Silent Seller Second And Forgiving Debt
I'm dealing w/ a broker, and this was actually his recommendation. He deals with sub-prime lenders who are very liberal.
Situation: Found a home that I could get into fo $115k; value = $130k. I can get a loan for 90% of value. Broker says purchase the property for $130k w/ a seller second of $15k, so I can get the 90% loan. Once the deal goes through, the seller will then 'Forgive' the loan. What are the implications to the seller for forgiving a loan? I want to make sure no harm would come to the seller if using this strategy.. TIA!!
Just came across this on the IRS website:
http://www.irs.gov/publications/p17/ch13.html#d0e34989
"Canceled Debts
Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. You have no income from the canceled debt if it is intended as a gift to you. A debt includes any indebtedness for which you are liable or which attaches to property you hold. "
sounds like I would have to include the canceled debt on my income tax return, and it wouldn't affect the seller.....which isn't good news for me.
If done poorly this is loan fraud (criminal offense).
Not sure if there is a clean way to do this and not be committing loan fraud.
It really comes down to if the second was a real second or just some paperwork to fool the lender into lending more then 90% LTV. If it was a real loan and for some reason other then deceiving the lender the 2nd is later forgiven then it might be legal. I still think the lender's underwriter would kick it out if they saw what was going on.
John
[addsig]
and here I go once again responding to my own thread
same link above, found the following info:
"Deductible debt. You do not have income from the cancellation of a debt if your payment of the debt would be deductible. This exception applies only if you use the cash method of accounting. For more information, see chapter 5 of Publication 334, Tax Guide for Small Business.
Price reduced after purchase. Generally, if the seller reduces the amount of debt you owe for property you purchased, you do not have income from the reduction. The reduction of the debt is treated as a purchase price adjustment and reduces your basis in the property. "
Quote:
On 2004-11-02 15:47, active_re_investor wrote:
If done poorly this is loan fraud (criminal offense).
John
Hi John, I appreciate your response. Believe me, I don't want to do anything "illegal" but I don't mind playing in grey areas. I think I posted above a way around it.... if the seller 'reduces' the loan, then it effectively reduces the basis in the propery.
So, if the seller reduces my loan from $15k to $1 then it would effectively reduce my basis by $15k.... and would be legal....
That does look like the answer that sounds legal per IRS. However...
I wonder, what could be legally drawn up in writing to require the seller to forgive the debt? It seems like a risk of trust to the seller to keep his word. No?
"Seller agrees to reduce this second from 15K to $1. as soon as lender has funded this deal." ?? I guess there is no way to simply pay 130K, ask for seller consessions (closing 4K, carpet 3K, roof 5K, 2pts) into the deal?
I've been reviewing the lenders notes and it does say 'cash out at closing allowed' and also says 'seller can pay up to 6% of closing costs'
so, maybe you are right. contract for $130k, and ask for $15k back in concessions and closing costs.....
I mean, 6% alone is $7800, then just pay me another $7k in concessions... and I'll put up 10% in cash myself, and refund myself the $7k I receive back.
Ok, there are two problems here. One is the tax problem (actually pretty minor) and the other is the bank fraud problem (more difficult).
The tax problem is that the seller by selling to you at $130,00 had a certain profit and had to pay taxes on that profit. He may defer the taxes because they are due on an installment sale but if he writes the note off then he must send you a 1099 for the income. This $15,000 then becomes income to you.
The fraud issue is more complicated. If you tell a lender you are paying $130,000 when you are in fact paying $115,000 then that is fraud. If you subsequently default on the loan and they decide to chase you then you are potentially liable for the fraud penalties.
fraud is often based upon "intent." What the other King said.
[addsig]
so, if intent could not be proved...
magically after the sale closed, the seller decided to reduce the purchase price, and thus his loan to me... it reduces my basis in the home, and I would think would thus reduce his purchase price, so he would therefore have a tax liability based off the newer lower amount.
does that sound feasible?
Assign the note (discount it) ---
Quote:
On 2004-11-03 16:18, roboxking wrote:
Assign the note (discount it) ---
do you have any experience w/ this? I know people do a lot of these strategies frequently, I just want to make sure what I'm doing is no explicity illegal
Sign a note purchasing contract with the Seller prior to closing on the loan.
Pay $5 for the note or whatever you agree on and then never record the note.
There is no law against you buying your own note from a note holder.[ Edited by dnvrkid on Date 11/04/2004 ]
roboxking and dnvrkid are right. Have your attorney prepare a document that locks the seller into selling you a newly created note for XXXXX.
However I could see this agreement being argued that this was just a cover up for a silent second.
A better option is to use a down payment assistance company. If this will not be owner occupied this service will cost you the upwards of 10-15% but this is the most clean way to do this transaction. Basically the company will send $10k (for example) at closing and the seller sends them $11-11.5k back from his proceeds.