Where to include Bad Debt

[OldJack]

-- the seller must net a certain amount to cover his mortgage or other obligations.

Jainen, I understand the problem you present... but the facts in writing is that the agent has made a commission deal with the seller and a loan deal with the buyer.

The seller has a taxable transaction to recognize gain or loss based upon the sellers closing cost and agent commission on the closing statement. The sellers tax transaction does not include anything related to the buyer's loan or buyers mortgage amount on the statement.

The purchaser/buyer has basis in the real estate which, in an indirect way, includes the loan amount as its part of the purchase price just like the bank mortgage is a part of the purchase price.

If the seller and the buyer were in fact the same person I could agree that the agent could net the bad debt and the commission. Its not likely that would happen or be the situation in this case. You can't let "creative financing" tricks confuse the end results since financing has nothing to do with the tax sale price and taxable net proceeds.

[jainen]

an amazing assertion

>>financing has nothing to do with the tax sale price and taxable net proceeds<<

What an amazing assertion, Old Jack! Buying a house is not like a new pair of shoes where you accept the listed price and the only question is cash or a credit card!

We've all seen the car ads--$2000 cash back or 2% financing. Real estate is the same way--all terms especially financing are negotiable. Sometimes the winning bid is not the highest price but has the best financing. Sometimes the seller himself will carry back paper. Sometimes a mortgage broker will assemble a package of loans, and for every one there are escrow instructions and agreements and calculations that affect the overall cost, with plenty of consequence for the bottom line.

One thing you'll never see, though. You won't see the real estate agent, licensed by the state, take money out with one hand while putting it back in with the other hand, calling it "a different matter, separate deal." That's the very definition of a sham transaction, and no lender would tolerate it.

[erchess]

Accrual

I have hesitated to weigh in on this because I have never handled an accrual except for ones whose books were kept by professional accountants. Please excuse me if I have misunderstood something..

However, OP specified that the broker in question reported the commission she had not received as income because she is apparently an accrual basis taxpayer. Someone else even noted, if I understood correctly, that a real estate agent is supposed to be an accrual basis taxpayer. And yet half of the respondents seem not to believe that a real estate agent would be an accrual basis taxpayer, apparently because so few are.

And then there's this transaction. OP states that something happened and half of respondents apparently do not believe it. OP of course was most likely not there for the transaction, but may still have seen documentation and in any case knows the taxpayer. If OP says this happened, I believe it happened.

It's late so maybe I am believing six impossible things before breakfast.

[OldJack]

One thing you'll never see, though. You won't see the real estate agent, licensed by the state, take money out with one hand while putting it back in with the other hand, calling it "a different matter, separate deal." That's the very definition of a sham transaction, and no lender would tolerate it.

It is a long established fact in court cases that a real estate deal is what is shown by the final written documents agreed to by the parties. Your comparison to the sale of a automobile is only laughable.

Your position from your first post must have changed since you stated "I don't have a problem calling this a business bad debt". A business bad debt by definition is a business "deduction" and not a net of commission income. The written documents clearly show a separate taxable commission and a separate 2nd lien debt due to the agent. The fact that the commission and the debt are due the same person is irrelevant for tax purposes. It is clearly a black and white tax issue.

[OldJack]

I have hesitated to weigh in on this because I have never handled an accrual except for ones whose books were kept by professional accountants. Please excuse me if I have misunderstood something..

One of the reasons we all use nicknames on a message board is so that we can express or opinion with such opinion remaining only on the message board. You should always feel free to express your opinion here and I for one welcome those that disagree with my opinion. After all... its just an opinion and its only my opinion.

With regards to the commission, this is not an issue of cash or accrual accounting for the real estate agent. A real estate closing statement and activity is for the purpose of transfering or paying all parties due anything. The broker or title company handling the closing has the responsibility to see to it that all moneys are received, all documents properly signed, and all debts due are actually paid with the closing.

One of those debts due at closing is the real estate agents commission. It must be paid at closing. In this tax case the closer/title company has paid the commission by giving a portion to the agent and with the agents approval has given a portion to the seller on behalf of the purchaser. However, the closer/title company never the less has paid the full taxable commission and the agent has acknowleded or agree they have received the full taxable commission. Therefore it is not a question of a cash basis or accrual basis agent.

Paid and received may not be the same thing much as the bank pays interest to your savings account and it is taxable to the customer even though the customer could say they have not received the payment.

This whole thing could have been avoided if the real estate agent would have simply agreed to take a lesser commission that was more realistic to what her services were worth. The agent was hired by the seller and the seller obviously did not think her services were worth the amount of commission demanded.

[jainen]

Old Jack and erchess

>>A business bad debt by definition is a business "deduction"<<

Old Jack and erchess are reading more into Carolyn's original post than is there. All she said was, "income from this deal was included on Schedule C." My response was that this fact establishes the lien as a business debt, but not one with any deductible basis.

I have not changed my position. Note that Carolyn never called it a "loan." Old Jack was the one who claimed the real estate agent "made a bad loan." I say the primary lender would not--could not--have allowed the deal to be structured that way.

In the simplified example of my previous post, the agent took a note for the full commission. In the real world she would have required at least enough cash to cover her expenses, and that is why (as I read it) the original post stated that, "income from this deal was included on Schedule C." There is no suggestion that the agent funded a loan with the same money she received as a commission.

[OldJack]

>>A business bad debt by definition is a business "deduction"<<

Old Jack and erchess are reading more into Carolyn's original post than is there. All she said was, "income from this deal was included on Schedule C." My response was that this fact establishes the lien as a business debt, but not one with any deductible basis.

Jainen...

1) In this original post case, who do you read owed the 2nd lien money to the agent? The seller or the buyer?

I assumed the buyer owed the debt to the agent.

2) Did you read or assume that the 2nd lien was a line item on the closing statement or a deal off or under the table?

I assumed it was a line item owed by the buyer on the buyers closing statement in the same category as the prime mortgage company financing the buyer.

3) Did you read or assume that the "bad debt / foreclosure" was in the same year as the recognition of any "commission income" on Sch-C?

I assumed the bad debt / foreclosure was not in the same year as the sale.

4) Did you read or assume that the commission income amount shown on the closing statement was NOT reported as income in the year of the closing date?

I assumed the full commission shown on the closing statement was reported on 1040 Sch-C.

[George Boutwell]

Assumption

>>1) In this original post case, who do you read owed the 2nd lien money to the agent? The seller or the buyer?

I assumed the buyer owed the debt to the agent.<<

Usually the way it's done is for the seller to take back a (subordinated) lien from the buyer, and then to assign some or all of the payments to the broker (who then pays the agent).

[jainen]

we don't know

>>Did you read or assume... <<

D--- fine questions, O.J. You caught me flat doing the same thing I accused you of!

1) It was that odd reference to COGS that caused me to assume the lien was on the buyer's property. Obviously it is just as likely that the seller, unable to pay the full commission, gave a note against a different property that he owned. Truly, we don't know.

2) Since I assumed that the note was a part of the purchase, I naturally also assumed it was listed as such on the closing statement. If it was on the seller's property, I would still expect it to be shown but wouldn't be surprised if it were incompletely described. It would be simplest to have the escrow agent record that lien along with the other documents, but it ain't necessarily so. We just don't know.

3) I didn't really think about which tax years might have been involved. Does it impact any of the scenarios we have considered? On reflection, the original post sounds to me as if the default was in a different year since she is not asking about offsetting income. Who knows?

4) As I already said, I'm sure any money received as commission was reported on Schedule C. The note should have been counted as income (either at face value or FMV), but it was probably only booked as a receivable. This opinion is based on my general experience -- as to the specific taxpayer, we don't know.

[jainen]

change your mind

>>the seller obviously did not think her services were worth the amount of commission demanded<<

I predict you will change your mind about this over the next year as real estate prices drop (which I also predict). Deals will not reflect what anybody wants so much as what is POSSIBLE. Lenders will have a lot to say about how the transaction is structured (even though you might think they don't care about what happens in second position) because their regulators have started watching them closely.

[equinecpa]

Wow...I had no idea I'd start a discussion such as this. You all have certainly given me food for thought...I will go on a fact finding mission and make sure I have the "real" facts and report back shortly. Perhaps it wasn't such a simple question after all?

I was wondering something here too, what parties are you all talking about? The way I see it a broker gets the commission which would then be split with the real estate agent. I'm doing the agents return. Is it the agent that enters into these deals to get the deal done or the broker, both or ?

This is what I'm working with right now (and will clarify with client the exact scenario):

Bad Debt $6000 ( I held 2nd lien on house sold, and house foreclosed -original loan amount was $8,200)

[OldJack]

>>the seller obviously did not think her services were worth the amount of commission demanded<<

I predict you will change your mind about this over the next year as real estate prices drop (which I also predict). Deals will not reflect what anybody wants so much as what is POSSIBLE.

I predict that real estate agents/brokers will have to give up their demand for the fixed 6%+ fees on such high priced real estate sales. When the dust settles on the internet real estate agent court cases such as "Redfin" the commissions will drop to a realistic fee for services provided (and so goes your prediction).

As I recall the Redfin company is a real estate broker/agents that list your home on the internet and handle the sale for a flat fee of $3,000 with about one-third of that being rebated to the "purchaser" since the purchaser actual found the home on the internet. The real estate agents national organization has refused to let Redfin list the houses in their online database and thus the lawsuit. Its a fight to protect the 6% standard commission for strip mall real estate brokers. It was a 60-minute program on CBS this last weekend.