their Cost Basis be in Apt Bldg, Client took back in 2016?

Their original Basis in 2010, prior to Install Sale was $325,000.00

Appreciate any insight and opinions regarding this matter.

Mike

[kathyc2]

Basis is the 325K at time of installment sale plus taxable gains during the time installment agreement was in effect. Since they are still in possession of building, no capital loss until they sell. I don't know if it applies in this situation, but you could look at if it qualifies for a casualty loss.

[MichaelDi09]

Basis is the 325K at time of installment sale plus taxable gains during the time installment agreement was in effect. Since they are still in possession of building, no capital loss until they sell. I don't know if it applies in this situation, but you could look at if it qualifies for a casualty loss.

If they sell Apt Bldg , when refurbished, will the balance owed on Install Mortg of $949K, be factored in or not ?

I'm thinking they have reclaimed property with a basis of $325K plus taxable gains of $88K and the courts ruled property is worth $256K presently.

The Capital loss would be Approx $ (157,000.)

[kathyc2]

If they sell Apt Bldg , when refurbished, will the balance owed on Install Mortg of $949K, be factored in or not ?

I'm thinking they have reclaimed property with a basis of $325K plus taxable gains of $88K and the courts ruled property is worth $256K presently.

The Capital loss would be Approx $ (157,000.)

949K does not factor in.

No capital loss if they still hold building.

[MichaelDi09]

Thank You. I appreciate your help.

[kathyc2]

You might want to check the taxable gain number of 88K. 1.3M sales price and 325K basis would be a 75% gross profit margin. Principal payments of 321K should yield taxable gains of 241K.

Brain freeze earlier but you also need to reduce basis by return of capital.

Formula is: basis at time of sale + taxable gain - tax free return of capital = current basis

There are worksheets in Pub 537 to work your way through it.

[TaxGuyBill]

You might want to check the taxable gain number of 88K. 1.3M sales price and 325K basis would be a 75% gross profit margin. Principal payments of 321K should yield taxable gains of 241K.

Brain freeze earlier but you also need to reduce basis by return of capital.

Formula is: basis at time of sale + taxable gain - tax free return of capital = current basis

There are worksheets in Pub 537 to work your way through it.

I think you are thinking of Personal Property. The procedure for Real Property is different. I agree with Michael that the basis remains at $325k, and there is about $80k of gain.

https://www.irs.gov/publications/p537/ar02.html#en_US_2016_publink1000221753

[kathyc2]

I think you are thinking of Personal Property. The procedure for Real Property is different. I agree with Michael that the basis remains at $325k, and there is about $80k of gain.

https://www.irs.gov/publications/p53...link1000221753

Maybe I'm more sleep deprived than I realize, but how are you coming up with 80K gain? OP stated that basis at the start of installment agreement was 325K and selling prices was 1.3M. That works out to a gross profit of 75%. 321K of principal was paid and it should have been 75% (241K) gain and 25% (80K) return of capital.

325 basis + 241 gain - 80 return of investment =486 Worksheet E goes at it a little differently, but I still come up with basis of 486K.

[TaxGuyBill]

First, let's take a step back and get some numbers straightened out. After rereading things, I think we might be a little off with our numbers.

The OP said "Current balance on Seller-Mortgage is $979,000.00" and "balance owed on Install Mortg of $949K"

The I read that, the client owes the bank $979,000, and the purchaser that defaulted owed the client $949,000. Is that correct?


I'm going to assume it is (if not, please correct me). That means we were using the wrong number ($979,000) and need to change it to $949,000.

Using the 75% Gross Profit Percentage, of the $1,300,000 sale price, the client had already received $351,000.

Using the 75% Gross Profit Percentage, of the $351,000 that they received, they already paid tax on $263,250. The other $87,750 was the tax free Return of Capital. It is that amount that was not taxable that becomes taxable on the repossession of the property. That is shown step-by-step on Worksheet D.

As you say, Worksheet E goes at it in a weird way, but as the first sentence on that link says "The rules for the repossession of real property allow you to keep essentially the same adjusted basis in the repossessed property you had before the original sale", plus any repossession costs.

Worksheet E would show (for simplicity, assuming no repossession expenses):
1) $949,000
2) 75%
3) $711,750
4) $237,250
5) $87,750 (from Worksheet D)
6) $0 (assuming no repossession costs)
7) $325,000

[kathyc2]

Well..... it appears I may have been mistaken. Not the first, sure it won't be the last....

[Roland Slugg]

Ok, my question is , what Capital gains or Losses does the Partnership have, regarding this defaulted Installment Sale?

Hello, Mike. Well, you got a lot of replies to your post, but only TaxGuyBill correctly answered your main question, which I have repeated above. He also correctly pointed out there there is a difference in the way repos of real property are handled for tax purposes versus personal property.

Using the numbers in your OP (and assuming that the reference to $949,000 in a later post was a typo, intended to be the same $979,000), your client, the p'ship, has a recognized and taxable gain of $80,250 in 2016. This amount is equal to the payments the sellers received from 2010 thru 2015 that were not taxed because they were treated as a return of capital. This may seem harsh, but it's really quite logical. The sellers received $321,000 altogether, and now they have their property back. Only 75% of that $321,000 has been taxed so far, so the other $80,250 (25% of $321,000) becomes taxable income in 2016 ... the year of repossession.

And as a follow up, What would their Cost Basis be in Apt Bldg, Client took back in 2016?

Their basis in the repossessed property is $327,100. That's the $325,000 original basis plus the costs of $2,100.

Everything can be nicely reconciled by assuming they now sell the repossessed property for the FMV mentioned in the OP, $276,000. Since their basis in that property is now $327,100, that would produce a taxable loss of ($51,100).

Cash received from original sale ($1,300,000 less $979,000) = $321,000
Plus -- Cash received from second sale = $276,000
Total cash received -- Both sales combined = $597,000
Less -- Basis of property sold ($325,000 plus $2,100) = $327,100
Overall gain on both sales combined = $269,900

Gain reported as follows:
Gain reported from 2010 through 2015 on first sale ($321,000 x 75% GP) = $240,750
Gain reported when property was repossessed in 2016 = $80,250
Loss on sale of repossessed property, in 2017 or later = ($51,100)
Net overall gains and losses -- Both sales combined = $269,900

Sine qua non

One person did refer you to an IRS Pub, and it may have a worksheet that should lead you to the same results as in this reply.

Finally, I'd like to add a non-tax but related comment: The sellers were extremely foolish to not insist that the buyers maintain at all times fire insurance on the sold property, naming their p'ship as an insured as a mortgage holder. They would have received annual notices that the insurance was still in force, or if it was not, giving them the opportunity to secure insurance themselves, then demand reimbursement, and starting foreclosure if the premium was not reimbursed. This (and a similar clause relating to real estate taxes) is a standard part of all the trust deeds I have seen, and I'm sure it is pretty much the same in all states. If the sellers had a lawyer, I would say that lawyer did not serve them well.

Good post on a matter not often seen on this board.

[MichaelDi09]

Hello, Mike. Well, you got a lot of replies to your post, but only TaxGuyBill correctly answered your main question, which I have repeated above.

Using the numbers in your OP (and assuming that the reference to $949,000 in a later post was a typo, intended to be the same $979k), your client, the p'ship, has a recognized and taxable gain of $80,250 in 2016. This amount is equal to the payments the sellers received from 2010 thru 2015 that were not taxed because they were treated as a return of capital. This may seem harsh, but it's really quite logical. The sellers received $321,000 altogether, and now they have their property back. Only 75% of that $321,000 has been taxed so far, so the other $80,250 (25% of $321,000) becomes taxable income in 2016 ... the year of repossession.

Their basis in the repossessed property is $327,100. That's the $325,000 original basis plus the costs of $2,100.

Everything can be nicely reconciled by assuming they now sell the repossessed property for the FMV mentioned in the OP, $276,000. Since their basis in that property is now $327,100, that would produce a taxable loss of ($51,100).

Cash received from original sale ($1,300,000 less $979,000) = $321,000
Plus -- Cash received from second sale = $276,000
Total cash received -- Both sales combined = $597,000
Less -- Basis of property sold ($325,000 plus $2,100) = $327,100
Overall gain on both sales combined = $269,900

Gain reported as follows:
Gain reported from 2010 through 2015 on first sale ($321,000 x 75% GP) = $240,750
Gain reported when property was repossessed in 2016 = $80,250
Loss on sale of repossessed property, in 2017 or later = ($51,100)
Net overall gains and losses -- Both sales combined = $269,900

Sina qua non

One person did refer you to an IRS Pub, and it may have a worksheet that should lead you to the same results as in this reply.

Finally, I'd like to add a non-tax but related comment: The sellers were extremely foolish to not insist that the buyers maintain at all times fire insurance on the sold property, naming their p'ship as an insured as a mortgage holder. They would have received annual notices that the insurance was still in force, or if it was not, giving them the opportunity to secure insurance themselves, then demand reimbursement, and starting foreclosure if the premium was not reimbursed. This (and a similar clause relating to real estate taxes) is a standard part of all the trust deeds I have seen, and I'm sure it is pretty much the same in all states. If the sellers had a lawyer, I would say that lawyer did not serve them well.

Good post on a matter not often seen on this board.

Hi Roland,

I am surprised as well that my Client didn't have a clause in place regarding Maintaining Insurance on said Property.
I do have a follow up question regarding new basis in repossessed property .

Do my clients(partnership), not get to include all the previous Taxable gains( yr 2010-2015) , including unrecaptured sec 1250 gain of 178,455.00(yr 2010), as part of the new Adjusted basis in repossessed property?

Thank you.

[Roland Slugg]

Do my clients (partnership) not get to include all the previous Taxable gains (yr 2010-2015), including unrecaptured sec 1250 gain of 178,455 (yr 2010), as part of the new Adjusted basis in repossessed property?

No, of course not. Would doing that have even occurred to you if you hadn't read that wrong advice in a previous post?

Your clients received $321,000, and they still own the property with the same basis as before it was sold (plus $2,100 in repo costs). If you were to increase the property's $327,100 basis by current and/or previously reported gain, where, pray tell, would you put the credit side of that bookkeeping entry?

Before adding this reply, I looked at IRS Pub 537 and found that it has not one but two nice little worksheets for repossessions like yours. They are Worksheets D and E, and if you will fill them out using your client's actual figures, you WILL get the correct taxable gain to report (Worksheet D) and the new basis in the property (Worksheet E).

Regarding the Unrecaptured §1250 Gain of $178,455 reported in the year of sale (2010) there is no "undoing" that, nor should there be. Keep in mind that there will be no additional Unrecaptured §1250 Gain when the repossessed property is again sold unless it is sold at another gain. If it is, the Unrecaptured §1250 Gain will be no greater than the depreciation taken on the property's repossessed basis of $327,100. If the repo's property is sold at a loss, the loss will be fully deductible as a §1231 loss. This means that the loss could offset income in the year of sale #2 that would otherwise be taxed at a rate higher than 25%. If that happens, then the overall tax result of the two separate sales will actually be a little better than would have been the case if the property had originally been sold for the net price of the two sales combined ... $321,000 + $276,000. If this isn't intuitively obvious, maybe the following little summary (using the same dollar amounts reported in earlier posts above) will help:

* Gain reported in 2010 and subsequent years on sale #1 = $321,000, of which $178,455 was treated as Unrecaptured §1250 Gain and, thus, taxed at a rate no higher than 25%.

* Loss reported in 2017 (or later) on sale #2 = (51,100) which will be fully deductible against other ordinary income, some of which may have otherwise been taxed at a rate higher than 25%.

Capisce?

Finally, a comment on something not asked in the OP or mentioned in any of the other replies above: The holding period of the repossessed property includes the time it was owned before sale #1 plus the time it is held from the date it was repossessed until sale #2. Thus, sale #2 will be long-term, even if the time between repo and sale #2 is less than one year.

[MichaelDi09]

Thanks for your input Roland.
I did read the prior posts and jumped the gun on assuming advice was accurate. I now, understand and see a bit more clearly how this transaction is to be constructed, and what the Reportable gain and new basis in property repossessed will be.
Appreciate all the help.

Michael