Tax Consequences on note sale - Posted by LMB-NC

Posted by Michael Morrongiello on February 14, 2000 at 15:51:02:

Richard:
Unless you can obtain a fee for arranging the funds to be advanced to the seller who is to use his note for collateral purposes then you are correct. I know I would be willing to compensate a finder who brought me this type of opportunity where I could invest funds into a well secured note.

The post stated that the seller was “skitish” about havingt to pay a $13K tax bite to Uncle Sam. With the PARTIAL sale of the note that would be the result. With the Hypothecation scneario you mitigate the tax impact and the seller is more incline to do the deal…

Warmly,

Michael Morrongiello

Tax Consequences on note sale - Posted by LMB-NC

Posted by LMB-NC on February 14, 2000 at 07:49:53:

I have a note holder with a great note (15 yrs seasoning) with a face value of $113k that we have offered a partial on for $65k to generate the cash he needs to do some developing. His tax advisor tells him he will get hit with $13k tax bill as soon as he takes the cash out. Is this the only way to do it? I need some creative alternatives to give him. He does 1031 exchanges and says this will not work. I am a newbie and do not know what to suggest.
Thanks for your suggestions.

Hypothecation of notes - Posted by John Behle

Posted by John Behle on February 15, 2000 at 13:30:10:

As Mike mentioned, you can hypothecate the note. That way it is borrowed money and the tax hit doesn’t happen. I don’t know of any of the “normal” national funding sources that loan against notes (except FNAC).

So, look for local investors and funding sources. This might be a deal where you “create” an investor through “Equity Arbitrage” or funds from an IRA, etc.

The investor then loans money secured by the note. Actually it is more safe than an actual purchase since they also have the guarantee of the note owner. Yet, there is a little higher risk because they could get tied up in a bankruptcy (but would be a secured creditor) if the note holder BK’d. There could also be a “usury” concern with a loan as opposed to a partial. Actually partial purchases are also high risk in the usury department, but that is another discussion.

You get paid through a fee: 1) from the note holder, 2) from the investor 3) by being in the middle - investor loans to you and you loan to the note holder. Option three could be slick if you had other collateral to put up. You arrange a decent interest rate and loan and then get a higher yield on the “note loan”. Again, “Equity Arbitrage”.

Now, there is one “National” funding source as an option. That is a little more complicated and somewhat results in a commissiondectomy (for future deals with this investor). That would be to put them in touch with First National Acceptance Corp. and the note holder takes out his own “Broker Line”.

If that seemed like the only or best option, you could charge a consulting fee - BUT - you could also form a longer term relationship with this investor and work out somewhat of a note buying partnership using the “Broker Line”. That could look like selling notes to the investor - funded by the broker line or buying notes with the investor and taking a piece of the spread and or cash up front. There could also be a “Buy sell” agreement with the investor that you can buy the notes in the broker line (except the one that would cause him a tax hit) when you are able to fund them through 1) your own Broker Line 2) Investor funds 3) Selling them (last option).

You could then springboard this one deal into your own note portfolio.

In some ways that is how I started. One of the first investors I worked with wanted more “Action” than just loaning against the notes and understood some of the upside profit potential. So, instead of just brokering them - (See “Let the Goose Live” - I was able to sell notes to them, with an option to buy them or split profits as we improved them.

There is a link to First National at my website along with other funding sources and I will be posting the article “Let the Goose Live” in a short while.

Uncle Sam strikes again… - Posted by Michael Morrongiello

Posted by Michael Morrongiello on February 14, 2000 at 14:01:12:

LMB-NC:
I am not a tax practioner but here is my $.002:

If that note holder got paid off in FULL by the payor on that note there would be tax due. The fact that he is willing to assign a PARTIAL interest to raise $65K will also result in a tax liability as well although he will still preserve some of the installment sale tax treatment benifits for the “residual” interest he will hold & still have in the note.

IRS code 1031 tax deferred exchanges cannot work for notes in the true sense since they are NOT real property but consider personal property.

There is another possible way to go here.

The noteholder can borrow the $65K by “hypothecating” or plegding their interest in the note as collateral for a loan. In this fashion the funds he collects are borrowed funds and not taxable. The payments he pays back on the loan might also be tax deductible. As long as he is willing to stand behind the loan payments this might work.

This very well may be the way to go.

Kind Regards,

Michael Morrongiello

Re: Tax Consequences on note sale - Posted by David Alexander

Posted by David Alexander on February 14, 2000 at 09:48:12:

You can do 1031’s with notes, don’t know exactly how just have heard you could. Maybe someone else will post?

David Alexander

Re: Hypothecation of notes - Posted by Tony-VA

Posted by Tony-VA on February 17, 2000 at 12:52:33:

Would you mind discussing “Actually partial purchases are also high risk in the usury department, but that is another discussion.”

Thanks,

Tony-VA

Re: Uncle Sam strikes again… - Posted by David Alexander

Posted by David Alexander on February 14, 2000 at 16:28:40:

In what can you 1031 a note? I was told you could, dont know the details so I’m dangerous, but I’m listening?

David Alexander

Re: Uncle Sam strikes again… - Posted by RichardTX

Posted by RichardTX on February 14, 2000 at 15:33:44:

Mike, in the hypothecation scenario, the transaction is between the nite owner and the lender. I don’t see any profit opportunity for the broker, or am I missing something?

Partials, Usury, Bankruptcy, etc. - Posted by John Behle

Posted by John Behle on February 17, 2000 at 15:03:55:

There is a lot of controversy and have even been some court cases about “partials” being construed as loans. The differences can be substantial. One is Usury. Partials could be construed as a loan instead of a purchase. If so, then a partial with a good yield could end up being “usurious”. There was a case recently that was settled out of court - so there was not a precedent.

A few note buyers will not do partials because of that risk and the risk of bankruptcy. If I buy a note and the note holder goes into bankruptcy later, I will likely not be affected. If I buy a partial - and it is contrued as a loan - then I could be dragged into a bankruptcy as a creditor.

I don’t get too concerned about the controversy and risks. Some people want to fight to do things the way they want to or feel like they should be able to. I just look for a creative solution.

The way I do partials (“Compensating Note” technique) avoids these and many other challenges related to partials.