Posted by Troy M on May 17, 2000 at 11:51:15:
nt
Partial Relief of IRS Dealer Status - Posted by JHyre in Ohio
Posted by JHyre in Ohio on May 16, 2000 at 15:31:50:
Possible Relief for IRS Dealer Status- Comments, Slings and Arrows Welcome
Recently released Revenue Procedure 2000-22 may provide some tax relief to “dealers”. Specifically, Rev. Proc. 2000-22 allows taxpayers with annual gross revenues under $1,000,000 to account for inventories under the cash method of accounting instead of using the accrual method. What in the He!! does that mean?
Well, most of you know that if you sell inventory (are a “dealer” in common parlance) with a basis of $2,000 for a note with a face value of $10,000 and a fair market value of $5,000, you will have $8,000 in gain IMMEDIATELY. This presents a return-killing problem, especially for Lonnie Dealers like me. The root of this rule is the accrual basis of accounting. It requires inclusion in income at face value of the note, regardless of cash-flow or the actual value of the note. And that nasty old accrual method is required for any business where inventory is a “material income-producing factor”. In English, if you sell stuff, even just a little, you gotta use this nasty method to keep your tax books.
Now, an exception to that blatantly unjust rule has been promulgated in the form of Rev. Proc. 2000-22. Taxpayers with annual gross revenues under $1 million can use the cash method of accounting. That method is generally more favorable than accrual method where sales on notes are concerned. To follow the example above: The immediate gain under the cash method would equal $3000- fair market value of the note less basis. The difference between Face Value and Fair Market Value would effectively equal Original Issue Discount (“OID”) and be taxable (more or less) ratably over the life of the note (The OID rules are very complex- I’ll not delve into them here). So if the note pays off on schedule, you’ll pay the same amount of tax as under the accrual method- but you’ll pay that tax a lot later- avoiding cash flow issues and creating present value.
For the skeptics and their attorneys/CPA’s- see: Rev. Proc. 2000-22; COWDEN 289 F.2d 20; SCHARF EST. 38 TC 15; Rev. Rul. 79-292; GCM 37218; CAMPBELL 661 F.2d 210 (Ct. Cl. 1981); HELLER TRUST 382 F.2d 675 (the latter dealt with land-contracts, no less).
You still pay at ordinary rates and installment sales contracts and 1031 are still no-no’s?.but I’ll take what I can get. If you have used accrual method in the past, you must file Form 3115 to change to cash method. Attorney/CPA (I’m the former!) can assist with this and advise on other ramifications of changing to cash method (generally good).
Comments & criticism welcome. Remember, you heard it here first.
John Hyre
Re: head spinning… hurts-to-think… - Posted by eric
Posted by eric on May 17, 2000 at 11:09:10:
Greater minds than mine, I guess. Every time I look at this stuff, I think, “I gotta get a guy”. Kiyosaki states there are 4 important business skills: Accounting, law, marketing and investment/analysis. I think I’ll leave the first two to folks like yourself - but thanks for the post, now at least I have a smart question I can ask!
Always great to hear useful tax info- Thanks again! nt - Posted by Sue(NC)
Posted by Sue(NC) on May 17, 2000 at 09:01:43:
nt
Re: Partial Relief of IRS Dealer Status - Posted by JPiper
Posted by JPiper on May 16, 2000 at 20:12:56:
Thanks for this important post.
One question that comes up for me. How would you recommend establishing the fair market value of the note so that the Original Issue Discount could be determined? I’m referring now to real estate secured notes if that makes a difference.
JPiper
Good point . . . - Posted by William Bronchick
Posted by William Bronchick on May 17, 2000 at 10:23:42:
What I do is create a second corporate entity that buys the note from the first at the market value, which is about 10-20 cents on the dollar. The “dealer” corporation reports the cash income from the sale of that note, and the second entity collects payments in installments. Although the two entities are related, the fair market value was paid for the note (which I established as John suggested below).
Re: Partial Relief of IRS Dealer Status - Posted by JHyre in Ohio
Posted by JHyre in Ohio on May 17, 2000 at 05:39:34:
For my mobile notes I intend to speak with 3 to 5 note brokers & get a range of discounted prices. I document the responses and assign each of my notes a spot on the lower end of that continuum…leaving something for the IRS to “take” on audit. I do not think an appraisal- assuming one could be obtained- is necessary. Just document the quotes obtained- that’s enough to put the ball back in the Service’s court.
John Hyre
Re: Good point . . . - Posted by JHyre in Ohio
Posted by JHyre in Ohio on May 17, 2000 at 12:00:35:
Hello Bill,
Had been discussing that option with other investors on MH board…I opine that need an unrelated buyer to avoid possible suspension of loss on initial note sale even if it’s at FMV (IRC 267). I assume you have not had audit issues by using related entity to buy?
John Hyre