When you consider selling your note, you may find buyers who offer you a deal called a "partial." A partial is a note transaction in which you do not sell the entire note all at once. In a partial, you do not step completely out of the picture. For example, if you sell half of your note to a buyer, you are actually only giving them the benefit of a certain number of payments -- the earliest half of the payments -- and you are keeping the rest. Did you really "sell" those payments? Did you really "sell" your note? Did you really "sell" half of it? Who really owns the note? You have a part and your buyer has a part. The actual ownership of the note is in a state of confusion. That confusion generates several serious problems.
Possession of the Note
First, the buyer will demand that you deliver possession of the original note. Possession of the note is the most important legal protection any note owner can have. Even though you will sign papers that say you haven't sold the entire note, you no longer have the note in your possession. If you have trouble collecting payments, your lack of possession could cause difficulty proving that you own any part of the note.
The two most common causes of trouble collecting payments are 1) the bankruptcy of the note buyer and 2) your note payor quitting payments. In either situation, you may lose the entire note because you do not have it in your possession.
Sale or Loan?
Second, with the confusion over the status of the note, it is unclear whether you have a sale or a loan. Did you simply borrow money against your note? Or did you really "sell" part of it? What difference does it make? If your partial is a sale, you are likely to be required to enter it on your income tax form as a sale. However, if your partial is a loan, you may not have to claim it at all.
Internal Revenue Service Reporting
Another problem with partials is the fact that three parties are involved: you, the note buyer, and the payor. How to report the interest on partials to the IRS is a matter of considerable confusion. The note buyer receives interest income on the payments you sold. The payor pays interest on the entire Note balance. Your position may be unclear when it comes to interest received or paid. If all three parties, you, the note buyer, and the payor, send interest information to the IRS, all three forms are likely to show different amounts. The Internal Revenue Service may question this difference and trigger an audit.
The Time Value of Money
Partials can cause another kind of confusion: the actual amount of money you will get is probably less than you expect. The reason is that you may fail to calculate the time value of money correctly. If, as in our example, you sell the first half of the payments on your note, you will not be collecting on the second half of those payments for a long time. Do you know the actual amount you will eventually collect? Is it as much as you expect? You can call us for a precise answer.
Early Payoff
If your note payor pays the note off early, or makes extra payments, you will receive much less money on the partial than you may have initially expected. The payor cannot be stopped from early payoff in most cases.
Lorelei Stevens is president of Wall Street Brokers, Inc. in Seattle, Washington. She has been a licensed real estate broker (Washington State Real Estate Brokers License WA-LL-SB-*275LD) and a discounted note buyer since the 1970s. She has worked her entire adult life with Wall Street Brokers negotiating millions of dollars of paper and is a nationally recognized expert.
Lorelei has taught Legal Continuing Education seminars and has written numerous articles for legal, real estate and other professional publications on the subjects of seller-financing, managing, reinforcing and buying paper. She is the author of two books, one on seller-financing and another on note buying. She also writes a monthly column for Noteworthy Newsletter and is a frequent contributor to The Paper Source. Her web site is www.WallStreetBrokers.com.
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