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Discounted Note purchase


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#1 tgaspard

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Posted 20 February 2009 - 04:21 PM

I receintly bought a first position note secured by a mortgage. The note is worth $99,750 over 12 years at 9.5% interest and I bought it with a $20,000 discount. All is fine and the buyer pays every month.

Here is my question. I know how to handle the interest taxes for both the home owner and myself being the lender. I'm just not sure how do I report the $20,000 discount. Do I report that as a capital gain now? Or Latter? Or do I have to report that in my personal tax braket. Must I report this gain now or once the loan is fully paid?

Thanks
Todd

#2 randian

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Posted 20 February 2009 - 05:35 PM

I receintly bought a first position note secured by a mortgage. The note is worth $99,750 over 12 years at 9.5% interest and I bought it with a $20,000 discount. All is fine and the buyer pays every month.

Here is my question. I know how to handle the interest taxes for both the home owner and myself being the lender. I'm just not sure how do I report the $20,000 discount. Do I report that as a capital gain now? Or Latter? Or do I have to report that in my personal tax braket. Must I report this gain now or once the loan is fully paid?

It's reported over time. Run a new amortization schedule with your basis as the principal balance. The interest portion is taxable.

#3 Dave T

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Posted 20 February 2009 - 11:59 PM

Todd,

The discount you received on the note purchase is called Original Issue Discount (OID). OID is taxed as interest on your tax return as it accrues.

Essentially you have to set up two amortization schedules. One for the borrower's payment on his loan amount and another for the borrower's payment on your discounted basis. The difference between interest collected on the two schedules is the amount of OID interest you report on your tax return, in addition to the amortization schedule interest the borrower paid you.

For example. Let's say you purchase a note that has a face amount of $100K at 6% fixed over 30 years. Let's say the borrower has already made 40 monthly payments when you bought the note, so the remaining balance on the note is $95603.96. The borrower's monthly payment is $599.55 which will fully amortize the loan at the end of the 320 payment remaining on the note. The next payment that the borrower makes will be the 41st payment on the original amortization schedule for which $121.53 will be principal, and $478.02 will be interest.

Let's say that you purchase the note for $75K, and that the borrower is making that 41st payment to you. You create a new amortization schedule for yourself, with $75000 as the loan amount, $599.55 is the monthly payment, and number of payments is 320. On your amortization schedule the monthly payment is stll $599.55 but for the first payment you receive, $50.13 is principal and $549.42 is interest.

The difference between the two interest payments of $71.42 represents the OID interest you received that month.

If you received only one payment on the loan in 2008, then you would report $478.02 in interest income from the borrower and an additional $71.42 in OID interest income.

Does this help

#4 tgaspard

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Posted 21 February 2009 - 09:54 AM

Ah!!! Thanks a million Dave

Todd

#5 tgaspard

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Posted 21 February 2009 - 10:38 AM

One more question.

Therefore if I understand correctly, both a form 1098 and form 1099-OID is used to report both interest? Is that correct?
(For your example $478.02 would be reported on form 1098 and $71.42 would be reported on form 1099-OID). Is that correct?

Todd

#6 randian

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Posted 21 February 2009 - 01:05 PM

I don't think the discounted interest is normally reported as OID. It's reported as ordinary interest.

#7 Dave T

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Posted 03 March 2009 - 12:05 PM

Are you asking whether you have to issue anyone a 1099, or 1098?

You can send both the borrower and the IRS a 1098 for the mortgage interest the borrower paid you on his note's amortization schedule. Or, in lieu of issuing a 1098, you can send the borrower a letter telling him the amount of mortgage interest he paid you during the year. Your letter also needs to tell the borrower your name, address and your SSN. If the borrower itemizes his deductions, he claims the home mortgage interest deduction but he has to document on his tax return to whom the interest was paid and provide the IRS your name, address, and SSN.

The OID interest you received is just reported on your tax return and taxed the same as your other interest income. You don't issue yourself a 1099-OID.




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