Expenses associated with a wraparound mortgage

[Angie Menegay]

For tax filing, where would expenses associated with a wraparound mortgage be reported? On Schedule A? Some examples would be interest paid to the underlying lender, note processing fees etc.

Thanks,
Angie

[Bill Walston]

Originally posted by Angie Menegay:
For tax filing, where would expenses associated with a wraparound mortgage be reported? On Schedule A? Some examples would be interest paid to the underlying lender, note processing fees etc.

Thanks,
Angie

What's the use of the property Angie? If it's rental property then the expenses would go on your Schedule E (or the appropriate form for your business entity reporting the rentals).

Hope this helps.

[Bill Gulley]

With some wraps arrangements you don't have equitable title but may be paying the mortgage paymens, without an interest in the property, on a deed or an equitable interest by contract you can't deduct the interest. If there is such an arrangement, make sure the original borrower isn't deducting the interest too, only one party is entitled to the deduction, as with a contract for deed arrangement.

Loan expenses, such as processing fees go to the original borrower, I suppose they got the loan and then sold to you, those will be on thier side of the deal.
:)

[Angie Menegay]

Originally posted by Bill Walston:

What's the use of the property Angie? If it's rental property then the expenses would go on your Schedule E (or the appropriate form for your business entity reporting the rentals).

@Bill Walston: It's no longer a rental. I'd sold it as a seller-financed transaction (installment sale). Therefore, I report all of the interest I receive from the Buyer as interest income. But I need to expense the interest I pay to my lender (the underlying mortgage). From what I've read, the only place for this is "Interest Expense" on Schedule A.

As far as other costs (e.g. note servicing fee), the only place I can find is to claim them under "Miscellaneous Expenses" of Schedule A, but those are subject to the 2% AGI limit :-(.

Thanks,
Angie

[Angie Menegay]

Hi Bill Gulley: Sorry I didn't clarify the situation better. I'm actually the "original borrower" in your explanation :-). I sold the house as an installment sale with a mortgage I still owe my bank.

I report the interest I receive from the buyer as interest income. But I need to expense the interest I pay to my lender (the underlying mortgage). From what I've read, the only place for this is "Interest Expense" on Schedule A, which seems good.

As far as other costs (e.g. note servicing fee), the only place I can find is to claim them under "Miscellaneous Expenses" of Schedule A, but those are subject to the 2% AGI limit :-(.

I don't know where else to claim these legitimate costs to offset the interest income I receive from the buyer.

Thanks,
Angie

[Bill Gulley]

Actually, in such an installment sale, the one who pays it takes it, but I see where you are. Bill W. is correct. I'm not a tax guy, but set up the contracts/financing allowing the tax issues to be assigned. If the bank still is sending you 1098s leave it alone and break it out as Bill suggested. :)

[Steven Hamilton II]

Angie Menegay,

Typically it is best if you can arrange a flat fee for such instances.

First you will report the sale on Form 6252 Installment Sale http://www.irs.gov/pub/irs-pdf/f6252.pdf

You report the interest received on Schedule B http://www.irs.gov/pub/irs-pdf/f1040sb.pdf

You must issue Form 1098 for the mortgage interest. http://www.irs.gov/pub/irs-pdf/f1098.pdf

You will then report your interest paid on Form 4952. http://www.irs.gov/pub/irs-pdf/f4952.pdf

Bill Gulley,

Typically one of the easiest ways to prove the ability to take the deduction for interest is if the person has a financial interest in the home or stands to lose upon its displacement.

In many cases there is a difference in interest rates and that is the income for the person selling the property, They are netting "the spread". So essentially there are two different sets of interest being paid.

Now, if the buyer had assumed the current mortgage that would be a different story. Typically at that point they are now on the deed.

Does your contract stipulate who pays the servicing fee? If you were able to have it paid all upfront you would have increased your basis by that. Otherwise it is simply a transaction fee.

-Steven

[Bill Gulley]

Steven Hamilton II Yes, but a displaced tenant might fit that determination, equitable interest is by contract or title.

The two ways wrap arrangements are done is either by a 1st and 2nd loan arrangement of under one where the equity tops the existing loan, inwhcih case the division of interest is accomplished.

And yes, a well written agreement stipulates who is entitled to the interest deductions, a sub-2 title is given so the buyer is entitled as well as any assumption taken such as with a VA or by notice given. A contract for deed may go to the buyer as well. Options are a different animal, if they constitute a financing arrangement then the buyer takes that part as may be allowed, usually I set the seller up to take the deduction as residentials usually won't be as involved as a commercial lease/option arrangement.

According to the IRS Regional Office in KC Mo, thier simple answer was "whoever pays the interest is entitled to the deduction if they have an interest in the property" while you can't rely on what they say, at least there is some comfort there.

Not sure what you meant by paying all up front increasing your basis, but pre paid interest (points) are not capitalized as an expense they are amortized over the financing period as well as loan expenses. Hard costs in acquisition are assigned to the basis. :)

[Angie Menegay]

Hi Steven Hamilton II

Thanks for your response. Yes I did all of those. The only part I'm left with are other miscellaneous costs associated with servicing these notes (e.g. fees paid to the servicing company etc.). As mentioned, if I put them under "Miscellaneous Expenses," it's just a waste since they don't add up to be anywhere near 2% of AGI (even though they're legitimate expenses). Unfortunately, we pay for those extra costs, not the buyer. Can I claim them under Schedule C by any chance, since after all, they are business expenses?

Thanks,
Angie

[Bill Gulley]

Angie, are your notes in a business name? Servicing adminstrative expenses are simply expensed before arriving at net income before taxes.

[Angie Menegay]

Bill Gulley: The notes are under our personal names. Yes, I agree in principle that I should be able to expense these administrative expenses, but on which tax form is my struggle.

As a side note, I don't understand why the IRS has this 2% AGI limit. They expect us to pay taxes on every dollar we receive in income but there are limits and restrictions on the legitimate expenses we incur to get that dollar? Sigh.

[Bill Gulley]

Don't know what Steve the tax guy will suggest, but I'd deduct my expenses before I arrived at my income, so the income claimed would already be adjusted before it ever hit any tax form. I also look at it as to the amounts in the big picture, while not trying to evade any tax, but avoiding tax, if the amounts are disallowed, that arisies from an audit, if there is an audit, then it will be a mistake and tax may be due as well as any penalty. If your expense is $62, what king of impact does that make on the big picture? Probably not much on the personal side.

What you could is assign the servicing to a business entity and pass the payments through, that will be easier to account for admin expenses, so long as it's a related business activity, see your tax guy. :)

[Angie Menegay]

Thanks Bill Gulley :). Agreed. I'd probably just let those go for now until I figure out how to put this whole thing into a business entity.

I don't want to deduct it first before the income (i.e. interest received) because then the amounts won't match what I sent the buyers on their 1098s.

Lesson learned for the next note gig :).

Thanks all for your thoughts!

[Bobbie T. Ingraham]

Personally I like it..

[Steven Hamilton II]

Yes, it is subject to 2% of agi.

That said this is why I prefer and recommend using business entities.

Bill, I was referencing the servicing fee. If it was paid up front in bulk at time of the sale we would take it as a selling expense.

-Steven