I lent money, foreclosed on property, am reselling, what is my gain?

Question

I lent $30,000 from my LLC on a property. I then later lent $15000 in 2nd position from my IRA on the same property. I had to foreclose, and choose to foreclose with the LLC. The 30k plus back payments added up to $47k, so i foreclosed at that amount and no one bid, so I got the deed. Now I am selling the property for a net of $47k. What is my basis in the property, is it the 30k i lent, or is it the 47k i took it back for at auction?

Also, technically the LLC mortgage wipes on the IRA 2nd, BUT, can i take some of my proceeds on the HUD and state that I need to satisfy a lien for say.. 17k, and send it back to my IRA to avoid having a gain in the LLC?

Steve Babiak · Answer

Usually, the first position lender does not want to do a "deed in lieu", because if they take it all the way to a completed foreclosure, the junior liens are extinguished. Here is one situation where the first position might have done the "deed in lieu", or the second could have done the "deed in lieu" (cleaner if the second did it IMO), and all liens get paid off upon the SUBSEQUENT sale of the property.

Not sure if this scenario would constitute a prohibited transaction or not ...

Daniel Hart · Answer

The 47k that I am selling it for is the principal balance plus back payments that the LLC should have gotten in the first place.

Question though, is it prohibited to make an ira loan on a property that you personally have a loan/lien on?  I figured if you have ownership its prohibited, but if you dont its ok, perhaps im wrong?

Steven Hamilton II · Answer

Chris Martin,

All of the incurred costs are added to the property basis. Just not payments any payments received actually lower your basis.  Taxes paid, utilities, etc, increase basis.
However, back payments are just income that has not been received.  The 47k was not a sale as he said. He received the deed to a property he already had an ownership interest in.

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.

David Wedemire · Answer

I think you need a Mitt Romney CPA

Chris Martin · Answer

What I don't understand is why all the costs related to the property are not added to the basis. The LLC owns the property now, so the original note amount ($30K, plus incidentals (if any)), cost of 'acquisition' (all the foreclosure related costs), and costs of sale (e.g. commissions (if any) on the $47K sale)... plus any holding costs related to the property (assuming the LLC paid interim taxes?)... seems like these add to basis. I guess that's why I'm not an accountant.

Raymond B. · Answer

Steven Hamilton II,
Linked for you:

http://www.irs.gov/retirement/article/0,,id=163722,00.html#2

Raymond

Steven Hamilton II · Answer

First,

I will second the notion that it appears to be a prohibited transaction.  That aside, your basis in the property will be computed as follows.

The 30k plus acquisition costs.  Back payments are irrelevant in your basis. Your LLC will have a gain. But don't worry you have to completely withdraw your IRA and pay penalties on it.  So that 17k gain isn't so bad anymore.

Interacting with your IRA in any way that benefits you is prohibited therefore it is a prohibited transaction and by default your IRA in its entirety is to be included in your income at FMV of all assets as of the first day of your tax year(January 1st) in the year in which the prohibited transaction occurs.

More details on prohibited transactions.
http://www.irs.gov/retirement/article/0,,id=163722,00.html#2

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.

Jon Holdman · Answer

The general rule is that your IRA can't do any transaction that benefits you personally.  I'm certainly not a lawyer or CPA, but making a loan to someone who owes you money would appear to be a benefit.   Would have been cleaner, I think, to have had you and the IRA partner from the start and have an equal stake in the deal.  Having the IRA do the loan in second position and later makes it look like you were using your IRA to try to salvage a bad deal.

In our case, we didn't actually have to do a foreclosure.  Instead, we did a deed in lieu and just took the house.  We did it after one missed payment, so by the time we actually had a deed we were owed a little under two month's interest.  I don't think that got added to the basis, but I would need to look back at the deal.  In our case it was also a net loss.

Chris Martin · Answer

I'm not sure, but initially (from the dollar amounts) it sounded like your trustee invoked Section 45?21.9A. Simultaneous foreclosure of two or more instruments? Maybe not. The LLC is completely separate from the IRA, correct?

I think your basis in the property from the LLC perspective is the trustee sale amount, since you add in all the costs of the sale (from the final report and account form). So, that would include the secured obligation and back payments... in other words the TOTALS line on form AOC-SP-402 or its trustee equivalent. The "net" on the trustee sale is $0... but I'm not sure how you account for the accued unpaid interest. If you are using cash accounting (vs. accrual) then maybe you subttract out the unpaid interest and that would put your basis lower than the TOTALS line. Please remmeber, I'm not an accountant.

Seems like the trustee couldn't have done much... the second (the IRA position) is screwed unless the property was worth way more than the combined liens. Doing other tricks, like a subordination agreement might raise red flags if someone saw you and your IRA were involved with the same property.

Jon Holdman · Answer

Hopefully one of the CPA folks will answer.  In a similar position, my partner used the amount we were owed, plus the money we sunk into the property after we took it back as our basis, IIRC.  Don't have those returns handy, though.

This looks like a prohibited transaction to me.  Your IRA made a loan to a property that you already had an interest in.  In the end, you foreclosed, and took possession of the property.  You're selling at what appears to be a gain, once you take away the payments you didn't receive.  So, your IRA takes a loss and you personally (since the LLC is a disregarded entity for taxes) have a gain.  You have benefited from a transaction done by the LLC.  That's the definition of a prohibited transaction.

Since the IRA's interest was wiped out by the foreclosure, any money you send into it now would be a contribution.

I lent money, foreclosed on property, am reselling, what is my gain?

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