Posted by Sheik on June 23, 2000 at 17:09:38:
…It is a $10K note.
John, If you don’t mind, can you cut and paste David’s
original example and make changes from top down for the Cash Accounting method?
I am sure others would appreciate it as well.
Thank you.
Sheik
JHYRE’s Rant Revisited… - Posted by David Alexander
Posted by David Alexander on June 22, 2000 at 14:54:44:
Ok, John,
here goes as My CPA tells me.
With Examples for illustration:
Different entities for each.
C Corps
Buy Houses
DR Asset --------50,000-------------------------------------
Cr Cash---------------- 50,000
Sells Houses - Creates Notes
DR Note--------100,000-------------------
Cr Asset---------------50,000-------------------------------
Cr Gain----------------50,000
Sells Note (10%) @ Discount
DR Cash---------90,000------------------------
DR Note---------------100,000------------------------------
DR Loss---------10,000
LP’s
Buy Notes at the discount
Dr Note-----------100,000-----------------
Cr Cash--------------------90,000------------------------------
Cr Gain-------------------10,000
C Corps
Buys MH’s
Inventory-----------3,000-----------------------------------
Cash--------------------------3,000
Sells MH’s - Creates Notes
Note-------------10,000-------------------------------------
Cash--------------1,000-------------------------------------
Inv.------------------------3,000---------------------------
Gain------------------------8,000
Sells Note (MH 50%) @ Discount
Cash-----------------5,000----------------------------------
Note---------------------------10,000-----------------------
Loss-----------------5,000
LP’s
Buy Notes at the discount
Note--------------10,000------------------------------------
Gain---------------5,000------------------------------------
Cash---------------------------5,000
Ok, The reasoning I was given was that once the Asset or Inventory is sold we are then no longer dealing with anything but a Note Recievable. In other words they are two seperate transactions and your trying treat them as one. We do however use the accural method for everything.
We are not selling the notes for anything different than the Fair Market Value so the dissallowing of the transaction is not an issue as per what Bronchick had said in earlier posts.
Also in the event that there was an issue with Related party rules which I believe is your biggest hang up, the transactions are completely arms length. I was also told we are consistently following GAAP.
But worse case scenario and everything was conglomerated on a single return it would all wash anyway, because the numbers would balance on all returns.
Ok, go ahead Rant some more… I didnt look up case law as I said because your right I should be doing deals, Lol… and letting my CPA and others deal with this stuff.
David Alexander
Re: JHYRE’s Rant Revisited… - Posted by The Baze - Jax, Fl
Posted by The Baze - Jax, Fl on June 23, 2000 at 10:24:10:
David,
Before I read John Hyre’s response, let me see if I can shed any light on the subject. If the limited partnership and the corp are related IN ANY WAY, there is no loss on the sale of the note from the corp to the LP. The loss will not be recognized until the LP sells the note, at which point the loss will offset any gain the LP realizes. If the LP & corp are not related, then the loss can be recognized at the time of the sale. As far as the purchase of the note by the LP, there would be no gain recognized at that time. I believe that the OID rules would apply here, just as they do when bonds are purchased at a discount, and the “gain” is amortized over the life of the note. As John has stated before, the OID rules are complex and beyond the scope of this post. I’m sure he can explain that better than I can. Hope this helps.
Tom Bazley
Re: JHYRE’s Rant Revisited… - Posted by JHyre in Ohio
Posted by JHyre in Ohio on June 23, 2000 at 08:39:34:
OK, let’s be sure that we are on the same page:
The reason Bronchick and I disagreed was that our underlying assumptions were different. He was implicitly applying cash method, I was implicitly applying accrual method. Once we understood that we were comparing apples and oranges, the disagreement went away. He was right vis-à-vis cash method, and I was correct with respect to accrual method. Your post explicitly states that you are applying accrual method- so my rules, as opposed to Bronchick’s, apply here.
Your accountant’s entries are essentially correct for tax purposes (as opposed to “book” or GAAP purposes) except for the final entry. Using your MH example, assuming that your Corp is directly or INDIRECTLY related to the LP, the “gain” on the final entry is neither “realized” nor “recognized” for tax purposes. The Corp’s loss is disallowed until the note is subsequently sold (assuming it is sold at a gain, based on the LP’s $5,000 basis). For TAX books (as opposed to pure GAAP books), based on accrual method of accounting IN CONJUNCTION WITH related party rules, the correct final entry is:
Note (debit): $5,000
Cash (credit): $5,000
Or
Note (debit) $10,000
Cash (credit) $5,000
Deferred Gain Reserve (credit) $5,000
The result is the same either way, the difference between the entries is really a matter of accounting theory and preference- I prefer the latter entry. By the way, on the second to last entry, “LOSS” should really be “SUSPENDED LOSS”.
If your Corp and the LP are truly not related, my concerns are MOOT because then you have an arm’s length transaction, in which case your accountants entries are nearly correct. I say “nearly”, because the Buyer would probably NOT recognize gain upon immediate purchase (no realization event in tax parlance). Rather, buyer’s gain would probably be recognized over time based on the Original Issue Discount rules, aka OID rules.
Given the mechanics of cash method, selling note to related entity at verifiable FMV does not produce a loss under that method IF cash method was properly applied (i.e.- initial gain on sale of home reported based on FMV, not face value, of note). That’s what Bronchick was getting at. Real estate can use cash method. Until recently, MH’s could not. That’s why I recommend switch to cash method for mobiles and CORRECT application of cash method if already in use for real estate.
John Hyre
Re: JHYRE’s Rant Revisited… - Posted by Sheik
Posted by Sheik on June 23, 2000 at 08:12:26:
David:
I’m a little dissapointed that no one’s taken a stab at this. I was actually looking forward to it.
The only thing I have to add is according to a post on Bronchick’s newsgroup, the $5K discount is not a ‘loss’ since the note was sold for FMV.
Needless to say, I am still baffled on how to address this discount for bookkeeping purposes.
Hopefully, John will see this post.
In The Same Boat
Sheik
Re: JHYRE’s Rant Revisited… - Posted by Sheik
Posted by Sheik on June 23, 2000 at 12:53:02:
John,
Your last paragraph lost me 
According to you last paragraph (at least w/ my !#$%& thickheaded understanding), the entries for Cash method would be as follows -
(please indicate if this is correct, thanks)
Sells Note (MH 50%) @ Discount
Cash-----5,000----------------------
Note---------------5,000–(even though the face value is $10K??)
LP’s
Buy Notes at the discount
Note----5,000-(w/ face value of $10K)--------
Cash----------------5,000
Thanks
Sheik
Re: JHYRE’s Rant Revisited… - Posted by The Baze - Jax, Fl
Posted by The Baze - Jax, Fl on June 23, 2000 at 14:05:01:
Shiek,
The entries would actually look like this:
For selling the note
Cash-------------5,000---------
Loss on sale------5,000---------
-----Note-------------------10,000
If the corp & the LP are related, the loss is not recognized for tax purposes. For GAAP purposes, the loss is recognized.
For purchasing the note
Note-----------5,000 (cost)
-----Cash-----------5,000
As John said, the gain is recognized ratably over the term of the note following the OID rules.
Tom Bazley
Correction… - Posted by JHyre in Ohio
Posted by JHyre in Ohio on June 23, 2000 at 13:41:54:
Your entries are correct, assuming both entities are on cash method. Note was carried at $5000 and so is completely removed from books by $5000 credit. My “second entry” from my original post could only apply to an accrual based taxpayer.
John Hyre
Re: JHYRE’s Rant Revisited… - Posted by JHyre in Ohio
Posted by JHyre in Ohio on June 23, 2000 at 13:29:25:
You got it…though it’s sloppy, which is why I prefer the second alternative that I gave.