DOI?

The boss(es) might be right. See Internal Revenue Code sections 108(a) (1)(D) and 1017 (and their regulations) and also see the instructions to IRS Form 982. Maybe just reading the IRS form instructions for line 1(d)would be enough. What you've got here is (may be) qualified real property business indebtedness, and the taxpayer can make an election to exclude it from taxable income. Basis adjustments are obviously needed.

In 1982 (which means the relevant tax code may kave changed), Susan and I purchased a condo that had a $20,000 first mortgage from Freddie Mac and a $30,000 second mortgage from the previous owner. I offered the previous owner $15,000. She said $20,000 and I said "Deal". My basis decreased by $10,000. The seller was unaffected since it was a separate transaction. Why did she take the discount? The second mortage was at 7% and interest rates were over 10%.

From what what you have written, there is no reason to presume the loan was in jeapordy. So in the absence of information that this was a discharge of indebtedness rather than a reduction in purchase price, I agree with your superiors. I can only speculate as to why the lender agreed to the discount. Perhaps since it was an 11% discount, the loan may have been at a below market rate and the payoff was the net present value of the loan less the lender's servicing costs. Dick

Was the lender also the seller? Or were they independent?

How did client convince lender to accept the discount?

Stu

I found the following in "Small Business Taxation, Planning and Practice," by Gary L. Maydew (Fourth Edition). Copyrighted by CCH (Page 157)

-----------========begin quoted text

Purchase-Money Debt Reduction

If the seller reduces the debt of a solvent buyer, then the reduction is treated as a purchase price reduction (reduces the basis). If the basis is exhausted, the remainder constitutes gross income. end quoted text

-----------======== I found this on Google by searching "purchase money debt reduction." It was in about the 5th item on the first page of returned hits. Condor

"James Lewis" wrote

It's a reduction in basis as I see it. The discount for early payoff was apprently part of the purchase agreement. That seems to lead more to an adjusted purchase price instead of income from discharge of indebetedness.

-- Paul A. Thomas, CPA Athens, Georgia

You are, of course.

Loan discount points, origination fees, other costs associated with a loan have nothing to do with basis. Only items which add value TO the property affect basis, e.g. improvements, additions, renovations. ChEAr$, Harlan Lunsford, EA n LA

After reading other responses, it appears that most thought that this was a seller financed mortgage, whereas I took it face value, that purchaser bought the property but acquired a mortgage from a different lender. What were the facts?

ChEAr$, Harlan Lunsford, EA n LA

Seller was not lender. Seller had been employee of lender before death of seller owner. Seller had terminated borrower before loan payoff. I believe they agreed to the lower payoff to help temper the termination, but there's nothing in writing to that affect. Seller says he offered to payoff early for a discount. The estate beneficiaries are young and like to liquidate when possible. The rental property purchased has plenty of basis to reduce if that is feasible. I'll have to read the code sited by one of the respondents. Mike

Moderator: Since the loan was not in distress, I still think it is a reduction in the purchase price.

I still don't quite get the facts. The seller and buyer were both employees of the lender, but the lender died and the seller inherited the company and then fired the buyer??? If that's what happened the lender stands in the shoes of the seller and the reduction in the loan amount was a reduction in the purchase price. Otherwise I'd think it would be taxable.

Does a loan being in distress have anything to do with it? I thought that if it were in distress as a result of the borrower being "insolvent," debt cancellation income is not required to be recognized. Or am I confusing that with something else?

Stu

After reading my own reply, it confused me:-) Only the first "Seller" is correct. Where it is used later, it should have been "Client". I still can't get around the section 108 which LoTax cited and which was the code section I was constantly coming back to. The value of the property was much higher than the loan payoff BEFORE discount, so Section 108 seems to negate this being a "qualified" DOI. Mike

Let's see if I have this straight: OP > Original Poster

Owner > Buter, Borrower, and Client of OP's employer. > Worked for Lender and was terminated. > Died possibly from complexity and vagueness of the relevant sections of the Tax code.

Lender > Company or person who financed the purchased of the real property involved.

Seller > Unnamed and presumably unrelated person who sold property to Buyer.

• Owner purchased real property rentals acquired with the proceeds of a loan.
• Lender terminated employment of Buyer.
• Lender accepted a ,000 (11%) discount for early pay-off of mortgage possibly as a form of severence pay.
• FMV of property was more than three times the loan balance at time of payoff.

At first reading, I thought this was a seller-financed mortgage. As I wrote previously, I paid off the seller's second mortgage at a discount in 1982 and two CPA's I knew agreed that it was not a taxable event for me. But that was mortgage was financed by a previous seller. So my anecdotal experience is not relevant.

After perusing the relevant sections of Pubs 525 and 334, I appears to me that an IRS auditor would call it DOI and have you convince the office manager and possibly a judge that it is RoPP. But it is confusing (at least to me).

One example of the confusion is it appears that if the Owner had disposed of the property at the time of the payoff, the discount may have been treated as a capital gain?

The OP's conflict is he thinks it's DOI and his superiors think it's RoPP. It is likely his superiors based their position on recollection and may have thought this a seller financed mortgage. My suggestion is to do a cut-n-paste on the relevant sections of the Code, present it to them, and go with their 'Final Answer". If the estate get audited, it will be their problem, not the OP's.

Dick

I agree that section 108 doesn't make the transaction non-taxable. But that doesn't mean it's taxable. Normally a cancellation or reduction in debt is considered taxable income. But there are exceptions other than section

HA! I'm sorry about being so vague on the original post and perhaps confusing matters with my "explanation" :-) Here we go again: Client worked for a "John" who treated Client like a son. Client located a two duplex rental property which he wanted to buy and John loaned him $300k to help Client buy a $400k property from a totally unrelated party. After 5 years, John died. John's two daughters are co-executors of John's estate, including the note due from client. The two daughters are both wanting to sell all properties so they can continue to live the lifestyle John had been providing. They have sold all the properties Client was hired to manage so his job is terminated. The property client bought has increased in value to $1,000,000. He sells one side of one duplex for $250k. He still owes $250k on the $300k loan and offers to payoff the loan early (so the daughters can get cash) for $220k. They accept. The question is, is the $30k "discount" taxable? If not taxed shouldn't the $30k discount be reduced from the basis of the remaining rental property?...I hope this is more clear. Thanks for the input to date. Mike

That's better now. However..... when John loaned client the 300$k to help buy the property, did John secure said loan with a mortgage? Anyway, seems to me that since client did not buy the property FROM John, any forgiveness of debt from John's executrices have nothing to do with the basis of the property. Hence it is income. ChEAr$, Harlan Lunsford, EA n LA

This is a little complicated, and could take some research to get you a complete answer. You might have a chance but my off-the-top-of- the-head reaction is that the discount is taxable currently as ordinary income. First of all, this was not a reduction from the original seller, so it's not likely to be a reduction in the purchase price. From what I can tell, discounts such as this are generally taxable as cancellation of debt income, unless they are clearly gifts. If the daughters had given you the discount because they liked you and wanted you to be able to afford to pay the loan off for your own peace of mind, it would be a non-taxable gift. But since they did it for their purposes rather than yours, it's clearly not a gift. On this point a quick review of cases came up with one from

It appears to me that Harlan was right all along. It's DOI.

It appears to me that if the Owner had paid-off the loan as part of the disposition of the property, the discount may have been treated as a capital gain. But post-hoc tax planning does not work.

Dick