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Payoff of Installment Note
Q:
Subject: Installment Sale IncomeI have found your insight helpful. I was hoping you would be able to help me.Purchased investment property 05/2004 secured by a bank loan. In 9/2004, I borrowed funds from father's trust to pay off the bank loan. I am a trustee on the trust account. Payments were made to the trust account until 2/2005.Another investment property was sold in 2002. The Installment Sale Income, Form 6252, was used for this transaction, and since 2002 I have recieved interest income from this property. In 2/2005, I transferred my interests in this property to father/trust in return for relief of debt to the trust.It is my understanding that this Installment Sale Income, since it was disposed of, will be taxed as capital gains. However, because the "gain" was used to purchase like property, is it a wash? If a gain, how is the gain reported?I asked my accountant and he has not gotten back to me. I want to be sure I know what questions to ask and know what needs to happen.Thanks.
A:
The proper time to research the tax consequences of an installment note payoff is before you receive the payoff. Once that is done, it's too late to do anything about it.
A common misconception is that using proceeds from an installment note payoff to invest into new property can save on the tax bite. That is flat out wrong. It has no effect.
A 1031 exchange involves like kind properties. Real property can only be exchanged for other real property. An installment note, even though originally arising from the sale of real property, is itself considered to be personal property. Personal property is not like kind for real property.
There are ways to delay taxation on installment note payoffs by substituting new borrowers and/or collateral. It is similar to re-loaning the money. However, this all has to be set up beforehand, with no actual payment received. Once you receive the payoff, it is a taxable event. What you do with the money, including loaning it to someone else or buying new property, will have no effect on the taxation of the note payoff.
Good luck. I hope you will be more careful next time you are faced with this kind of situation.
Kerry Kerstetter
Labels: 1031
- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/16/2006 11:56:00 AM Send this post:
