Tax Help? IRS and Land Contract Sales (long) - Posted by Stacy (AZ)

Posted by Stacy (AZ) on January 15, 2001 at 22:26:17:

Good advice, John. My CPA was a field agent for the IRS for well over a decade. He really seems to know his stuff. The insider’s view has been of great benefit in that he knows where he can be aggressive. I’m going to pass all of this by him.

Thanks again. I know you’re busy, but your help is very much appreciated.


Tax Help? IRS and Land Contract Sales (long) - Posted by Stacy (AZ)

Posted by Stacy (AZ) on January 15, 2001 at 16:55:44:

JPiper posted an interesting decision from tax court at the following link:

Then JHyre posted the entire text. As I read the text of the decision, it seemed obvious to me that the main issues revolved around identifying the GIA transactions as “sales”. To quote JPiper (and the court):

"The tax court decided that factors which would be an indication of the benefitis and burdens of ownership include:

  1. a right to possession
  2. an obligation to pay taxes, assessments, and charges against the property
  3. a responsibility to insure the property
  4. a duty to maintain the condition of the property
  5. a right to improve the property without the seller?s consent
  6. bearing the responsibility of loss
  7. a right to obtain legal title at any time by paying the balance of the full purchase price

All of these factors were present in the contracts for deed used by GIA."

My reply to JPipers post:

"I wonder if we could use the list of factors to fashion a CFD that does not comply with all seven, as did the GIA contracts? For example, you listed the following factors:

  1. a right to improve the property without the seller?s consent

If specifically stated in the contract that any improvements must be approved by the seller, this one could be eliminated.

  1. bearing the responsibility of loss

If the underlying Hazard Insurance policy is in the seller’s name, and the buyers only have a contents policy, it seems this one may be eliminated. Also, if the hazard ins. is in the seller’s name, and there is no mention of the buyer being responsible for insuring against loss, this probably eliminates #3:

  1. a responsibility to insure the property"

I wonder if this would significantly reduce the possibility of the tax court causing problems (only meeting four of the seven indicators)? I would think that identifying the transaction as an outright sale would be impossible, since the the “seller” retains some rights and resposibilities of ownership.

Can anyone offer an opinion on this? It’s important to me (and others), since it may be a way to sell with owner financing, and not be concerned about the IRS categorizing the transaction as a “dealer” sale. This would allow these deals to be taxed only as the installments are made, instead of all in the year of the sale.

Further, in prior research I found that using the accrual method of accounting is another way the tax code interferes with this strategy. My question is, if I ran a business buying houses and selling on Land Contract, but I used the cash method of accounting, would this allow me to avoid the problem of having to declare all profit the year of the transaction?

Am I on to something here, or out in left field?


This may help - Posted by Bud Branstetter

Posted by Bud Branstetter on January 15, 2001 at 21:04:54:

The provision in the tax law that outlawed small business from using installment sales when using the accrual method was repealled three days after Christmas. Retroactive to 1999. Installment Tax correction Act of 2000.

Now, why not use the Pactrust? It satisfies all these criteria. The property can be improved but unless the RB gets agreement he doen’s get the full benefit. He has responsibility to insure as it is a triple net lease. Bearing the responsibility on loss is covered too since he owns part of the trust and would suffer if there was an uninsured loss. But then that couldn’t happen since it is the function of a collection agent etc. to be sure bills are paid from a contingency fund.

Oh, you can do a 1031 with your interest in the trust to another property.

Re: Tax Help? IRS and Land Contract Sales (long) - Posted by JHyre in Ohio

Posted by JHyre in Ohio on January 15, 2001 at 19:57:30:

I’m mondo busy right now, so I’ll have to keep this short. Jim Piper is usually more conservative than I on tax issues…but not this time. First, if you sell real estate and are on the accrual method GET A NEW ADVISOR…real estate not only shouldn’t be on accrual method, there are cases saying it CANNOT be. Besides, as Jim explained, cash method provides a much more favorable outcome for RE sold on notes- and you can use cash method for RE (as opposed to personal property like MH’s) even if you are over the million dollar mark (there’s some debate over whether RE C-corps can do this.).

Second, the list of factors that determine who bears the benefits & burdens of ownership…numerous cases have analyzed the issue and very few went well for the taxpayer. If the tenant has possession and a right to buy title, you’ve two strikes against you, and the courts will strive to find a third. With the exception of properly structured L/O’s, it’s unlikely that the factors can be sucessfully manipulated to yield a non-sale without giving up ALL the benefits thereof…and the only reason L/O’s get better treatment (i.e.- deferal of the tax on the option) is a unique but firmly rooted case history (the “open transaction doctrine” is almost never applied to anything other than options.) Note, I didn’t say impossible, just unlikely. I think that the cost of fighting is high enough- and the probability of sucess low enough- to make such a position difficult and unduly risky- and I happen to be fairly agressive where tax planning is concerned. I just don’t see the Tax Court- or even oddball California appellate courts- siding with the taxpayer on this issue…this is a conbination of analysis and plain old gut feel on my part. I did see the piece on Dychess Bodiford’s site relating to this…I congratulate them for aggresive thinking, but I think that such plans will certainly fail on audit and probably in court. Only EXTREMELY aggressive people with a love of fighting- and the resources to engage in such- should try to manipulate the list of factors described in GIA and report “no sale”. By the way, the GIA CPA should be shot for permitting use of accrual method on RE- and use of accrual accounting did warp the amount paid (though not the logic of the holding itself) substantially. Sloppy work, nearly as sloppy as this hasty post. I’ll try for a better post down the road.

By the way, I don’t think documenting FMV of notes is too hard…get some legitimate quotes or real-life examples of such sales. And (Piper notwithstanding) I am quite happy to have investors pay for my kids shoes!

John Hyre

Re: Tax Help? IRS and Land Contract Sales (long) - Posted by JPiper

Posted by JPiper on January 15, 2001 at 18:28:31:


Sorry I overlooked your post before. I may not have the answers for you on it?but here?s a few thoughts.

First, John Hyre made a post about 6-8 months ago regarding Revenue Procedure 2000-22. To put this Procedure in real estate terms, you may ?discount? the face value of a note to fair market value, then amortizing the difference over the life of the note?.thus delaying the payment of taxes on that amount. To do this you would need to be a business with gross annual revenues of less than $1,000,000 and be on a cash-basis accounting system. This may not be quite as good as an installment sale, but it?s obviously better than paying the entire tax upfront. The problem appears to be in how you establish fair market value. And my guess is that you would want to have this well nailed down in the event of an audit.

But let?s assume for a moment that you had a note (or contract) with a face value of $100K. Let?s also assume that you cost basis in the property is $80K. Further assume that you?re a dealer, and that your gross revenue is under $1,000,000 and that you?re cash-basis taxpayer. Let?s assume that the market value for this $100K note is $90K. You would then pay the upfront tax on $10K, and then amortize the other $10K profit over the life of the contract. Again, the key would be to establish the fair market value of the note at $90K. Frankly, my guess is that if you looked around you might find plenty of bids for $80K for a high LTV contract?.thus creating a scenario very similar in effect to an installment sale.

Frankly, this appears to be substantial relief, but the Procedure is new so definitely have your CPA check it out. And understand that I?m not a tax expert, so my comments are conditioned upon that.

The rest of your post seems to be related to whether we can modify a contract sufficiently to cause it NOT to be a ?sale?, and therefore change our tax treatment of it. One thought that occurs to me is that there is already a ?contract? that contains some of the modifications that you suggest: it?s called the lease option. I suppose that one reason that an investor might prefer to sell with a contract for deed though is that the buyer may gain some tax advantage to acquiring this way?and therefore might put up a larger down payment. So when you start to take away some of the typical ?benefits? of ownership, this may well benefit the investor, but then again may take away the incentive that the buyer had to do a contract for deed to begin with?.namely tax advantages.

I think that one of the implications of the GIA case is that the court will look at a variety of factors to determine whether a contract (or perhaps a lease/option?) is a ?sale?, or ?not a sale?. I suppose the point is that the fewer the factors that exist in your contract, the more likely it is to be construed a ?non-sale?. But it also looks to me like a poorly defined area, and therefore one that is full of risk if you are audited, and perhaps penalized for paying your taxes wrong.

Definitely put me in the camp of not being a trailblazer when it comes to that. The audit comes around and the IRS decides what you owe. If you want to dispute that you now pay a tax lawyer?.not an inexpensive proposition. But I think I?ll let you keep John Hyre?s kids in shoes?.I?ll watch from the sidelines, probably paying more tax than I need to. Then again, look at those penalties GIA paid?.good thing the primary partners were a radiologist and a dentist!

And again, I?m not a tax expert.


Re: How is the gain reported? - Posted by Stacy (AZ)

Posted by Stacy (AZ) on January 15, 2001 at 21:22:12:

Hi Bud-

How is the gain reported to the IRS? Can you make a PACTrust sale, and report the income as an installment sale, rather that being taxed on the entire gain in the year of the sale? Think in terms of CFD.

I’m not intimate with the intracacies of the PACTrust. My goal is to get a 7% to 10% downpayment, a spread every month until the buyer refinances, and then get a nice back-end. BUT, I need to do this without having to pay taxes on the entire amount of gain in one year. Does the PACTrust allow this, without the fear of an IRS ruling that puts me and my kids out on the street selling apples?

The way Jim and John characterize tax court makes me want to crawl into a hole and die before I consider treading any new ground. And I believe them.


Re: To JPiper, JHyre and Bud - Posted by Stacy (AZ)

Posted by Stacy (AZ) on January 15, 2001 at 21:38:38:

Thanks a lot guys. You’ve sufficiently scared me out of it. If I was 25, single, and already a multi-millionaire, maybe I’d go for it. Yep, there I’d be; taking-on the big bad IRS, Ralf Nader at my left side, TV cameras in my face as I walk down the street from the courthouse. And who’s on my right-side? Oh, come on, do you really need to ask? Oprah, of course!


(My wife might read this. Did I do good with the Oprah part?)

Re: How is the gain reported? - Posted by Bud Branstetter

Posted by Bud Branstetter on January 16, 2001 at 02:33:35:

During the years the trust is in effect you would report the income as investment income on your schedule E because you are an owner(although partial). The tenant is on a triple net lease so you don’t show that the gross, just the net.

When you sell you typically get cashed out because they get refi’d. You could do an owner financed note and sell the note while keeping a second. I would prefer the cash and 1031 it into other investments that will generate the cash flow. Or even do it in that Roth so that the taxes are not an issue.

Re: How is the gain reported? - Posted by JHyre in Ohio

Posted by JHyre in Ohio on January 15, 2001 at 21:49:07:

I think that this paticular issue is a bad one to take the court…but don’t be afraid to be aggressive or go to Court IF the argument and the money are there. Taking conservative positions is like a self-audit- you pay more than you should. Be aggressive- but pick your battles.

John Hyre