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‘Tis Tax Time Season for Note Buyers

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(Reprinted from the December 1998 issue of The Cash Flow Connection Newsletter)

Chestnuts, open fires, Jack Frost, a mail box full of catalogs, Sunday papers twice the normal size…it must almost be….tax season. The holiday season is just a short six days away from the end of another tax year. While April 15 looms as the dreaded tax deadline, there are actually quite a few filing deadlines in January that affect many cash flow professionals. It may understandably be the last thing on your mind, but don’t be caught unaware. We’ve compiled a basic primer for some of the more common 1099 and 1098 tax form filings utilized in our business. Just remember, we don’t make the rules!

As a general rule, every person engaged in a trade or business must report to the IRS any payment of $600 or more made to any person during the calendar year for items such as rent, compensation for service, commissions, interest and annuities. To make these filings, the IRS has provided a series of 1099 forms.

Form 1099-MISC

A 1099-MISC is usually filed for each payee on reportable compensation type payments of $600 or more made to non-employees and/or independent contractors. These are frequently issued to report referral fees paid by note buyers to consultants/note brokers.

Form 1099-DIV and 1099-INT

If your business is incorporated, your corporation will have to file a Form 1099-DIV for each person to whom it pays dividends of $10 or more each year. You will also file Form 1099-INT for each person to whom you pay $10 or more in interest on bonds, debentures or notes issued by the corporation in registered form. These 1099 forms are also required for any other payment of dividends or interest on which you are required to withhold tax.

Form 1099-S and 1099-B

In general, Form 1099-S must be given to recipients of the proceeds from the sale of real estate, while Form 1099-B is given to recipients of the proceeds from the sale of securities. Typically, these forms are handled by the escrow, closing or funding agent; however, it never hurts to verify that it has been appropriately filed.

Form 1098

Federal law requires that you give From 1098 to any individual from whom you receive $600 or more in mortgage interest during the year in the course of your trade or business. Form 1098 generally has the same filing requirements as the various 1099 forms. If payments are made by the payor to a third party escrow, collection, or servicing company, chances are this is being handled.

Filing Deadlines

The appropriate form is prepared for each reportable party and sent to the IRS with a duplicate form sent to the individual payee. You must also prepare and file a Form 1096 summarizing all the information on the forms in the 1099 series. Each of these forms is due to the IRS by February 28 of each year for the prior calendar year. A copy must also be sent to the recipient of the payment by January 31.

Penalties

There are stiff IRS penalties for not filing the appropriate 1099 forms. First, there is a $50 penalty for failure to obtain an appropriate tax identification number and/or filing late. There is also a penalty for not filing or not giving a 1099 to a payee, which runs $50 per failure. Since there is a separate penalty for not giving a copy of the 1099 to the payee, as well as for not filing a copy with the IRS, it can cost your $100 for each person for whom you fail to prepare 1099’s.

Exemptions

Fortunately, a number of important exemptions from the 1099 filing requirements will eliminate most of the people or companies to whom you are likely to make payments of $600 or more. You do not have to report:

  • Payments to corporations
  • Payments of compensation to employees that are already reported on a W-2
  • Payments of bills for merchandise, telephone, freight, storage, and similar charges.
  • Payments of rent made to real estate agents
  • Expense advances or reimbursement to employees
  • Payments to a governmental unit

Electronic Filings

If your business files 250 or more returns for a calendar year, the IRS requires an electronic or magnetic media filing. These returns include Form 1098, the Form 1099 series, the W-2 series, and various others. The electronic filing is in lieu of actual paper forms and includes very specific formats for the computer tape or disk which must be met.

This overview should assist the cash flow professional in identifying potential filing requirements. This is not intended as tax advise so please review your specific situation with a qualified tax advisor. Free tax publications and forms can be obtained by from the IRS at 800-829-3676 at www.irs.gov

Selling Mortgage Notes – Mastering the Simultaneous Closing

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(Reprinted from the June 1998 issue of The Cash Flow Connection Newsletter.  Please visit our online newsletter for more updated information including  Selling Mortgage Notes – Where Have All the Simos Gone? Published November 2010)

With investors reporting over 40% of their new private mortgage purchases having less than 12 months seasoning, it’s no wonder the simultaneous close and working with realtors are some of the hottest marketing techniques. Perfecting the simultaneous close provides an alternative to conventional financing that can enable sellers to sell, buyers to buy, properties to move, realtors to earn, and investors to profit.

Working with the purchase of a private mortgage immediately following the real estate closing provides opportunities as well as challenges. Investors know that one essential component of the simultaneous close is maintaining it’s identity and distinction as a private purchase money mortgage. It is an alternative to lender financing not another form of a loan. Over the years elements have been identified that aid in maintaining this important distinction. A review of these may prove helpful for use in your own business activities.

1. Become familiar with basic residential mortgage lending requirements.

While traditional mortgage lending requirements do not typically apply to a seller financed purchase money mortgage or real estate contract, you should become familiar with them anyway. Why? First of all, this makes good marketing sense. How can you position seller financing as a great alternative to the traditional loan if you don’t understand how it works?

Secondly, it is essential to know what constitutes a loan and is subject to a variety of governing laws. Anyone in real estate investments should be aware of the number and brevity of regulations passed to protect the borrowing consumer. There are the Consumer Credit Protection Act of 1968, Truth in Lending (TIL), Regulation Z, Real Estate Settlement Procedures Act (RSPA), Home Mortgage Disclosure Act (HMDA), Usury, Mortgage Broker and Lender Licensing, and the list certainly goes on. It isn’t late night reading but become familiar enough with them that you can either 1) comply or 2) completely avoid any activity that falls under their application.

2. Substance Over Form

The substance of a seller financed real estate transaction and your level of involvement have a considerable impact on maintaining the purchase money distinction. It is important to remember that the seller is allowing the buyer to purchase the property by accepting a certain amount down and the remaining amount over time with payments of principal and interest. The consideration for the lien is the purchase of the property. The seller is the one extending credit by accepting installments on the sale, rather than a lender providing cash to the borrower for payment to the seller.

It is certainly appropriate for the seller to request a financial statement and a credit report from the buyer since they will be relying on their credit worthiness for payment. The form or authorization the seller utilizes should in no way reflect the lending of money. Once again the extension of credit is from the seller by accepting an installment sale.

Once the seller and buyer have agreed upon a price and terms of repayment an investor can provide a quote reflecting the amount they would be willing to invest or pay for the lien subsequent to closing. As an investor it is advisable that you don’t get involved in the actual negotiation of terms. Avoid determining such items as down payment, interest rate, and payment amount. Be certain that the real estate agent, seller, buyer, and closing agent, clearly recognize the difference between seller financing and a loan.

3. Your words say it all.

Loan is a four letter word. Abolish it from your private mortgage investment vocabulary and do not confuse the issue by using incorrect terminology. There are sellers not lenders, buyers not borrowers, investors not banks, seller financing or purchase money liens not loans, and never ever are there points, origination fees, or buy downs!

4. The Documents

It’s all in the details. The documentation that the closing agent prepares plays an important part in evidencing the items outlined in substance over form. As the potential investor, review them carefully to be sure they utilize the correct terminology. Be certain that the financing instrument clearly states it is a purchase money lien and names the seller as the mortgagee or beneficiary.

Pay particular attention to the closing statement. It is fairly common for the closing agent to use a HUD-1 Settlement Statement. This however is not a preferred closing statement for owner financing since it was primarily developed for traditional lender financing and is filled with inaccurate terminology. If your agent insists on using this form review it closely. Be sure they leave Section (F), Name of Lender, blank or put in the property seller’s name and address. Line 202, Principal Amount of New Loan, of Section J, should also be left completely blank. The agent should utilize an empty line in this section and entitle it seller carry back contract (deed of trust, or mortgage), purchase money lien, or something similar in order to correctly reflect the amount paid by buyer. Of course avoid all lending terminology including any items in Section 800, Items Payable in Connection With Loan. Again, the buyer shouldn’t be paying discount, origination fees, or any other items typically associated with a loan. If the buyer is paying for an appraisal or other item, have these listed in Section 1300, Additional Settlement Charges. These may seem like small items but again, it’s all in the details.

5. Doing it Right

In summary, if simultaneous closings are part of your investment portfolio, learn to clearly recognize and differentiate this product from a traditional residential real estate loan. If planning to originate loans, be confident you are aware of and comply with all regulations as well as licensing requirements. If working with both product lines, consider utilizing separate entities to conduct each business activity. It is certainly appropriate to obtain legal counsel on these issues and of course, as in all business transactions, treat people fairly, ethically, and with professionalism at all times.

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