Ordinary Income or Capital Gain?
Alorac Jones
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My wife and I are sole stockholders of an S-Corp whose
principal activity is the making of short-term loans secured
by real estate. The loans, in addition to requiring monthly
interest payments at almost the maximum interest rate
allowed by law, require the payment of a prepayment penalty
should the borrower elect to pay off the loan prior to its
maturity. We are advised by counsel that this prepayment
penalty is not considered interest under State law. (If it
were, our loans would be usurious.)
Bonds frequently allow their prepayment at a premium. I
believe that such premiums are capital gains, not ordinary
income, to the holders. In view of the foregoing, can we
reasonably consider the prepayment penalties to be
short-term capital gains, rather than ordinary income?
David Woods EA MST
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> Bonds frequently allow their prepayment at a premium. I
> believe that such premiums are capital gains, not ordinary
> income, to the holders. In view of the foregoing, can we
> reasonably consider the prepayment penalties to be
> short-term capital gains, rather than ordinary income?
They are, but in all reality is there a difference? You
want a LONG-TERM capital gain here.
David M. Woods, EA, MST
(617) 723-2422
Boston, MA
www.rytercpa.com
Richard B. Gardner
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Alorac Jones <alo...@airmail.net> wrote:
> My wife and I are sole stockholders of an S-Corp whose
> principal activity is the making of short-term loans secured
> by real estate. The loans, in addition to requiring monthly
> interest payments at almost the maximum interest rate
> allowed by law, require the payment of a prepayment penalty
> should the borrower elect to pay off the loan prior to its
> maturity. We are advised by counsel that this prepayment
> penalty is not considered interest under State law. (If it
> were, our loans would be usurious.)
>
> Bonds frequently allow their prepayment at a premium. I
> believe that such premiums are capital gains, not ordinary
> income, to the holders. In view of the foregoing, can we
> reasonably consider the prepayment penalties to be
> short-term capital gains, rather than ordinary income?
For what it's worth, prepayment penalties paid for the early
retirement of mortgage debt are deductible as *interest*
(Rev. Rul. 57-198). Since the deduction is considered
interest expense, I don't think the IRS would characterize
the income as capital gain, but would probably view it as
interest income.
--
Richard B. Gardner, EA (OK)
Drew Edmundson
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evild...@aol.comfreddy (David Woods EA MST) wrote:
>> Bonds frequently allow their prepayment at a premium. I
>> believe that such premiums are capital gains, not ordinary
>> income, to the holders. In view of the foregoing, can we
>> reasonably consider the prepayment penalties to be
>> short-term capital gains, rather than ordinary income?
> They are, but in all reality is there a difference? You
> want a LONG-TERM capital gain here.
Sure there is a difference. Short-term capital gains will
allow taxpayer to claim more capital losses if they are
currently limited by the $3,000 rule.
Drew Edmundson, CPA (NC)
BobLindEA
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>> reasonably consider the prepayment penalties to be
>> short-term capital gains, rather than ordinary income?
> Since the deduction is considered
> interest expense, I don't think the IRS would characterize
> the income as capital gain, but would probably view it as
> interest income.
And, if you want to stick to the argument that this isn't
interest under your state's law, then it is still ordinary
income, since you are in the BUSINESS of lending money. It
is NOT a portfolio activity, and certainly is not a capital
gain of any kind, in my opinion.