Posted by JHyre in Ohio on June 05, 2000 at 16:42:57:
David-
Hardheaded you are- and that’ll get you places. I’m glad you’ve got some outside help to supplement your efforts…you’ll need to be VERY hardheaded to stay awake while researching this stuff! LOL,
John Hyre
JHyre Rants: “Agreeing to Disagree” with IRS results in penalties and large involuntary boyfriends - Posted by JHyre in Ohio
Posted by JHyre in Ohio on June 05, 2000 at 11:34:48:
(This is a follow-up of the related entity discussion conducted many posts ago- and specifically a response to David Alexander- for whom I have both repect and a liking- even though I disagree with him on many tax issues.)
I know that sounds crass, but it’s true. When they disagree, interest and penalties can and do get applied- and the penalties are a killer. Now, alot of the “rich” think you can just pay the mouthpiece to negotiate the penalties away. So they take positions based on “great tolerance for risk” (I’m being very, very polite in my phrasing)- not on the law. And they get away with enough to justify what penalties they do pay…or so the story goes.
It generally doesn’t work that way.
Oh, sure there are anectdotes where the auditor has given away things that could have hammered the taxpayer. Counting on that sort of behavior is a bad idea. Maybe I’m jaded- because I’m the guy who would get caught. Sure, there are those who never get nailed. In which case, ANY discussion of the law is moot, because such people are above the law- they can do anything, so who cares about the law if you’re not going to get caught (e.g.- Mr. & Mrs. Clinton)?
When I make a post, I focus on the law. I do not get into audit lottery or “creative” arguments. Note the quotes around “creative”- I mean stuff like one-man sales contests where the Rolex is the prize. That sort of thing is pure audit lottery. Indulge in it if you’d like- you’ll not hear ME advise it. Maybe- just maybe- you can get away with it- IF your VERY well represented by VERY pricey counsel AND VERY LUCKY. Leona Helmsley pays the best- and still spent time in Club Fed. Are you feeling lucky?
Well, nothing like a good rant to get things out of my system. If you are going to play games with related companies, get good, WRITTEN advice. Advice based on the specific laws involved- here IRC 267, among others. I will tell you this: If you directly or indirectly (i.e.- through mom, your corporation, a chain of corporations, a business partner, your son, your dog, your evil twin in a parallel universe, or all or some of the above) own 50% or more in two or more entities, those entities ARE related. No question about it. If the auditor is not a complete moron, you have a problem.
There ARE ways around IRC 267- like owning less than 50% of buying entity (remember directly AND INDIRECTLY). So if you ONLY own 1%, no problem. But if you get too cute- for example, own 1% control stake with the ability to require distributions out-of-proportion to 1% to you or a related entity- then common law principals can be used to foil the scheme. My recollection was that Kiyosaki uses an entity owned by his accountant to funnel management fees, thereby (ostensibly) avoiding IRC 267. That may work- IF it is not deemed a sham (for example, accountant kicks back money via another means without STRONG business purpose for so doing).
Bottom line- if you are generating losses by selling to a company in which you (or your mom, dog, etc.) has an interest, get REALLY good advice in WRITING. You’ll probably need it. Please do not engage in a transaction that you’ve seen others do (I mean Kiyosaki, among others) without getting the written advice you need to ensure that the transaction works for YOU. You are a neat guy, I’d not want to see you get hammered by the IRS. They can and have ruined businesses and lives, their kinder, gentler rhetoric notwithstanding.
John Hyre
Re: JHyre Rants: “Agreeing to Disagree” with IRS results in penalties and large involuntary boyfriends - Posted by Bronchick
Posted by Bronchick on June 05, 2000 at 13:28:06:
I still think Sec 267 does not apply, since the note is NOT sold at a loss, since the market value of the note = the sales price. Keep in mind that if the IRS tags the taxpayer as a dealer, it would be the same as if the taxpyer had “opted out” of the installment sale in the first place. When opting out of an installment sale, the gain is not on the face value of the note, but rather on the FAIR MARKET VALUE of the note (see IRS publication 553 - http://www.irs.gov/forms_pubs/pubs/p53703.htm).
The IRS cannot have it both ways; it cannot tell the taxpayer it cannot do an installment sale, then at the same time say that the value of the note is face value!
I did some research and could find no case law on whether the opt-out value or the face value applies when the IRS disallows installment sales (since this rarely happens anyway). If the taxpayer chooses to to the two-party entity method on a regular basis, he may just simply opt-out from the beginning, then sell the note anyway for it’s fair market value (no related entity issues, since the sale is for basis, not a loss).
Re: JHyre Rants: “Agreeing to Disagree” with IRS results in penalties and large involuntary boyfriends - Posted by Sheik
Posted by Sheik on June 05, 2000 at 12:51:49:
JHyre,
This post is a ways down on the board - I take it that this is the kind of thing your post speaks of. Please comment.
Sheik
If my c-corp did a Lonnie deal where it bought a MH for $5K and sold it for $10K with $3K down and a $7K note.
Without selling off the note, my c-corp will owe taxes on the $5K profit.
If my c-corp were to sell the note to my LLC for $1K (market value), on what amout is the C-corp taxed? Is it the $1K it received for
the note? Does the c-corp show a ‘loss’ of $4K?
Also, how do I determine the fair market value for the note?
Re: JHyre Rants: “Agreeing to Disagree” with IRS results in penalties and large involuntary boyfriends - Posted by David Alexander
Posted by David Alexander on June 05, 2000 at 12:23:16:
I was agreeing to disagree with you not the IRS.
Ok, I’m going to research this myself, and look for any actual case law if I can, and besides it’s time to actually expand my brain on this stuff, not just take others opinions before as Jim says the wheels fall off.
I understand what your saying but I do infact own less than 50% of the other Corp, which is the General partner of the LP.
Time for me to learn. I will post as I do.
David Alexander
The Rant: clarified - Posted by JHyre in Ohio
Posted by JHyre in Ohio on June 05, 2000 at 16:24:10:
Bill:
We have disagreed once in the past- and still do- on the tax treatment of lease options created by a dealer. Otherwise, it is odd for us to differ, though that it was lawyers are generally good at. I think I see what you are getting at- and you are correct- and so am I. The issue is borne of ambiguity- mine, really. I have mobile homes on the brain…and realty is a bit different. To wit:
You are correct IF a taxpayer is on the CASH method of accounting. Taxpayers selling REAL property are permitted to use the cash method (excepting C-corporations over $5 million in revenues) because REAL property is not considered merchandise- and it’s businesses where merchandise is an income-producing factor that MUST use ACCRUAL as opposed to CASH method of accounting. So if a real-estate business is on CASH method and sells realty with basis of $2,000 on note with $8,000 face value and $5,000 FMV, gain is $3,000. In that case, you are correct, there is no loss to taxpayer on sale to related entity. So no loss is being manufactured.
If, on the other hand, mobile homes are involved, things are different. MH’s are personal property in most states- and therefore constitute “merchandise” and inventories must be kept. As such the accrual method must be used (Treas. Reg. 1.446-1(c)(2)). Under the accrual method, the amount “earned”- the face value of the note- is the realization amount. So the gain equals $6,000 and the basis of the rsulting note equals $8,000. Selling THAT note for $5000 results in loss- and creates problems with the related party rules.
So, with respect to Rev. Proc. 2000-22, which I had previously described: Those of you ALREADY on the CASH method of accounting (ask your CPA!) should be declaring gain based on the FMV of a note received- NOT based on face value. If you haven’t been doing this all along- AMEND! On the other hand, those of you on ACCRUAL method- that should include mobile home investors in most states- that Rev. Proc. can benefit you by permitting a switch to the CASH method.
David Alexander- I think you do both real estate and MH flips. Thus, you need to see what method your CPA has you on and act accordingly. By the way, the Regs impose certain consistency requirements between businesses to keep the IRS from getting whip-sawed. So in choosing a particular method for ONE entity, be sure that it not foul-up the method for another entity. Researching such issues is not for the faint of heart…I WOULD get a professional to look at it. And as the ambiguity I spawned shows, details count!
I should have used a more specific example, instead of trying to generalize…serves me right. Just goes to show you, the most arcane (i.e.- dry, trivial, boring) things have a big impact.
John Hyre
Re: JHyre Rants: “Agreeing to Disagree” with IRS results in penalties and large involuntary boyfriends - Posted by Sheik
Posted by Sheik on June 05, 2000 at 14:01:44:
How is the FMV of the note determined??
And if the note is sold for less than the face value,
how is the discout addressed for tax purposes?
Thanks
Sheik
Re: JHyre Rants: “Agreeing to Disagree” with IRS results in penalties and large involuntary boyfriends - Posted by JHyre in Ohio
Posted by JHyre in Ohio on June 05, 2000 at 16:39:50:
Sheik,
Per my response to Bill, you are dealing with MH’s- probably personal propety where you live. As such you are on the accrual method. Therefore, your gain on the initial sale of the note was $5,000. The note has a basis of $10,000. If you sell it to a RELATED entity for $1,000 FMV (I must say, that is improbably low), you have created a $9,000 loss- that is disallowed. If you sell to an unrelated entity, the net effect of the loss and gain is a $4,000 loss.
I agree with Bill determining FMV- get some offers and document them.
John Hyre
Re: JHyre Rants: “Agreeing to Disagree” with IRS results in penalties and large involuntary boyfriends - Posted by JHyre in Ohio
Posted by JHyre in Ohio on June 05, 2000 at 16:33:20:
David:
Agreeing to disagree with me does not get you penalized or thrown into Club Fed. Disagreeing with the IRS on exactly the same thing- where you were headed- CAN cause problems. If you are going to disagree- know EXACTLY WHY. I worry that you consumate ideas or employ techniques without the proper guidance or based on anecdotal evidence gleaned from others. If I’m right- I suspect I am if you are literally researching the area yourself- that’s dangerous. In spite of your obvious ability, I would be surprised if you knew all you needed to on related entities- because that is a COMPLEX area for those who deal with it for a living, much less those who do not.
I very much respect your willingness to directly grapple with the issues…but agree with Piper that your time is probably more lucratively spent on investing.
John Hyre
Re: JHyre Rants: “Agreeing to Disagree” with IRS results in penalties and large involuntary boyfriends - Posted by JPiper
Posted by JPiper on June 05, 2000 at 12:42:05:
Yeah right David, you’re going to research this yourself and read all that case law! LOL, good luck buddy, when do you plan to have time for your deals? Sounds like a guy getting ready to build his own internal combustion engine from scratch…without the background necessary to do it!
Here’s a suggestion: Why not hire somebody really good, ask them some question, have them research it? No need to reinvent the wheel…let alone have them fall off.
JPiper
Re: The Rant: clarified - Posted by Sheik
Posted by Sheik on June 05, 2000 at 16:52:01:
Thank you JHyre…your post is, as always, informative.
Thanks for going the extra step.
Quick question - the discount taken on the note - is that clasified as expense for the c-corp since it’s not a loss?
Thanks Sheik
Lease/Option Clarification… - Posted by JPiper
Posted by JPiper on June 05, 2000 at 16:46:26:
I’d be interested in knowing your view of how lease/options by a dealer should be treated.
In fact, I’d be interested in your view of what makes an entity a dealer IF the entity is taking title to real estate, and then lease/optioning the property for let’s say two years, at which point the option is exercised in some cases, or in others is extended, or in still others, it expires and the property is lease/optioned again. What exactly would make this entity a dealer if the above is the activity?
JPiper
Excellent Point - Posted by Mark R in KCMO
Posted by Mark R in KCMO on June 05, 2000 at 16:38:40:
John,
That is an excellent point, and I can see that is a distinct difference…
The Notes that I deal with ARE RE based, and it is also good to point out the accounting differences.
As you say something and Dry can become quite exciting and involved when all the details are unclear, Just imagine calling the IRS Info number and trying to get an answer on this one… LOL
Call me Crazy but this thread shows one more reason to not “own” the corporation (entity) that are doing the transactions.
Just as crazy as starting the Corp before you open to do business…
I Maybe Crazy, but conventional wisdom is what keeps the 95% the 95%…
Mark R in KCMO
Re: JHyre Rants: “Agreeing to Disagree” with IRS results in penalties and large involuntary boyfriends - Posted by Bronchick
Posted by Bronchick on June 05, 2000 at 14:21:47:
Discount is determined by a market appraisal. Fax the info to two or three note buyers and get their offers in writing.
Re: JHyre Rants: “Agreeing to Disagree” with IRS results in penalties and large involuntary boyfriends - Posted by David Alexander
Posted by David Alexander on June 05, 2000 at 12:49:51:
I will have it researched, but I figure I need to read it myself (you know that hardheadedness).
I actually have one written down in some notes about the selling of notes at a discount, just need to find the notes and post the case # and details.
David Alexander
Re: Lease/Option Clarification… - Posted by JHyre in Ohio
Posted by JHyre in Ohio on June 06, 2000 at 07:11:10:
Jim:
I think lease options held by a dealer (assuming that they are correctly structured- i.e., not as a disguised financing- not usually a problem with investors) are treated just like any other lease options…the option consideration is not taxed until expiration or sale, and there is no sale unless the option is in fact exercised.
As to whether the creator of such options is a dealer…there is NO area of tax law that is less certain. As you are surely aware, there is a huge body of law on intent to hold for sale. And that law is not very consistent. This provides some opportunity for the taxpayer.
In my view- and it is only that, given the uncertainty in this area, a business that lease-options property and has a low rate of exercise (say< 30%) has a strong argument that it is NOT a dealer. The argument is: “I lease my investment properties. To get good tenants, I give an option to buy. The few times they exercise, I sell the property.” If you can, to some degree, predict who will buy and and who will not, I’d segregate the high-liklihood people into a “dealer” entity…and I’d differenciate the contracts…make one more attractive as a sale (higher credits? provide financing? You tell me…what would you do to “ease” a purchase?). The issue there is that the property would have to be placed in one or the other entity before you know whether you have a buyer as opposed to a renter…Ideally, the dealer entity will sell 50%+ of its properties, while the non-dealer entity will have a much lower exercise rate.
Given the fact-sensitivity and inconsistency of the law, this is not sure-fire. From a risk standpoint, the important thing is to have “substantial authority” in taking a position. If you have that, penalties are generally avoided if the IRS rules against you…so you’re only on the hook for interest. I haven’t seen any cases that directly address how lease/options are treated under the facts I just described…but the uncertainty in the law could allow for “substantial authority”.
Under the facts you gave, if most of the houses you L/O eventually sell (look at your record over 10, 20 or 30 years- the courts will) or you have a high rate of exercise in general (no published numbers…I’d say 30% or more and the IRS has a good argumemt), then dealer status will probably stick.
John Hyre