Discussion:Habitat Home resale - contingent ghost 2nd mortgage, is it 'interest'?

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Discussion Forum Index --> Advanced Tax Questions --> Habitat Home resale - contingent ghost 2nd mortgage, is it 'interest'?


Discussion Forum Index --> Tax Questions --> Habitat Home resale - contingent ghost 2nd mortgage, is it 'interest'?

Kevinh5 (talk|edits) said:

31 January 2013
Taxpayer purchased a home built by Habitat for Humanity 7years ago for $70,000. Sell it in 2012 for $101,000. First mortgage balance at time of sale is $62,000. 1st mortgage was no interest, principal only. At closing, an additional 32,000 was withheld to pay a ghost '2nd mortgage' that was contingent as to amount and as to timing: If the taxpayer had kept the house for 30 years as her residence, she would not owe anything on the ghost 2nd. If she paid off the mortgage early, she would owe something. If she rented it out, she would owe something. The amount was entirely dependent on the amount of sale within 30 years. In other words, all the equity for 30 years belongs to Habitat.

The mortgage statement shows the payment of her monthly principal, the payment of the $62,000 balance, $0 interest paid, but $32,000 in 'fees', which represents the ghost 2nd (the difference between those amounts and the 101K sales price was realtors commissions and closing costs).

Who votes that I can deduct this $32,000 as mortgage interest?

Kevinh5 (talk|edits) said:

31 January 2013
Well, I've done some more research. Things are never exactly as the client tells you, are they?

Habitat retains a 2nd mortgage for the difference between market value of the house and what the person gets to buy the house from Habitat for. This is forgiven (apparently over time, certainly by the end of the 30 years of mortgage.

1st mortgage was really $78,000, 2nd mortgage was really $42,000 something. Real estate prices went down, they forgave the balance of the 2nd mortgage.

I got the mortgage info off the county registrar of deeds online lookup page.

I think her purchase price was really $120,000 based on these recorded mortgages.

I don't think I can deduct the 2nd mortgage as interest.

Ckenefick (talk|edits) said:

1 February 2013
I was kinda thinking that's what it was...or a usurious interest rate.

I had an audit one time where they guy deducted 100% of the principal payments on his (second) home.

Captcook (talk|edits) said:

1 February 2013
The "silent 2nd", as we call it on the Habitat side of things, is definitely not interest. I was treasurer for our local affiliate for three years and we kicked around the idea of booking the silent 2nd on our F/S as an additional amount due, but ultimately decided against it since it really isn't earned until the partner family stops using the home as their personal residence (usually by selling or renting the home).

I did encourage the organization to begin sending out the balance of the Silent 2nd on the annual statements to partner families. We had bigger fish to fry when I came on board and I'm not sure that has happened, but that probably would have helped in your client's case.

Ckenefick (talk|edits) said:

1 February 2013
So, what's the deal with it? Does the family not even know about it?

Captcook (talk|edits) said:

1 February 2013
In our sales docs, the amount of the Silent 2nd and what triggers its payment is very clear. The mission of the organization is to provide afforable housing and not build their net worth. The Silent 2nd does a good job of providing incentives to that end. In addition, the presentation made to potential partner families also contains a very clear explanation of how this dynamic works. It just seems like this dynamic seems to become more "ghostlike" than "silent" after a while.

Ckenefick (talk|edits) said:

1 February 2013
So, it's basically like a seller financed note of sorts (2nd Mortgage), with Habitat being the seller?

And, it sounds like home buyer (family) is well aware of it.

Also sounds like home buyer (family) doesn't have to pay interest on it...is that correct?

Ckenefick (talk|edits) said:

1 February 2013
Does Habitat book it up as a Receivable, upon completion/sale of the home?

Kevinh5 (talk|edits) said:

1 February 2013
Oh she signed the 2nd mortgage document at the real estate closing (I looked it up online). But I have a feeling that Habitat buyers aren't sophisticated home buyers, especially if this is their first home. She claims she had no idea about it, perhaps a truer statement would be that she had no memory of it.

The Habitat program sounds GREAT in helping a partner family buy their first home, but the 'silent 2nd' or 'ghost 2nd' comes back to haunt them when they are ready to move up. In my client's case, she got married, had a 2nd child, and needed a bigger house.

EmpireCPA (talk|edits) said:

1 February 2013
I am also treasurer of a local affiliate. We do not book the note as receivable as it is unlikely(in our estimation) to be collected. If a house is sold for $150,000, the first mortgage is a 0% $90,000 mortgage with a 30 year amortization. The second mortgage is $60,000 forgiven over 10 years. The intent is to provide safe, affordable housing and provide a disincentive to flipping the house even if after a few years. Based on the structure of the program, if the silent second is absent, a huge windfall may be realized and the program would be abused.

EmpireCPA (talk|edits) said:

1 February 2013
Clarification: We do not book the second mortgage. We record the first with a discount for the below market rate.

Captcook (talk|edits) said:

1 February 2013
Habitat, to my knowledge, does not recognize this receivable because that "income" has not been earned. The "earning" event would be a conversion of the home away from their principal residence prior to the end of the note term. We had several of these that were on 20yr terms and, also, due to some poor handling of paperwork, some 2nds that were not registered and, thus, went unpaid upon the subsequent sale of the home.

As I mentioned above, I considered the propriety of recognizing this mortgage as an asset, but couldn't get to a point of justifying when the income was earned. It wouldn't surprise me if some affiliates recognize this as income. We do book the forgiveness of interest over the term of the loan. This could probably be handled similarly, if desired.

Again, I have no sympathy for the person who isn't afforded the ability to leverage equity from a Habitat home into a new home. In most cases, the amount they pay to "buy" the home is well south of what it would cost to rent a similar home. This is the whole mission of the organization. We want to provide people a decent place to live if they are currently living in substandard housing. The system isn't perfect, but, again as I said above, the mission is not to build partner families net worth.

If you look at the land trust model, they cap growth at modest rates to maintain affordability, which is consistent with their mission. In those situations, that home is usually purchased back by the trust to be sold at an affordable rate to a new deserving family.

Sorry for the long post. I could go on, but I won't.

Kevinh5 (talk|edits) said:

1 February 2013
Well, Habitat lady comes in today and is not happy with the amount of her refund (only $3,500). I give her her papers back, shred the tax return, and tell her 'good luck' elsewhere. A waste of my time, except I learned something thanks to you folks.

Our firm policy is 'satisfaction guaranteed' and the time to tell us they are not satisfied is BEFORE we transmit to the IRS. I'd rather waste an hour of my time doing a return than to have some jerk thinking I've done bad work. Each year we have about 2 or 3 people who are not satisfied. I look at it as a cost of doing business: we're not going to please everyone, and those we don't please are better served by going elsewhere and making someone else miserable. I've got no time in my life to be miserable. Move on to the NEXT return. I'll say a prayer for her new husband. He will need all the help he can get dealing with her.

Ckenefick (talk|edits) said:

1 February 2013
Again, I have no sympathy for the person who isn't afforded the ability to leverage equity from a Habitat home into a new home. In most cases, the amount they pay to "buy" the home is well south of what it would cost to rent a similar home. This is the whole mission of the organization. We want to provide people a decent place to live if they are currently living in substandard housing. The system isn't perfect, but, again as I said above, the mission is not to build partner families net worth.

I'm down with that. I was just thinking through the *important* part - the *accounting.*

But I would think, in theory, the minute the title is switched to the home buyer (initial purchaser), Habitat has a valid receivable, which would be immediately collectible if, for example, the home buyer sold the property the next day. But at the same time, seems we'd have a corresponding Unearned Revenue liability for the exact same amount. The two would initially wash and would continue to wash as both are amortized down, at the exact same rate, due to forgiveness.

I was wondering about the forgiveness of the accrued interest too. Thanks for mentioning it.

Captcook (talk|edits) said:

1 February 2013
You've mentioned this policy before, Kevin. I didn't understand how it worked in practice. I have to say, I consider it ballsy, but can find no fault in it.

Kevinh5 (talk|edits) said:

1 February 2013
I figure it costs much less per year than having those one or two folks out there bad-mouthing me. If someone is pleased with your work they tell 2 or 3 people. If someone is displeased with your work they tell everyone who will listen. Even though these people's friends might know them to be unreasonable (at best), they've still heard bad word-of-mouth about you. This way, if these people talk about us, about all they can say is 'I didn't get as big a refund as I was expecting, so they gave me all my stuff back.' That's not so negative in my book.

EmpireCPA (talk|edits) said:

1 February 2013
Ck, we book the $90,000 0% mortgage with a discount of about $45,000. The $45,000 is amortized over the life of the first mortgage. In effect, we record it as though its a $45,000 5% mortgage and record interest over time. Any proceeds from a silent second mortgage are recorded when received due to the reasons you cite above. I believe this treatment has substantial support.

I wonder at times if there are any potential tax consequences to the buyers. Is the forgiveness of the second mortgage taxable?

Ckenefick (talk|edits) said:

1 February 2013
Is the forgiveness of the second mortgage taxable?

Wouldn't it be covered under 108(e)(5)?

Podolin (talk|edits) said:

1 February 2013
Wouldn't it be covered under 108(e)(5)? Yes, it would be.

Another theory might be that the second mortgage is not even a recognized liability for tax purposes, possibly under Sec 461, because it is contingent. 461(h)(2)(A)(iii) says economic performance occurs as the property is used. However, I am not sure whether 461 applies only to accrued expenses/deductions, or whether its principle is equally relevant to timing of a capital expenditure. And our taxpayer is cash basis, so maybe it does not apply at all.

Still, it seems to me there must be some tax principle saying that, even though a cash basis taxpayer gets to include debt in the basis of assets, that debt may not be included if it is contingent. An example might be a cash basis doctor who buys some state-of-the-art equipment for $100,000, evidenced by a note and an agreement that the note does not become enforceable unless and until the equipment has performed for, say, 2 years, after which payments of principal and interest begin. when does he get depreciable basis? Concept of condition precedent or condition subsequent may be relevant, but IANAL, so I don't know.

Ckenefick (talk|edits) said:

1 February 2013
I was kinda thinking along the same lines, hence asking about if buyer knew of the 2nd mortgage. If buyer does know of it, not sure why it's called "silent" or "ghost." And if buyer does know of it, I would think it would show up on buyer's settlement statement and buyer would include in basis.

Podolin (talk|edits) said:

1 February 2013
Probably right, Ck, but I'd still want to know all the terms of the 2nd mortgage. Although, it does not matter much, because of all the surrounding facts - low income people, statistical probability that they do not stay in the house for the required years, not a business asset, not forgiven if rented or sold, etc.

And my doc example? When does he get basis?

STG (talk|edits) said:

1 February 2013
Kevin's Satisfaction Guarantee policy is also a good way to generate new clients. People are much more likely to come see you for the first time if they know that they will know results and fees before being held to paying. I know it sometimes results in work for no money, but if I get 10 new clients and two walk, I'm still eight ahead.

Marezidotes (talk|edits) said:

3 February 2013
Was she thinking she was going to get to deduct the $32000, or was she just unhappy in general because now she's married and doesn't get all the EIC she's used to? Have already had two like this. Like Kev, I let them go out the door with their stuff. Not worth my time.

Kevinh5 (talk|edits) said:

3 February 2013
I think she is upset that she is married and no longer gets EITC. She said she would have been happy paying me $300 if she was getting $6,000 back, but not for a measly $3,500. LOL. She works in the Health & Beauty department of my local grocery store. I think I'll buy my toothpaste and soap elsewhere.

Ckenefick (talk|edits) said:

3 February 2013
No, you should buy it there and then complain to her about the price. And then when she says she has no control over it...

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