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I have recently been involved in a settlement agreement in…

Hello, I have recently been...
Hello, I have recently been involved in a settlement agreement in lieu of litigation against the seller of my home (one of two unit condo). The seller did not disclose the fact that he removed moldy subfloors and replaced them, covering up a problem that resurfaced after I bought the house. We (the HOA comprised of the upstairs owner, myself and my non-registered domestic partner) ended up taking loans out to complete the work to remediate the house, which amounted to approx $80k in hard costs and temporary relocation costs. The upstairs and downstairs units split the hard costs 50/50, and took out separate loans to pay the costs upfront. The moldy foundation and subfloor has since been fixed and we filed for litigation, yielding a settlement agreement (being drafted in the next couple days) of $60k. This amount will likely be paid in a single check to all three plaintiffs, however we will need to a) distribute the settlement check to pay the owners of both units a specific percentage and b) file for taxes in a way that will maximize our take home amount and reduce what we will owe for taxes. Do you have any recommendations?
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Answered in 13 hours by:
10/19/2017
Lane
Lane, JD, CFP, MBA, CRPS
Category: Capital Gains and Losses
Satisfied Customers: 14,668
Experience: Have been providing Financial and Tax advice for 30 years.Concentration in Corporations, Estate, Income Tax and Business Planning
Verified

HI, MY NAME’S LANE - I hold a law degree (J.D.), with concentration in Tax Law, Estate law & Corporate law, an MBA in finance, a BBA, and CFP & CRPS (Chartered Retirement Plans Specialist) designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice 1986.

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Homeowners associatons that qualify as exempt organizations under IRC Section 501(c)(4) are completely exempt from income taxes, except for any unrelated business activities. Associations that qualify under IRC Section 501(c)(7) are exempt on member activities, but pay taxes on net income from nonmember activities and investment earnings.

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How do you file?

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Customer reply replied 9 months ago
I file as a single person. The hoa is not registered as a business, other than the forms we filled out during escrow. We do have a joint bank account that belongs to all three hoa members though.

Ok, well then, what will drive the taxation is who the check is made out to. So if's made to you all jointly, you'll report on line 21 (other income) your respective share.

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Becasue this is a business issue, you CAN deduct any attorney's fees and court costs.

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And if the check is made out to one of you, they will send only that person a 1099 and that person will report (SO you'll need to distribute ONLY after holding back enough to cover the taxes)

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Customer reply replied 9 months ago
I just found out our attorney will be receiving the check from the seller directly, then he will take his fee of 2500 (reasonable) and then he can distribute to us how we need him to. That said, I think we still will need to claim as income individually under line 21. So that may means we'll all be taxed at our rate of 28%(or whichever rate we fall under) correct? Finally I was wondering if we incorporated our hoa, would we be able to transfer all the money to that account and then pay credit card bills directly to avoid paying excessive taxes?

One the first part that's correct.

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What you CAN do is apply for exempt treatment under IRC Section 501(c)(7), as a non profit HOA.

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Then you would file form 1120-F and only Non-exempt income would be taxable.

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Things like this that are about the ongoing running of the HOA would be exempt.

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What state are you in? In some state such as Florida HOA's are automatically exempt

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Customer reply replied 9 months ago
Since the lawsuit and subsequent settlement specifically pertained to damage to, and remediation of, our primary residence, can the award be considered a capital gain and taxed as such? If it would save us a significant portion when filing taxes that is.
We are in CA.

The taxable amounts received will depend on how the lawsuit proceeds were labeled. If the proceeds were given solely to compensate you for property damage, that is not taxable income and you will enter the amount on line 21 of your return and then take it out as a negative to show the IRS hat this was for property damage.

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UNLESS you've already taken a casualty loss on a previous return.

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But treating this THIS way (as a personal issue) if part of the settlement is DESIGNATED (read the award) as attorneys fees, that portion will be taxable

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Customer reply replied 9 months ago
OK, so if I'm understanding you, I should make sure the settlement agreement clearly states that this award is solely for property damage reimbursement, and should not state anything about attorney fees in order to avoid paying taxes on it.Since the whole check will be written out to my attorney, is the ball in my attorney's court to deal with his own income declaration? Then the remainder of the proceedings can be distributed to the HOA members by my attorney and we can still claim that it is reimbursement as above even though it would be coming through our attorney. That sound right?The ultimate goal, obviously, is to find a way of receiving the maximum amount of take-home money to be able to directly pay off accrued credit card debt and loan balances (which the award will not cover in full) and legally avoid paying taxes however possible.

"OK, so if I'm understanding you, I should make sure the settlement agreement clearly states that this award is solely for property damage reimbursement, and should not state anything about attorney fees in order to avoid paying taxes on it."

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That's correct

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"Since the whole check will be written out to my attorney, is the ball in my attorney's court to deal with his own income declaration? Then the remainder of the proceedings can be distributed to the HOA members by my attorney and we can still claim that it is reimbursement as above even though it would be coming through our attorney. That sound right?"

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Also exactly right

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"The ultimate goal, obviously, is to find a way of receiving the maximum amount of take-home money to be able to directly pay off accrued credit card debt and loan balances (which the award will not cover in full) and legally avoid paying taxes however possible."

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I understand ... and again, if it's all designated AS for property damage and (1) you haven't previously taken a loss and (2) received no insurance money for this, it wont BE taxable.

Lane
Lane, JD, CFP, MBA, CRPS
Category: Capital Gains and Losses
Satisfied Customers: 14,668
Experience: Have been providing Financial and Tax advice for 30 years.Concentration in Corporations, Estate, Income Tax and Business Planning
Verified
Lane and 87 other Capital Gains and Losses Specialists are ready to help you
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Customer reply replied 9 months ago
Got it. Thank you very much for your help! Hopefully it's OK if I have a minor follow up question in the next couple days that I keep this thread open. Think I'm pretty much there though. I'll be sure to give you a great review, yet again.

Sorry - they didn't give me a notification that you had come back - You're very welcome, and ... Yes, just bookmark the page and you can always come back to review. or to ask a followup on this.

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I would appreciate a positive rating using the stars, so they'll compensate me for the work here.

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In the event you use Turbotax, you may find this helpful:

https://ttlc.intuit.com/questions/3257038-i-received-a-settlement-for-damage-to-my-property-i-used-a-good-amount-of-the-proceeds-for-repairs-is-the-entire-settlement-taxable-can-i-deduct-the-cost-of-repairs

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Thanks,

Lane

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Lane, JD, CFP, MBA, CRPS
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