Orbach, "Installment Reporting: Wraparound Mortgages After the IRS's Temporary Regulations and Hunt," Journal of Real Estate Taxation (Winter 1985): 145.
In 1980 my article, "Installment Sales of Mortgaged Real Estate and the Wraparound Mortgage," on the use of a wraparound mortgage in the sale of real estate on the installment basis, appeared in The Appraisal Journal.(1) The focus of the article was the use of a wraparound mortgage to circumvent the impact of the former 30% eligibility test when existing mortgages exceeded the basis of the property.
Though a wraparound mortgage is no longer necessary to avoid the impact of the 30% test, it can provide two important tax advantages for an installment seller.
In my earlier article, I observed that a wraparound mortgage was commonly used to circumvent the problem of having to report the excess of loans over basis as a payment received in the year of sale.(15) Three tax court cases were cited as providing the basis for this tax planning device.(16) Thus, prior to the temporary regulations issued by the IRS in 1981, both of the advantages cited previously were available to installment sellers.
A wraparound mortgage is simply a mortgage that a buyer issues to a seller, of which the principal amount includes the outstanding balance due on the existing indebtedness that encumbers the property.
Treasury issued a temporary regulation that took the position that a wraparound mortgage should be treated as if the buyer had acquired the property subject to the wrapped indebtedness.(17) One result of this regulation was that a seller was deemed to have received a constructive payment in the year of sale to the extent that the wrapped indebtedness exceeded the seller's basis (including selling expenses) in the property.
Because the wraparound mortgage agreements define and govern the parties' obligations, the terms of the documents generally control the tax treatment of the transaction.
As a result of the tax court's decision in Professional Equities, the use of a wraparound mortgage will result in a lower gross profit ratio.
By using the wraparound mortgage, the seller was able to circumvent the mortgage-over-basis problem and defer a larger portion of the gain to subsequent years than would have been the case under the temporary regulations.