A taxpayer who buys home mortgages

[dyne]

Years ago I encountered a taxpayer who reported very little income but who purchased
home mortgages every year. That is correct: he would spend $50,000 or $100,000 etc.
every year to acquire one or more home mortgages. That was his way to hide his
unreported income from his business. IRS caught him.

[erchess]

Am Confused

When I hear you speak of buying a home mortgage I understand you to mean that a person or institution has loaned someone the money to buy a home and is now entitled to periodic payments from the person but someone else gives the loaner a sum of money in exchange for the right to receive the periodic payments. Is that what is going on here? If not would you explain what is going on here and in either case would you explain how this hides income? (To me it seems like he would have made the payments through his bank thus leaving a paper trail to show that he had the money and giving him the obligation to stand ready to prove where it came from if the taxing or criminal authorities should ask.)

[dyne]

The taxpayer was purchasing existing home mortgages of large amounts yet he was
reporting very little income from his self-employed business. I believe that he was
reporting the interest income he received from the mortgages he had purchased.
An indirect method such as a net worth computation by IRS caught him.

[JoshinNC]

We're a little slow down here in the Ol' North State

The taxpayer was purchasing existing home mortgages of large amounts yet he was
reporting very little income from his self-employed business. I believe that he was
reporting the interest income he received from the mortgages he had purchased.
An indirect method such as a net worth computation by IRS caught him.

so explain the whole thing again. What did the mortgages have to do with the SE income?

[BHoffman]

I think the question was: "Where did he get the $$ to buy up the mortgages?".

Looks like undeclared income from his business....

[dyne]

The taxpayer was reporting perhaps $20,000 income per year from his self-employed
business but purchasing $100,000 worth of home mortgages each year. An indirect method prepared by IRS determined that he was understating his business income by about $100,000 each year. He was spending $120,000 per year to live and invest in home mortgages of other people, therefore his income had to be $120,000 per year. These amounts are examples only. We need to watch out for such clients, although this is rare.

[DaveO]

I reviewed returns for a small contractor

He worked for a handful of rental property owners. He would remodel, repair or upgrade an apartment building. Instead of submitting a bill and being paid he would take a future stream of income from one or more units for some period of years. He would then report this as rent income. His "C" showed a huge loss since all the expenses were offset only by the few cash jobs he did all the income was reported on the "E". He was audited for several years and the auditor forced him to use the accural method for inventory but never figured out the rental income. Needless to say I declined to do his returns for him.

[erchess]

How Should He Have Reported This?

He worked for a handful of rental property owners. He would remodel, repair or upgrade an apartment building. Instead of submitting a bill and being paid he would take a future stream of income from one or more units for some period of years. He would then report this as rent income. His "C" showed a huge loss since all the expenses were offset only by the few cash jobs he did all the income was reported on the "E". He was audited for several years and the auditor forced him to use the accural method for inventory but never figured out the rental income. Needless to say I declined to do his returns for him.

Dave would you have done the return if he had been reporting the "rental" income on C (as it came in or accrued depending on his accounting method) instead of E so that it was exposed to SE Tax? And by the way isn't there a way to do an E and expose that income to SE Tax? (I realize he thought he had a clever legal trick to get around SE Tax and of course you could not go along.)

[JohnH]

I think it should have been reported as self-employment income on Schedule C. He had constructive receipt at the time the work was done - he just chose to have it spread out over a certain number of years. (That is, unless the owner was dumb enough to commit to an unending payment stream).

[DaveO]

JohnH is right

He wasn't renting anything, he didn't own the property. He had the option of being paid in cash but instead concocted this scheme. His rationale was that he was creating an "annuity" of sorts for his retirement. I told him he was creating a mess.

[JohnH]

Yeah, but we're such simpletons about things like this. What really matters is how his hairstylist and mechanic would classify the transaction. They have so much more depth & breath of experience in these complex matters. I want to hear their opinions and then I might change mine.