Question About Notes & Taxes

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If I borrow money from an investor (or a bank, or whoever) and buy a note, is the interest I receive reported on Form 1040, Schedule B, Part I, and the interest I pay to the investor an itemized deduction on Form 1040, Schedule A, Line 13 as "Investment Interest"? This seems consistent with publication 550, which treats notes as interest-producing capital assets. Or is all this reported on some other form or schedule? Assume I buy notes on a regular and consistent basis.



If I understand Publication 550, when I buy a $100 note for $60, and convince the payor to make a quick payoff of $80, my $20 of profit is short-term capital gain, *not* interest. Payoffs by the debtor are considered retirements or redemptions, which are treated as a sale or trade. Is that your understanding?

Comments(6)

  • NewKidInTown331st March, 2006

    Quote:If I borrow money from an investor (or a bank, or whoever) and buy a note, is the interest I receive reported on Form 1040, Schedule B, Part I, and the interest I pay to the investor an itemized deduction on Form 1040, Schedule A, Line 13 as "Investment Interest"?I agree with this treatment.

    Quote:If I understand Publication 550, when I buy a $100 note for $60, and convince the payor to make a quick payoff of $80, my $20 of profit is short-term capital gain, *not* interest. Payoffs by the debtor are considered retirements or redemptions, which are treated as a sale or trade. Is that your understanding?
    Just for clarity, I am assuming that the $100 note you are purchasing is really a note with a loan balance of $100 -- the face value of the note could have been higher. For notes between individuals for $10K or less, the accrued interest at redemption or retirement is ordinary income, while capital gains tax treatment applies to the balance of your gain that exceeds the accrued interest.

    In your example, a portion of your $20 gain is really the interest you have accrued on the note. This accrued interest is reported as interest income. The rest of the $20 gain that exceeds the accrued interest is a capital gain. In your scenario, with a quick payoff, I agree that will have a short term capital gain taxed at your ordinary income tax rate.

    Additionally, since you are forgiving a portion of the indebtedness, you have to give the borrower a 1099-C for $20 -- the difference between the $100 balance and the $80 discounted payoff. This $20 in forgiven debt is taxable to the borrower as ordinary income.

  • LeaseOptionKing2nd April, 2006

    It is my understanding that Colorado is one of the few states where it is illegal to assign an Option (without a license). So, as long as you do a simultaneous closing, you should be within the law.
    [addsig]

  • mcole4th April, 2006

    Excellent advice InvestmentBanker!

  • SolutionsKid4th April, 2006

    Makes sense...like I said, just weird ideas every now and then.

    Best,
    [addsig]

  • americanbanker4th April, 2006

    You can do purchase renovation financing O/O or N/O/O. I construction lending and do it all day long and I work for a large regional bank in MI. For investor you need 10% down.

  • ypochris7th April, 2006

    It depends on how good your credit/income stream is, and how well you know your mortgage broker. If your loan aplication is seen as sub prime, you may have trouble finding a loan without a year of "seasoning" to prove that you can make your payments. And a six month deadline to come up with a quarter million dollars is a lot of pressure to some. Be sure that you KNOW you can do this in time before you put your $60K at risk- or get a longer term loan to give you as much time as you need.

    Chris

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