Newsletter Hip
H & P Capital Investments LLC
Issue 31
January 2008
Tax Traps and Solutions
by Tom Henderson

Since it is getting that time where everybody is starting the hustle to have their financial affairs wrapped up in order to see how much Uncle Sam is going to demand from us, I thought I might give a few tips and hints as it relates to notes.

To begin, in 2007, if you owner financed a note as part of your business or trade, you need to get your 1098s in before January 31st. Remember to fill out your 1096 also. Ask your CPA to be sure.

Here are some "biggies" to be on the alert for if you owner financed a note(s)

1. If you are NOT considered a real estate investor and took back a note to sell your property, the IRS considers this the same as receiving cash. OUCH!! For example, you made a $20,000 profit, but this amount was realized in the form of a note, you owe money as if it were cash. In this example, say you were in the 30% tax bracket, you would owe $6,000 cash, although you have only an owner financed note.

2. If your property is considered investment property, and you sold using owner financing, although you can take advantage of an installment sale, you run the risk of having depreciation "recaptured". This means the IRS is going to consider the depreciation you took on property as income, and then tax you for it. DOUBLE OUCH!!!!

Assuming these examples are first lien notes, both of them have solutions. Sell part of your note to pay for the taxes, and keep the remainder of the note for the future. There are several methods that can be tailor made to meet your goals.

A case in point is a rehabber who sold several properties using owner financing. He accumulated a $28,000 tax liability, but had no cash, only several notes, most of which were second lien notes. However, he did have a $100,000 first lien note that he could sell, although he did not want to sell the entire note. We are now in negotiations for me to purchase between four and five years of payments for $28,000. A second possibility would be for me to buy part of the monthly payments for 10 years. This would give him continued smaller monthly cash flow, while at the same time providing him with the $28,000 to pay off his taxes.

Either way, his tax bill on all his notes is going to be solved by selling a partial of his best note. There is a another desirable result of paying off his tax bill. He will now be in a position to trade his second lien notes at face value for other real estate, and not have tax consequences. As usual, be sure to ask your CPA about the tax implications of taking back a note, or selling a note.

If you have a note you want to convert to cash, contact me for professional pricing.

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Tom Henderson
H&P Capital Investments LLC