Is this the correct tax treatment for factors and judgments? Factoring: I buy a $100 receivable for $80. The customer pays off in full. I book $20 interest income. Judgment: I buy a $100 judgment for $50. The debtor agrees to (and does) pay $75 as payment in full. I book $25 interest income. Both are considered capital assets, so losses are booked as short-term capital loss (assuming, generally, you write them off within a year of acquisition). As the profits are interest, and assets capital, an IRA may purchase them without incurring UBIT on its profits.
The issue comes down to whether or not you are in a business and what you do with your unpaid collectables.
The moment you contact a debtor in an effort to collect (other than to provide them with notice that you are now their creditor), you are in a business and you are into ordinary income for all the paper you are holding.
Now if you make no individual effort to collect and you sell say 180 day old paper to "an unrelated third party", you may not be in a business. But as an auditor, I would that third party though a grinder before I let you off the hook.
My belief is that factoring is a low risk endeavor and judgements are a high risk endeavor. The former may be interst income (if you don't screw it up) and the latter is a crap shot and not worth more than 10 cents on the dollar. But all my best to you.
You can't buy paper for the production of income (definition of capital asset) if you intend to force the debtor to pay? Why would anybody buy paper then? So if my IRA buys a mortgage and the payor stops paying, when I demand payment all my interest income gets converted to UBTI? Or worse, if it buys delinquent paper it's UBTI to begin with?
The auditor might be better off arguing the sale was intended all along, thus categorizing your paper as inventory, and sales of inventory are ipso facto business transactions.
My judgment example was for the tax result, not the business result. I agree that judgments should be purchases at 10% or less of face value. I get the sense that the risks are reversed, as judgment holders have far-reaching collection authority factors (mere unsecured business creditors) don't have, and it's a lot harder to be defrauded buying a judgment (the facts of which are on file with the court) than buying an invoice.
I buy paper because I reasonably expect NOT to have to force the debtor to pay.
No, the interest already paid remains interest. I'd say that further payments are also interest; but if the default accelerates the payment obligation and you collect early, the excess is more likely to be UBTI.
I think so: collecting on delinquent paper is generally a business.
Buying a security with the intent to sell it later at a higher price doesn't make it inventory (if you aren't specifically a dealer in it).
It depends on the circumstances.
If somebody wins a judgment against an insurance company, which is required to pay him $100,000 annually for 20 years, and you buy that, discounted at (say) a 10% rate, I'd say you're getting interest income. If you buy a random judgment against somebody where in order to collect you're going to have to find his assets (if any), attach them, etc., then I'd say you're engaging in a business. So I'd say the issue is the amount of work you're reasonably expected to have to do to collect. If none, then there's interest income. If lots, then it's a business. There is, of course, no guarantee that the IRS will agree with me. Seth
If my income is business income, not interest, are my gains and losses ordinary, not capital? If I'm doing this in corporate form, which has no schedule C to "convert" my interest income to business income, do I report it on Form 1120/1120S as business income, not interest? I sure wouldn't want the IRS claiming it should have been reported as interest.
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