Investing foreign capital - English pounds, THOUGHTS?

Question

Hey BP,

I have a property under contract for ~80K.

I have a family relative who is interested in a trust deed investment (1st position).  However, I'm not sure how the taxes and interest payments would be calculated or accounted for.

Does anyone have any experience in this matter?  I'm open to hearing the community's thoughts....

Best,

AG

Steven Hamilton II · Answer

Arthur Garcia,

The Lender should be issuing a 1098 showing the interest received.  The payer on a mortgage does not issue a 1099.

Arthur Garcia · Answer

Dion DePaoli - actually, that makes perfect sense.   The loan would be a simple interest loan of roughly 10% with a balloon due in 5-10 years.

Based on what you're saying, I can deposit the interest payments directly into their account.  I guess they would need to discuss taxation with their accountant.

I just got tripped up on who would pay the taxes on the interest payments if they don't have a social security or tax ID.  In the past, I've been able to issue the private lender a 1099 for the interest I've paid on their capital.

Dion DePaoli · Answer

One other concept, the income in a loan is the interest, not the principal so the balance of a loan is not taxed.  The interest received is the investors income which is subject to tax.

Dion DePaoli · Answer

You don't give the mortgagee anything, the mortgagee (through their servicer) will issue you a 1099-INT. (Mortgagee = Lender/family member)

Your family member can form a company here, I would say an LLC is more appropriate than a C-corp if they wish but they do not have to do that.  The mortgage servicer will remit investor distributions from your payments to what ever entity they choose, which can simply be a private bank account held personally.

Your relative should seek accounting advice from a UK professional on how to structure that interest income best for the taxation that may come from the US income and the UK income.

Arthur Garcia · Answer

Dion DePaoli - when I do my taxes and I write off the interest paid to the foreign investor, how do I handle the 1099 situation?  Does that even apply?  Say they make $8000 over the course of a year.

Do they have to form a corporation here in the states so I can tax their C-corp?   Essentially, they're C-corp would pay taxes here and they would pay taxes on the balance?

Sorry - I'm not sure I'm making sense.

Also, I agree hiring a lawyer to handle a portfolio tax exemption might be cost prohibitive on such a small amount of capital (the lawyer fees might soak up all the yearly profit).

Dion DePaoli · Answer

Foreign currency will simply have to be converted coming in and going back.  There is a "Portfolio Tax Exemption" that if structured properly will apply to the foreign investor.  We operated a fund using this exemption for foreign investors which invested in mortgages.  There are attorney's who specialize in this.  It may not be a huge benefit and cost prohibitive on a $80k loan but worth a look, nonetheless.

Arthur Garcia · Answer

Dion DePaoli - Thanks for the detailed response.  I REALLY appreciate it.  I agree with everything you've said, in fact, I've used an mortgage servicer before.  However in this particular interest, I was curious see if anyone had any experience with invest foreign capital - I.E. pounds.

Dion DePaoli · Answer

As I hit post, I see you wrote the word 'interest payments' and I guess I just ran off doing taxes and insurance escrows.

Taxes and insurance are not the same as interest and principal.

If you get a loan, you will likely amortize the loan, unless you get an interest only period.  So, you can simply download a simple excel amortization table, plug the loan terms in and it will show the accounting for each period.

In a fixed rate loan, you will have the same payment amount for each period.  Each payment will allocate an increasing amount of principal and decreasing amount of interest.  In the note, it should state how payments are applied.  Usually it is fees, interest and principal in that order.  Your ongoing principal balance will simply be the previous period's principal balance less the amount of principal allocated from the current period's payment.

Dion DePaoli · Answer

If I understand this properly, you are buying a property that a family relative will finance via a 1st position Deed of Trust.  Within the scope of the financing you want to escrow your tax and insurance payments.

Calculate your escrows:

[Annual Property Taxes Due] + [Annual Home Owner Insurance Premium] = Total Escrow

**if there is HOA fees, you would add it to the above to and break it out like below, I am omitting it though.

[Total Escrow] / 12 = Monthly Escrow Payment

When you close with the financing, the closing agent will help you prorate your taxes.  Usually institutional lenders will collect 2 or 3 months of insurance payments at closing, which gives them a buffer to pay the bill when it comes due.  The taxes function the same way but since each county is different in terms of payment due dates, you will calculate how many payments need to be collected at closing to have enough money in the account to pay the bill when due.  Keep in mind some counties offer a discount to pay earlier, so you might want to use that as the target date.

Example:

Insurance = $1,000
Taxes = $2,000
Closing Date = May 15
Tax Due Date = Nov

Total Escrow = $3,000
Escrow Payment = $250

Escrow Insurance at Closing (3 months @ 83.33) = $249.99
Escrow Taxes at Closing (9 months @ $166.67) = $1,500.03

You will receive a closing credit (6 months) for prorated taxes from the Seller (unless otherwise negotiated) which accounts for the portion of the payments during the ownership of the seller.  As you pay into the escrow you will have a 3 month buffer, so in September the total taxes due should be in your escrow account, which you will pay in November.

It is a good idea for your relative to look into a mortgage servicer.  Escrow accounting is pretty regulated and can be administratively intense.  The cost of servicing can be as low as $30 to $45 per month.  This insures everything is done properly and all your relative will have to do is collect the distribution from the servicer.

The maximum allowed buffer for an escrow is 1/3 of the total amount needed to pay the sum of all the bills.  You don't have to buffer it with 3 months but I would not recommend using zero either.  You want padding for when policies change in price or taxes go up.  Each year a proper servicer will do an escrow analysis, usually on your loan anniversary and give back any overage or increase the payment do to catch up with rising costs.