The term “income” is broad. It includes just about any money or gains that a person receives. There are exceptions, however.
Take the purchase price reduction. Assume Party A sells a property to Party B for $100. Party A will likely have a gain on the sale. The gain is income and may trigger income tax.
But what if Party A sells a property to Party B for $50 and Party A pays Party C $50 to provide a service to Party A? Does Party A still have $100 of income for tax purposes? Does Party B have $50 of income?
The answer as to whether there is a purchase price reduction or income is not all that clear. The IRS addresses this in PLR 200721013. This can be a great way to lower capital gain taxes and save on other taxes as well.
Facts & Procedural History
This ruling request involves a common situation whereby a buyer’s agent credits part of his commission to the buyer. The transaction works like this:
- A person selling a piece of real estate (Party A) will generally agree to pay a commission to their real estate agent.
- The real estate agent will then pay a portion of this commission to a second real estate agent (Party C) who produces a ready, able and willing buyer (the buyer’s agent).
- At the real estate closing, the buyer’s agent may pay or credit the buyer (Party B) with a portion of the commission that the buyer’s agent received.
Thus, the listing real estate agent gets the commission. The listing agent may then pay a portion of this commission to a second real estate agent who found a buyer. At the closing of the sale, the buyer’s agent may pay or credit the buyer with a portion of the commission received.
These are the facts the IRS considered in the ruling request. The question is whether the commission rebate is taxable to the buyer.
Gross Income vs. Gifts
Gross income is defined in Section 61 as income from any source. The courts have said this is an accretion to wealth. Unreported income is the number one item that the IRS checks for during its audits.
The ruling cites Section 61 and then addresses Rev. Rul. 2006-27, 2006-21 I.R.B. 915. Rev. Rul. 2006-27 deals with nonprofits that provide first-time homebuyers with assistance making down payments on houses. The ruling concludes that down payment assistance is a purchase price reduction.
Rev. Rul. 2006-27 is based on Section 102. Section 102 provides that the value of property acquired by gift is excluded from gross income. A gift “proceeds from a ‘detached and disinterested generosity,’ . . . ‘out of affection, respect, admiration, charity or like impulses.’”
It would not seem that the intent to make a gift is as clear as the present facts. The buyer’s agent is presumably a for-profit business. There may not have been a detached and disinterested generosity involved. It may have been a requirement or expectation for the buyer’s agent to get the deal or to be able to complete the transaction.
Gifts v. Rebates
The ruling goes on to cite Rev. Rul. 2005-28, 2005-1 C.B. 997. Rev. Rul. 2005-28 is closer. It involves rebates to customers who purchased cars. The rebates were offered by car manufacturers.
A gift is a voluntary transfer of property or money from one person to another, without any expectation of repayment or return. It is typically made out of generosity, affection, respect, or other like impulses. On the other hand, a rebate is a partial refund or return of money paid by a customer to a seller after the purchase of a product or service. It is usually given as an incentive to customers to purchase more of the seller’s products or services or as a reward for a previous purchase.
In PLR 200721013, the IRS confirmed that the payment or credit in this common transaction is treated as a purchase price reduction and not as taxable income. As a result, the buyer did not have to report the income on his or her tax return and the buyer’s real estate agent did not have to send the buyer a Form 1099 to report the transaction.
Sales Tax and Property Tax Considerations
Income taxes are not the only consideration when it comes to purchasing price reductions. Sales taxes and property taxes may also be reduced by using purchase price reductions.
These taxes vary widely in scope and application from state to state.
In Texas, for example, the Texas sales tax is based on the total cost of a purchase, without any discounts being taken into account. This means that sellers in Texas are not required to charge sales tax on any discounts that they offer to customers, as these discounts are specifically excluded by law. Therefore, sellers are not obligated to collect sales tax from purchasers in cases where discounts are given. Sales tax does not necessarily apply to real estate, at least it does not in Texas, but the same concept applies to discounts for other items–such as the sale of inventory, etc.
Property taxes in Texas are similar. They do apply to real estate. The amount of tax is based on the fair market value of the real estate. The value is typically recorded in the deed records and real estate records as the fair market value, which is the price that the parties paid for the property. However, if the parties do not report the full value of the property exchange in these records, there is a possibility that the local tax assessor may use the value listed in these records for computing property taxes. This means that if the actual fair market value of the property is higher than the recorded value, the property owner may be able to pay less in property taxes than what they otherwise would.
As this case shows, the term “income” is broad and encompasses most forms of money or gain received by an individual. Whether a purchase price reduction constitutes income for tax purposes is not always clear. In the case of a commission rebate paid by a buyer’s agent to the buyer, the IRS has ruled that it is treated as a purchase price reduction and not taxable income. By engaging in careful tax planning, taxpayers may be able to avoid paying unnecessary income tax on purchase price reductions. This can also result in lower sales and property taxes.