![]() The regulation, however, was deemed invalid in the first tax court case to consider it, and the IRS acquiesced.īy invalidating the temporary regulation, the court decision made the wraparound mortgage a viable planning tool in disposing of mortgaged real estate on the installment basis. The IRS subsequently issued a temporary regulation that appeared to eliminate the use of wraparound mortgages in this situation. Taxpayers, relying on three tax court cases, usually were successful in circumventing the mortgage-over-basis problem by using a well-structured wraparound financing arrangement. Traditionally, the Internal Revenue Service (IRS) has taken the position that a mortgage is included as part of the seller's initial payment received to the extent that it exceeds the seller's basis in the property. The seller, in turn, uses a portion of the payments received to service the existing indebtedness that has been wrapped. The seller remains primarily liable on the underlying indebtedness, and the buyer makes debt service payments computed on the face amount of the wraparound to the seller. ![]() When a buyer issues a wraparound mortgage to a seller, the principal amount includes any outstanding balance due on the property. The Wraparound Mortgage and the Mortgage-over-Basis Problem This amount is calculated by subtracting the liabilities a buyer assumes or takes subject to that do not exceed the seller's basis (including selling expenses) from the selling price. The total contract price is the total of the principal payments a seller will receive over the term of the installment contract. The gross profit-the total gain that the seller will report over the term of the installment contract-is calculated by subtracting the basis of the property and the selling expenses from the selling price. This is in contrast to assuming a loan, in which the buyer assumes responsibility and liability for the loan. Purchasing real property subject to an existing loan is done without being personally liable to the existing lender. The principal payments actually or constructively received during the taxable year include the seller's indebtedness that either is assumed or taken "subject to" by the buyer, to the extent that it exceeds the seller's tax basis (adjusted for selling expenses). This alleviates possible liquidity problems that could arise from reporting the entire gain on a sale before receiving all of the sale proceeds. Using this formula, investors can spread the tax due over the installment period during which they receive tax payments from buyers. If a transaction qualifies for installment reporting, the amount of taxable gain to be reported each year can be determined as follows: When a real estate investor sells a property on the installment basis, a down payment usually is received with the balance of the purchase price paid in installments in subsequent years. Under IRC Section 453(b), an installment sale is defined as the disposition of real (or personal) property by a nondealer, provided that at least one payment is received subsequent to the taxable year in which the disposition occurs. Real estate investors can maximize the use of the installment sale provisions of the Internal Revenue Code (IRC) when disposing of properties by using the wraparound mortgage when a taxpayer has a mortgage-over-basis problem having the buyer pay the taxpayer's selling costs as a strategy to reduce the tax on the initial installment payment and arranging installment sales for larger transactions to avoid paying interest on the deferred tax. Installment Sales Use This Method to Maximize Your Tax Position.
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