James Lewis wrote:

- quote -

It appears to me that Harlan was right all along. It's DOI.

It appears to me that if the Owner had paid-off the loan as
part of the disposition of the property, the discount may
have been treated as a capital gain. But post-hoc tax
planning does not work.

Dick

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"James Lewis" <jmpj[at]verizon.net> wrote:

- quote -

This is a little complicated, and could take some research
to get you a complete answer. You might have a chance but
my off-the-top-of- the-head reaction is that the discount is
taxable currently as ordinary income.

First of all, this was not a reduction from the original
seller, so it's not likely to be a reduction in the purchase
price.

From what I can tell, discounts such as this are generally
taxable as cancellation of debt income, unless they are
clearly gifts. If the daughters had given you the
discount because they liked you and wanted you to be able to
afford to pay the loan off for your own peace of mind, it
would be a non-taxable gift. But since they did it for
their purposes rather than yours, it's clearly not a gift.

On this point a quick review of cases came up with one from
1956 - Capital Coal Corp. v. Commissioner 26 T.C. 1183
(1956). It might be worth it to have a tax attorney look
into whether this is still the law. But it's unlikely that
you will be able to avoid the tax.

Stu

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James Lewis wrote:
- quote -

That's better now. However..... when John loaned client
the 300$k to help buy the property, did John secure said
loan with a mortgage?

Anyway, seems to me that since client did not buy the
property FROM John, any forgiveness of debt from John's
executrices have nothing to do with the basis of the
property. Hence it is income.

ChEAr$,
Harlan Lunsford, EA n LA

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"Dick Adams" <rdadams[at]smart.net> wrote:

- quote -

HA! I'm sorry about being so vague on the original post and
perhaps confusing matters with my "explanation" :-) Here we
go again:

Client worked for a "John" who treated Client like a son.
Client located a two duplex rental property which he wanted
to buy and John loaned him $300k to help Client buy a $400k
property from a totally unrelated party. After 5 years, John
died. John's two daughters are co-executors of John's
estate, including the note due from client. The two
daughters are both wanting to sell all properties so they
can continue to live the lifestyle John had been providing.
They have sold all the properties Client was hired to manage
so his job is terminated. The property client bought has
increased in value to $1,000,000. He sells one side of one
duplex for $250k. He still owes $250k on the $300k loan and
offers to payoff the loan early (so the daughters can get
cash) for $220k. They accept. The question is, is the $30k
"discount" taxable? If not taxed shouldn't the $30k discount
be reduced from the basis of the remaining rental
property?...I hope this is more clear. Thanks for the input
to date.

Mike

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"James Lewis" <jmpj[at]verizon.net> wrote:

- quote -

I agree that section 108 doesn't make the transaction
non-taxable. But that doesn't mean it's taxable.

Normally a cancellation or reduction in debt is considered
taxable income. But there are exceptions other than section
108. It could be a gift. It could be a reduction in
purchase price.

The OP's description of how this all came about is still
pretty vague on the essential details. Depending on exactly
what happened it could go either way.

Stu

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Let's see if I have this straight:
OP > Original Poster

Owner > Buter, Borrower, and Client of OP's employer.
- quote -


Lender > Company or person who financed the purchased of
the real property involved.

Seller > Unnamed and presumably unrelated person who sold
property to Buyer.

* Owner purchased real property rentals acquired with the
proceeds of a loan.
* Lender terminated employment of Buyer.
* Lender accepted a $34,000 (11%) discount for early
pay-off of mortgage possibly as a form of severence pay.
* FMV of property was more than three times the loan balance
at time of payoff.

At first reading, I thought this was a seller-financed
mortgage. As I wrote previously, I paid off the seller's
second mortgage at a discount in 1982 and two CPA's I knew
agreed that it was not a taxable event for me. But that
was mortgage was financed by a previous seller. So my
anecdotal experience is not relevant.

After perusing the relevant sections of Pubs 525 and 334, I
appears to me that an IRS auditor would call it DOI and have
you convince the office manager and possibly a judge that it
is RoPP. But it is confusing (at least to me).

One example of the confusion is it appears that if the Owner
had disposed of the property at the time of the payoff, the
discount may have been treated as a capital gain?

The OP's conflict is he thinks it's DOI and his superiors
think it's RoPP. It is likely his superiors based their
position on recollection and may have thought this a seller
financed mortgage. My suggestion is to do a cut-n-paste on
the relevant sections of the Code, present it to them, and
go with their 'Final Answer". If the estate get audited,
it will be their problem, not the OP's.

Dick

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"James Lewis" <jmpj[at]verizon.net> wrote:
- quote -

After reading my own reply, it confused me:-) Only the
first "Seller" is correct. Where it is used later, it
should have been "Client". I still can't get around the
section 108 which LoTax cited and which was the code section
I was constantly coming back to. The value of the property
was much higher than the loan payoff BEFORE discount, so
Section 108 seems to negate this being a "qualified" DOI.

Mike

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"James Lewis" <jmpj[at]verizon.net> wrote:

- quote -

I still don't quite get the facts. The seller and buyer
were both employees of the lender, but the lender died and
the seller inherited the company and then fired the buyer???
If that's what happened the lender stands in the shoes of
the seller and the reduction in the loan amount was a
reduction in the purchase price.

Otherwise I'd think it would be taxable.

Does a loan being in distress have anything to do with it?
I thought that if it were in distress as a result of the
borrower being "insolvent," debt cancellation income is not
required to be recognized.

Or am I confusing that with something else?

Stu

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"Harlan Lunsford" <hnslunsford[at]bellsouth.net> wrote:
- quote -

Seller was not lender. Seller had been employee of lender
before death of seller owner. Seller had terminated
borrower before loan payoff. I believe they agreed to the
lower payoff to help temper the termination, but there's
nothing in writing to that affect. Seller says he offered
to payoff early for a discount. The estate beneficiaries
are young and like to liquidate when possible. The rental
property purchased has plenty of basis to reduce if that is
feasible. I'll have to read the code sited by one of the
respondents.

Mike

Moderator:
Since the loan was not in distress, I still think it is a
reduction in the purchase price.

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James Lewis wrote:

- quote -

After reading other responses, it appears that most thought
that this was a seller financed mortgage, whereas I took it
face value, that purchaser bought the property but acquired
a mortgage from a different lender.

What were the facts?

ChEAr$,
Harlan Lunsford, EA n LA

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James Lewis wrote:

- quote -

You are, of course.

Loan discount points, origination fees, other costs
associated with a loan have nothing to do with basis. Only
items which add value TO the property affect basis, e.g.
improvements, additions, renovations.

ChEAr$,
Harlan Lunsford, EA n LA

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"James Lewis" <jmpj[at]verizon.net> wrote

- quote -

It's a reduction in basis as I see it. The discount for
early payoff was apprently part of the purchase agreement.
That seems to lead more to an adjusted purchase price
instead of income from discharge of indebetedness.

--
Paul A. Thomas, CPA
Athens, Georgia

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- quote -

I found the following in "Small Business Taxation, Planning
and Practice," by Gary L. Maydew (Fourth Edition).
Copyrighted by CCH (Page 157)

-----------=========
begin quoted text

Purchase-Money Debt Reduction

If the seller reduces the debt of a solvent buyer, then the
reduction is treated as a purchase price reduction (reduces
the basis). If the basis is exhausted, the remainder
constitutes gross income.

end quoted text
-----------=========

I found this on Google by searching "purchase money debt
reduction." It was in about the 5th item on the first page
of returned hits.

Condor

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"James Lewis" <jmpj[at]verizon.net> wrote:

- quote -

Was the lender also the seller? Or were they independent?

How did client convince lender to accept the discount?

Stu

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"James Lewis" <j...[at]verizon.net> wrote:

- quote -

The boss(es) might be right. See Internal Revenue Code
sections 108(a) (1)(D) and 1017 (and their regulations) and
also see the instructions to IRS Form 982. Maybe just
reading the IRS form instructions for line 1(d)would be
enough.

What you've got here is (may be) qualified real property
business indebtedness, and the taxpayer can make an election
to exclude it from taxable income. Basis adjustments are
obviously needed.

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"James Lewis" <jmpj[at]verizon.net> wrote:

- quote -

In 1982 (which means the relevant tax code may kave
changed), Susan and I purchased a condo that had a $20,000
first mortgage from Freddie Mac and a $30,000 second
mortgage from the previous owner. I offered the previous
owner $15,000. She said $20,000 and I said "Deal". My
basis decreased by $10,000. The seller was unaffected since
it was a separate transaction.

Why did she take the discount? The second mortage was at 7%
and interest rates were over 10%.

From what what you have written, there is no reason to
presume the loan was in jeapordy. So in the absence of
information that this was a discharge of indebtedness rather
than a reduction in purchase price, I agree with your
superiors.

I can only speculate as to why the lender agreed to the
discount. Perhaps since it was an 11% discount, the loan
may have been at a below market rate and the payoff was the
net present value of the loan less the lender's servicing
costs.

Dick

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Client paid off his loan early for a discounted payoff $34k
less than the remaining principal of the loan. Such loan
had been to acquire rental duplexes which were worth
$1,000,000 when loan payoff was made (net of discount=275k).
Client is solvent. Based on these facts, I conclude there
is a taxable DOI of $34k. My superiors say the discount can
be applied as reduction in basis of duplexes. Who agrees
with my superiors, and why?

mike

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