>>he purchased a duplex from the seller for $80K, without taking formal title and immediately resold it to another party for $105K<<
Formal title memorializes ownership but does not create it. Your client should report his short term gain in the ordinary way on Schedule D. This is a good example of the substance-over-form doctrine.
I have a different situation but similar question.
An individual holds title to land and has their name on the construction loan used to buildout a home on the land. Company "A" contracted with the individual to develop and build the home. After which Company "B" has an agreement with the individual to obtain permanent financing and buy the home from the individual upon completion of the build-out. The real estate market tanked and now the individual is faced with having to short-sale the home. The individual doesn't want to be 1099'd for the difference of the short-sale and the liability and wants to pass on the "income" to Company "B" since Company "A" and Company "B" know each other. The principals of Company "B" do not mind doing it to save a relationship.
Is it legally possible for the 1099 not to be shown on the individuals tax return but instead Company "B" recognize the income?
I would venture to say no, but I wanted your opinion. :-)
RE: 1099-S (Complex Real Estate Sale) -
5/8/08
at 10:35 PM
>>Does my client in turn issue the seller who he bought the property from a 1099-S for $80K?<<
Something does not seem right here! How could your client pass a good title at closing if he did not own the property?
I expect the title company that was closing/handling the deal must have completed his purchase title making him the formal owner and he just did not pay attention to what all he was signing. In any event the title company would have issued any 1099-S that needed to be issued.
In any case your client has a $25,000 short term gain on Sch-D.
>>How could your client pass a good title at closing if he did not own the property?<<
A contract of sale is valid between the principals even if it is not public. There is some risk because a third party, such as a creditor, might not be bound by an unrecorded transfer. But hiding the true chain of title is sometimes the main purpose of doing it that way.
Anyway, it is common. In fact it's almost universal in 1031 exchanges--the IRS even established direct deeding as a safe harbor. Although technically the intermediary receives both properties, the recorded deeds show only the exchangor with the ultimate buyer and original seller. Typically this is done by assigning the contractual rights to the intermediary.
Outside of exchanging, it is sometimes done with an option that can then be assigned to the ultimate buyer. Tax reporting should be similar unless the middleman is acting as a broker or dealer.
But... the title company still had to deal with the fact that a 1099-S may have been *required* to be issued to the $80,000 seller holding actual title. The $80,000 seller holding title could not be ignored at the "recorder of deeds" government office and therefore could not be ignored by the title company with its closing paperwork.
>>a 1099-S may have been *required* to be issued to the $80,000 seller<<
I don't know what triggers 1099-S. If the client came to escrow with a quitclaim from the seller and a purchase contract from the buyer, there would probably just be the one form.
One form to rule them all, and in the darkness bind them.
Scan it or make a photocopy to keep in your file with the other exchange documents.
Try to use the 1099-S data on Form 8824, especially box 1 (to line 5) and box 2 (to line 12), if it matches the facts of the exchange.
The 1099-S is often used incorrectly so I wouldn't worry too much about it. Still, it does suggest that the escrow officer didn't think the transaction qualified as a 1031 exchange. That should cause you to read ALL of the exchange and closing documents to make sure it went down the way it was supposed to.
1031 is one section of the code where substance-over-form doesn't apply. Everything has to be letter perfect. Count all the dates out on your fingers, and look carefully at who got what money and how the properties were described. (You can ignore all the mortgages, however.)
>>loan for the old property 171,670, loan for the new property 269,230<<
I told you to ignore the mortgages, and I will not answer questions based on mortgage data. In this matter, an exchange is no different than a sale or any other disposition and acquisition. The fact that the property has a lien against it does not affect the basis or amount of gain. Think about it--if you could eliminate gain by borrowing money, our whole economy would be very different.
When the replacement property is worth more, there are two ways to determine the new basis. You will know you have the right answer when both ways give the same number.
First, the new basis equals the old adjusted basis plus any new equity. The old basis is adjusted for exchange costs of both properties as well as depreciation, etc. New equity means the difference between the FMV of the old property and the new property.
Second, the new basis equals the FMV of the acquisition minus any deferred gain. Deferred gain means the FMV of the disposition minus the adjusted basis (including costs).
Obviously if you trade down there is cash boot. But don't be confused about mortgage boot. That is a reference to the very rare situation where property is taken subject to the debt, with comparable reduction in the contract price.
Note that land value is not tracked through the exchange. It is combined with the old basis, then separately allocated as a percentage of the new basis. However, any non real estate like appliances may count as "other property."
In my opinion it is not possible to enter an exchange directly into software. Work it out with pencil (and eraser) first.
Yes. You are missing my instruction to ignore the mortgage.
As I said, the new equity is the difference between the FMV of the old property and the new property. Ignore the fact that he used a mortgage to cover most of that and only put $51K down payment, just like you would ignore it if he bought it outright.
If you are uncomfortable calling it equity when it secures a liability, try a different term like money or value or beebopalooza, but follow my definition. Using the property as security for a loan does not increase or decrease the basis. So ignore all the mortgages.
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