1099's

[rick in cal]

I have a client who purchased two properties putting 18k down on each. He was told that upon close of escrow he would be rebated his original investment, and he was. He just received a 1099misc for 36k marked as other income. To my way of thinking this is return of capital and should not have generated a 1099. Does anyone have a thought of where to put this a his tax form. These properties are sfr rental property.

[kcjenkins]

I agree, this is return of capital, and you should reduce the basis accordingly. I'd show the income on Line 21 worksheet, then back it out on the blue lines at the bottom of the same worksheet. That should reduce the chance of a letter questioning why it was not included.

[rick in cal]

Thanks KC, that was what I thought I would have to do. It just seemed like since the activity is on sch E and the expenses are on sch E the money returned should go there too. It probably doesn,t have an obvious place because the 1099 shouldn't have been generated in the first place.

[jainen]

>>the 1099 shouldn't have been generated in the first place<<

I wouldn't go that far. The trend is to use information returns for more and more payments. If you decide to treat it as an adjustment to the sale price, be sure to document the basis reduction. Don't try anything weird like allocating it all to the land. If the transaction had a nefarious purpose such as to evade taxes or defraud the lender, consider leaving it on line 21 without an offset. (Please don't take offense at the suggestion. This kind of deal almost always indicates a manipulation of mortgage qualifications, which is part of why the IRS is pushing for more 1099s and other disclosure.)

[rick in cal]

Jainen, I am also licensed to do loans and the answer is of course this deal was put together to "manipulate" the lending process. This broker was able to get show a substantial down payment to get the client a loan, never intending to have the client really use any of his own money. The client is for the most part an innocent party and the broker can plead stupid and escape prosecution. My question to you is, if this is really not income why do you think I could or should add this to the clients income. The reason I ask is this particular client was on disability for several months and his income is 20 or 25k below his personal write offs. In this one case I would love to report the 36k as income.

[jainen]

>>why do you think I could or should add this to the clients income<<

I didn't say that much. You'll need to look at the details and see how the client feels about going one way or another and see if tax court has had anything to say on point. There is a general principle that you can't get a tax benefit from fraudulent activity, and this transaction had a major tax motivation in claiming depreciation and other rental expenses for property that he doesn't really have any investment in.

By the way, that "innocent party" line doesn't get much traction with the IRS.

[rick in cal]

Jainen, Thanks for your opinion but I don't see how you arrived at fraudulant in regards to this client unless you think 100% financing is some how against the law. He purchased a rental property which generates income and expenses and pays taxes accordingly. It is the 1099 that is suspect.

[lbbwest]

Jainen, Thanks for your opinion but I don't see how you arrived at fraudulant in regards to this client unless you think 100% financing is some how against the law. He purchased a rental property which generates income and expenses and pays taxes accordingly. It is the 1099 that is suspect.

As a respected lending professional I'm sure you are much more aware of the lending laws than I. In my area which has as poor a foreclosure record as CA, the problem isn't that the lenders agreed to 100% financing; the problem has been as follows using the numbers in your scenario:

Rental property is worth 42K, buyer has no money. Lender requires 30% downstroke on loans of commercial property, which would require $12,600 cash. Aggressive broker has seller agree to sell property at 60K rebating purchaser 18K at closing. NO money exchanges hands. Lender pays $42K and has financed property 100% equity, when lender policy is on 70%. Buyer walks, has no equity interest in property, bank forecloses. If the lender has knowledge that it is 100% financing, no problem. (In this day and age VERY unusual.) The problem has been that the lender was UNAWARE that it was financing 100%, that's where the f word comes in. f=fraud

Taxation issue: seller reduces sale by $18k rebate, buyer reduces basis using a pro-ration between building and land, pesky 1099 requires documentation.

Documentation proves 100% financing. lbb