How on earth to report THIS?

[Catherine]

Not my client. Thank God. Theoretical for me, real for someone else.

A colleague asked for advice handling an issue. T/p (not a NYS resident) got a letter from NYS demanding a return for a property sale in 2021. Property was sold in 2021 but t/p's brothers failed to pay her share of the proceeds. My original thought was report to NYS that no $ was received in 2021, therefore no return needed for a cash basis taxpayer. We will now ignore the NYS computer-letter non-responses, and go on to the weird parts.

Stack-o-stuff brought to me to go over with colleague (with t/p's permission). Property was a family-owned cottage; t/p was bought out by her brothers for a whopping $25K total. They had her take back a mortgage for that amount. First payment was to be late 2022 ( a full year later!), with monthly payments from the 3 brothers for ten years. Legal docs notarized plus an amortization schedule, plus ability to call the note, plus more. But no payments were made until 2024 - and then only by 2 of the 3 brothers. Those 2 caught up in full, with hand-written apologies for having forgotten. Whole thing stinks to high heavens but that's not the issue.

How would one report this?! Installment sale, starting in 2021, with zero $ in payments until 2024? Installment or Sch D sale in 2024 as that's when first $ was received? Ancient property records will be needed for basis; 4 siblings inherited this cottage from their dad who died in the early 1970s (all these people are in their 70's or 80's at this point).

What do people think is the right way to handle this mess? By the time we'd gone through the docs, my colleague and I were just staring at each other, each wondering what on earth to do with this thing. And that's before we try to deal with the NYS Taxpayer Advocate office!

[jklcpa]

Oh boy, my first thoughts are these -

First, you have to figure out the basis to know whether you're dealing with a gain or loss since the sale price is so low.

If a loss then you would report the entire in 2021, the year of the sale.

If a gain, was this family cottage ever rented with depreciation taken? Then you'll have the recapture in 2021 and (possibly) no income again until in 2024, but with it being a sale to related parties you need to know if the brothers have already disposed of it before she got all of her money. If they have already disposed of it, then this client must recognize what they realized as if she received it herself. You can check out the IRS Pub that deals with installment sales for more on this.

Also, if the transaction results in a gain, then you definitely have to use installment sale reporting which is the default method of reporting. The opportunity to elect out of installment reporting is gone because that election has to be done on a timely filed tax return, including extensions, for the year of the sale.

Will this woman ever receive the money from the brother that is technically in default, or will his non-payment ultimately result in the terms of the installment sale being redefined?

With installment reporting, it sounds like you are looking at 6252 and Sch D for 2021 to document the transaction on the return with no payments in that year, and then in 2024. If it was ever rented and depreciated, then you possibly have recapture income for 2021 and add 4797 into the mix.  If no installment reporting because it's a loss, then only 2021.

[Lion EA]

Wow!

[Sara EA]

You can't take a loss when selling to a related party.

[jklcpa]

23 minutes ago, Sara EA said:

You can't take a loss when selling to a related party.

True, I assumed Catherine was aware of that. The reason I mentioned it is because it still has to be reported, and the taxpayer already received a letter from the state looking for the transaction. So if a loss, then the entire sale(not installment reporting) would be on the 2021 Form 8949 showing total sales price, basis, and using code "L" for the disallowed loss from other than wash sales.

[Catherine]

Thank you so much, @jklcpa Judy; I was afraid we were looking at an installment sale with $0 received for several years. It is a family vacation property and I don't think it was ever rented out (but I have no idea - as I said, this isn't even my client, praise God). 

The terms of the note allows her to call the note for any non-payment - and that the buyers (her brothers) have to pay all her legal costs should she do so. Were I this person, I'd call the note. But not my call. 

The colleague is someone relatively new to the field, so I may end up hand-holding on this one. I'll send him back to make inquiries about prior rentals and depreciation; I've already sent him off to research basis. Fortunately, his wife has extended family in the same county as the property and they already planned on going for a visit, so he was going to research property records at the county registry the next town or two over. Client's dad died so many years ago there's no hope of those records being online.