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Lev
Lev, Tax Advisor
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Contractor received loan draws from the bank and 1099.

Customer Question

Contractor received loan draws from the bank and 1099. Turned over funds to borrower for disbursement. Contractor issues 1099 to Borrower for total amount less his portion for his services, then the borrower needs to 1099 all subcontractors he paid (with the exception of the GC who initially received the funds)...correct? Now, how does the borrower report the income (that was ultimately used for materials) on his tax return to offset the difference between the amount he received and the amount he reported on the 1099's to subcontractors when the project is still ongoing in to the next tax year?
Example: $148K from bank to GC. $140k from GC to borrower. $45K from Borrower to Subs. $95k in materials.
Submitted: 9 months ago.
Category: Tax
Expert:  Tax.appeal.168 replied 9 months ago.

Q: Now, how does the borrower report the income (that was ultimately used for materials) on his tax return to offset the difference between the amount he received and the amount he reported on the 1099's to subcontractors when the project is still ongoing in to the next tax year?

A: The 95k in materials is reported as Cost of Goods (COGS), on page 2, Part III, of the Schedule C.

Let me know if I can be of further assistance to you regarding this matter. If all is clear, a positive rating of 3 or more stars is appreciated so that I may receive credit for assisting you.

Customer: replied 9 months ago.
COGS? I guess I left out a small detail, the borrower is the homeowner. Still COGS even though they were bought and not "sold"? Sorry, I'm just trying to do the 1099 portion for both sides. I don't do his tax returns (obviously), and I am very unfamiliar with this construction loan process, as is his GC, unfortunately. I just want to make sure that I get it right before the 1099 deadline.
Expert:  Tax.appeal.168 replied 9 months ago.

I thought you were referring to an independent contractor. However COGS will still apply. Line 36 of Part III reads as follows; Purchases less cost of items withdrawn for personal use. This is where the 95K will be entered.

Link to Schedule C:

https://www.irs.gov/pub/irs-pdf/f1040sc.pdf

Customer: replied 9 months ago.
the homeowner (borrower) will treat this project as a business? That doesn't seem right. I understand that he would have to report any excess funds from the construction loan as income, but he wouldn't be able to report a loss from building a house, it is just the cost of building the house. This is what is confusing. I understand from the perspective of the GC...Schedule C makes sense. But from the homeowner (borrower) perspective, I just don't get it. At the end of the project, he will have a home and a mortgage for the amount borrowed. I wouldn't think that he would report any income or loss from the entire project, rather the actual cost (whether borrowed or paid out of pocket) would just be the basis of the home. However, I can't figure out how to avoid reporting the funds from the lender as income due to the 1099 transactions and the fact that the home is not finished yet. Perhaps I should do all the 1099 transactions from the GC and leave the borrower out of it, even though the borrower actually disbursed the funds for subs and materials. However, I work for the homeowner (borrower), so that is easier said than done!
Expert:  Tax.appeal.168 replied 9 months ago.

My apologies, I see where you are referring to the borrower as being the person wanting to deduct the $95k. The cost of the materials gets added to the cost basis of the property and is not deductible until the property is sold. The borrower is not allowed to take a deduction at this point.

Customer: replied 9 months ago.
any recommendations? Or did I answer my own question? :)
Expert:  Tax.appeal.168 replied 9 months ago.

No, you don't have to answer your own question, maybe someone else can. I am releasing the question back into the queue.

Customer: replied 9 months ago.
Thanks for your help! I should have done a better job with the details to start!
Expert:  Lev replied 9 months ago.

My understanding is that the Contractor is NOI a borrower and did not receive a loan - BUT received a payment for services - which the bank is reported on form 1099misc.

If the contractor is cash based taxpayer - that amount is reported into his/her income as it was constructively received.

That is regardless if the project is overlapping two tax years.

If the contractor is an individual - that amount is reported on schedule C as gross income.

Expenses are correspondingly deducted.

The cost of materials will be deducted an amount paid to subcontractors as well - and will be reported on forms 1099misc sent to each subcontractor who is paid more than $600.

If you as a general contractor HIRE teh borrower to perform some work - that amount will be reported the same way as for other subs.

If you allow the borrower to purchase some materials - be sure to collect receipts and keep for your record.

If you simply return some money to the borrower - you are still responsible for that amount as it is reported to you as a contractor.

Questions?

Customer: replied 9 months ago.
I am working for the borrower. Borrower controlled funds because it was GC's first project of complete home build and borrower did not trust GC having control of the money and wanted to ensure that work was satisfactory. Turns out GC was useless and borrower has had to hire and control the majority of the project. Borrower has receipts for $150k+ spent on project in 2015. So, let's go from another angle and assume the borrower received the funds directly from the bank and the corresponding 1099. How does the borrower handle the reporting of the income shown on the bank's 1099 when the funds are being used to construct a personal residence? Would he use Schedule C as if he were a contractor and given the facts, only report expenses up to the amount of the bank 1099 to result in a $0 profit/loss? He has two other legitimate sole proprietor businesses with their own Federal ID's plus wage income from a separate employer. So, this schedule C would use his personal Tax ID as if he was a contractor for this project? I realize it would be much easier if the so-called GC would handle the entire situation, but at this point that is not going to happen given the filing deadline.
Expert:  Lev replied 9 months ago.

You wrote that the Borrower controlled funds - that is OK - but the control is exercised but but taking over the GC - but negotiating with the bank that funds are provided in steps upon approval from the borrower.
Based on your explanation - the borrower is taking over and wants to act as a GC not only monitoring the building process, but having an authority to hire subs and purchase materials.
That is not how the contraction loan is working.
In such situation If the bank agrees to provide funds directly to the borrows - that would be the situation you want.
If the bank disagrees - unused funds must be returned to the bank - and the borrower would likely need to present a different GC who will take over the project.

It is possible that the borrower will present himself as the GC - subject to the bank approval.

Customer: replied 9 months ago.
Unfortunately, I cannot change what has already happened. Therefore, I would like to know how this situation would be handled if the borrower received the funds to build home and received the 1099 from the bank for the funds received when the project was not finished by the end of the tax year. Would he use Schedule C as if he were a contractor and given the facts, only report expenses up to the amount of the bank 1099 to result in a $0 profit/loss?
Expert:  Lev replied 9 months ago.

The issue is not that the borrower received funds - that is a loan for the borrower and as he is responsible to pay that loan back - that is not his taxable income.

The issue woudl be with form 1099misc that is sent to contractor - as you originally pointed out - and should NOT be sent to the borrower.

If the bank sent 1099misc to the borrower - that is not correct - and you would need to communicate the bank asking to correct that mistake.

If you take a position that the borrower is acting as a general contractor - and that is his business activity - then - you are correct - income woudl be reported on schedule C as for self-employed person - and he will be responsible for both - income and self-employment taxes on net business income.

However - because the project is still ongoing in to the next tax year - and not all funds were spent during the tax year - I do not see how you could report zero profit/loss.

I would expect to see a positive income.

Customer: replied 9 months ago.
The borrower has actually paid out more than he received from the construction loan in 2015. However, can we just get around the right or wrong of this specific case and help me to understand how this would work if I am acting as my own GC to build my personal residence, would the bank still send me a 1099-Misc for the funds released? If so, how would I avoid reporting funds as income that will eventually be in the form of a mortgage?
Expert:  Lev replied 9 months ago.

The borrower may act as a general contractor - that is not an issue - however as I mentioned - in this case - there should NOT be any reporting forms

Whether the bank agrees to accept that person as a general contractor - that is another issue - there might be some additional requirements.

But if expenses are more than reported income - I do not see any issues from IRS prospective.

Customer: replied 9 months ago.
to clarify, if the bank paid the construction loan directly to the borrower, a 1099 would not have been issued to the borrower, correct?
The borrower is frustrated and is telling me to just show that the GC paid the funds to him (the borrower) and he will take care of it from there. However, I need to understand the tax consequences before "following orders" so that I can help him fully understand the situation along with the pros/cons and an explanation if had it been done differently.
Expert:  Lev replied 9 months ago.

That is correct - if the money are issued to the borrower - there is no reporting form.

However based on current practice - the bank is financing construction and is using the property to be built as a collateral.

Expert:  Lev replied 9 months ago.

They do not want just to give the money to the borrower - so the borrower will use the loan as he wish - but ONLY for the construction as agreed.

When the borrower just takeover the construction - that might be a violation of his agreement with the bank - but that woudl not be a concern of the IRS.

Whether the borrower is acting in the capacity of the general contractor or subcontractor - he is a self-employed person.

.

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