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Tax issue of Paid back Principal plus appreciation linked to equity index, eg gold

Fairport, NY |

What is the IRS Tax treatment of a loan principal paid after 3 years with appreciation :
A person A loaned Principal P to B to be paid after 3 years with interest I, paid quarterly, The interest i was reported at end of year on 1099-interest and taxed accordingly.
The loan , Promissory note stipulates that its principal value is tagged/indexed to the price of Gold at the outset, and would be paid accordingly, ie if Gold is up by 20% the principal is paid back with 20% increase, and the opposite is true, ie if Gold is down by 20%, the principal is paid back with 20% decrease, so principal value is at risk. Fortunately it did increase..
Is it to be reported as Long Term Cap Gain on sched-D ? Is there any IRS ruling/opinion in that regard? -link appreciated. Thanks , Abud.

anahou1@hotmail.com

Attorney Answers 1

Posted

There is no deduction for the repayment of principal on a loan. (Arguably there is an exception for ESOP loans.) What you have described is not a mere loan: it is a loan which might be characterized as either an adjustable interest element or as an equity kicker. The issue is whether the arrangement will be characterized as a loan or as a partnership. If it is characterized as a loan, then the borrower wil be entitled to deduct the entire amount of interest. If it is characterized as a partnership, then there will be no interest deduction. The analysis of the arrngement requires a review of the actual documents.

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3 comments

Asker

Posted

Thanks for your prompt answer. The APPRECIATION of the principal paid after 3years , eg 20% , is it Long Term Cap gain -sched D - or not. The already quarterly paid interest (1099-int) were reported as interest and taxed as such. The Return on Capital after 3 yesrs, ie appreciation of 20% , is it Long term Cap Gain or mere interest ? How about if it were a LOSS of 20% , is it capital loss or what ? The contract was a Promissory note to a -mortgage company/venture buying underperforming mortgs from Fed Resolution trust , using my Loan/Prom.Note and others to buy those Mortgages and try to collect them. Abud

Bruce Givner

Bruce Givner

Posted

The appreciation in principal may well be long-term capital gain. You must have your tax advisor read the contract to confirm. It may well be a long-term capital loss. Again, your tax advisor must read the contract. This is not as much a question of law as a question of the facts. It sounds like it will, indeed, be a long-term capital gain.

Asker

Posted

Thank YOU Abud

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