"Penalty" for Delay in Closing - Commercial Building

Client (sole owner S Corp - yes, I know) is selling a commercial building for several million dollars. Closing has been pushed back several times. So far, she has received payments that will be credited against the sales proceeds to be received at closing. Buyer wanted to extend the closing date and client refused unless she got $1,500 per day which will not be credited against the closing proceeds. I have seen an agreement to that effect, described as "Fourth Amendment to Agreement for Purchaser and Sale of Real Property."

Client gets to keep the cash unless she defaults on the agreement. In that case, she would have to refund it.

It seems to me that this is simply an increase in sales price and, therefore, LTCG. Does anyone see ordinary income here? The "Amendment etc" provides that closing date is set for no later than 7.31.21, although I suppose she could agree to extend subject to further penalties.

I agree, sales price adjustment.

A unanimous decision. That'll do me. TYVM.

Buyer wanted to extend the closing date and client refused unless she got $1,500 per day which will not be credited against the closing proceeds.

Are you sure that this isn't in lieu of rent in a sort-of sale-leaseback agreement?

Interesting thought. Current rent (re-appraised in last couple of years) is $50,000pa, give or take. So, on its face, $1,500 per day in rent seems a bit excessive. Then again, that whole street is slowly being demolished & rebuilt and the buyer is one of those doing the demolishing and rebuilding. So maybe the buyer thinks over $500,000 (annualized) in rent is a fair rent. I'll have to think about that.

Client is collecting rent from the existing tenant (bar/nightclub) and will continue to do so until the property is sold. At that point, tenant has thirty days to vacate. They are going to the other end of a short street to another property owned by my client and it is expected the tenant will purchase that in due course. (That property is more in keeping with what the neighborhood is set to become and is a much smaller lot. So likelihood of someone wanting to buy and demolished is reduced.)

I had not seriously thought of it being treated as rent. I suppose that is because of the existence of a tenant.

But the closing has been delayed (at the request of the buyer, right?), the deed remains in seller's name, and a formal document exists saying it is an amendment to the agreement of sale. Contrast this, in which The current owners of the new place would like to sell the property and continue to stay in the property for a few months in exchange for a large lump of cash. This would be in substance rent and likewise formally structured as rent. The sellers do not want to delay the sale as they need the cash. viewtopic.php?f=8&t=22430

That's right, Nilodop. It is the buyers who want to delay closing, hence my client's insistence that they pay $1,500 per day until they do close. Client has already received the first $10,500 check. She will have to refund it only if she does not close. My client still holds the deed to the property.

Now that I think about it, I don't see rent here. Buyer can walk away at any point at no additional cost to them - the $1,500 per day is paid weekly in advance. I had seen the other thread and it seems to me that the critical difference is that the sale will take place before cash changes hands.

Dave829 always raises interesting and thoughtful points so I'd be interested to hear his further thoughts.

Usually, when one refers to a "sales price adjustment," it's a downward adjustment. If the extra $1,500 per day being paid by the buyer to the seller is a "sales price adjustment," then it's an upward adjustment, which is unusual. That's why I suggested that it might be rent.

It's a factual determination, and it depends upon what sort of provisions are in the "Fourth Amendment to Agreement for Purchaser and Sale of Real Property." What threw me for a loop was your statement in the OP that the $1,500 per day "will not be credited against the closing proceeds" which suggests no effect on the sales price.

Or which suggests added proceeds.

I just have trouble seeing rent from buyer to seller in OP's facts.

At most, a fee for allowing a later closing, arguably in the nature of interest, but not really interest because no debt yet exists.

So here's a more detailed history. Client has had several offers for this property, because the whole area is being redeveloped. One might say it is being gentrified. It has a bar at one end, a bar/nightclub at the other (both owned by my client) that are, to put it bluntly, well-maintained shacks. In between are a variety of businesses - a bakery distributor and an auto mechanic for instance. The whole street is going to be redeveloped over the next several years.

Buyer has dragged their feet on closing and has asked for closing date to be put back several times. The first three times, they offered large sums of money ($50,000 in one instance) which are to be deducted against seller's proceeds at closing. If buyer does not close, my client gets to keep the cash. That sounds like earnest money to me.

The fourth time, the client said "No. If you want to push the closing back you can pay me $1,500 per day and you're not getting it back at closing." She is getting $10,500 per week in advance and buyer is required to give three days notice of closing. The $10,500 is pro-rated in the week of closing but the three days' notice provision means that she would only have to repay if notice is given on a Wednesday and then it would only be $1,500.

The first 3 payments were advance payments made against the purchase price because they were to be credited against the seller's proceeds upon closing. As to the $1,500 per day payments, in my opinion, they are damages representing compensation for delaying the date of closing, which are taxable income to the seller and not part of the sales price. See this excerpt from Kieselbach, 317 U.S. 399 (1943):

petitioner contends that as just compensation requires the payment of these sums for delay in settlement, they are a part of the damages awarded for the property. But these payments are indemnification for delay, not a part of the sale price. While without their payment just compensation would not be received by the vendor, it does not follow that the additional payments are a part of the sale price under Sec. 117(a).

See also Ferreira, 57 T.C. 866 (1972). It’s basically interest on the seller’s failure to receive the sales price within the time expected.

As to the $1,500 per day payments, in my opinion, they are damages representing compensation for delaying the date of closing, which are taxable income to the seller and not part of the sales price. See this excerpt from Kieselbach, 317 U.S. 399 (1943):

Sketchy citation. That case involved a condemnation. Government took the guy’s property on 1/3/1933. He got paid on 5/12/1937. He got paid interest for the intervening period (at a stipulated 6% rate). That compensation wasn’t for a delay in closing, it was for a delay in payment after the property had already been taken. The other cited case is similar.

In the immediate case, there hasn’t even been a transfer of title yet. So (one might say) the purchase price is still being negotiated, with the $1,500 amounts being part of that calculus.

That sounds like earnest money to me.

Yeah, me too, but with a twist - with a corresponding increase to the purchase price. Seems like both parties agree this is a purchase price adjustment. Not sure how it will be papered, if at all, on the closing statement. If you wanted to insulate your client, and if buyer pays, say, an extra $21k, increase the selling price on the closing statement by $21k and give credit for the $21k on the closing statement. (Adjust accordingly if buyer will get some small piece of that back). The practical effect is that the buyer really doesn’t get it back (other than maybe a small piece) since the purchase price is increased commensurately. That comports with the intent. It would actually behoove the buyer to treat it that way since the public record would reflect a higher purchase price.

Jeff, I read both cases earlier this afternoon and do not see that my client's case is the same as either Kielsebach or Ferreira, for the reason you state.

My comment on the earnest money related to the first three extensions, which yielded large sums that will be deducted from my client's proceeds at closing. It is this last one where there is no adjustment to the closing proceeds that I am trying to figure out.

I like the idea of increasing selling price by $21,000. Not sure if buyer will go for it. We will see.

My comment on the earnest money related to the first three extensions, which yielded large sums that will be deducted from my client's proceeds at closing. It is this last one where there is no adjustment to the closing proceeds that I am trying to figure out.

Gotcha. And the last one sounds like traditional earnest money too (but with the twist I noted). It is forfeitable, just like traditional earnest money. And the payment of it ties up the property, just like traditional earnest money, such that the seller can’t sell the property to anyone else until the earnest period expires. So, if we want to treat “the last one” like traditional earnest money, we can…we can show the payment of it on the cs as a credit to the buyer, but we’d also bump the selling price accordingly. If this really is a purchase price adjustment, then we’d think the closing statement would be papered that way. This isn’t like we’ve already sold the asset and we have to wait to see what the future holds to determine this particular purchase price adjustment. It will be know when it comes time to close, unlike a working capital true-up which happens after corporate stock is sold and only after a final working capital calculation has been completed.

Usually, when a seller demands that a buyer begin paying periodic amounts for the buyer’s request to delay the closing date, it’s because the seller is taking a loss for the delay and wants to be compensated for that loss. The seller has usually prepaid such items as real estate taxes, utilities and maintenance expenses, and is also suffering a loss while the real estate market continues to rise and the sales price is locked in. So, if the seller is unable to increase the sales price (OP said that the $1,500 payments will not be credited against the closing proceeds), then these payments are income.

I notice that although the “big three” (Nilodop, Jeff-Ohio and SumwunLost) have decided that a quote from a United States Supreme Court case is not sufficiently authoritative here, none of you has cited any authority for your position.

... then these payments are income. Of course they are, never been in doubt. All that's on the table is what kind of income, and when. I say addition to sale price and at closing.

And I say income when received, and not sale price at closing. I thought I had made that clear.

Dave, I have no doubt these payments are income. The question is whether it suffers tax at 20% or 37%.

As for Kieselbach, are the facts there similar to my client's? In that case, the taxpayer was deprived of the property. The only question was how much they got, which was settled some years after the fact. SCOTUS decided part of the payment was interest and not part of basis. I am always open to convincing that it is relevant but I do not see it.

Does 1234 apply? I think not as we have a sale agreement and it is just a matter of closing.

I am flattered that I should be mentioned in the same breath as Nilodop or Jeff-Ohio but I doubt I am there yet, at least as it relates to tax.

Just seen last two posts. Agreed it is income. Issues remaining, I think:

Character of income - LTCG or ordinary?

Timing - Well, as it happens, they will either close this year or not at all. Client would have to repay if she decides not to sell, if buyer is still willing and able to buy. Is that enough to delay recognition until sale? Not that it will matter in my case, but I am interested from an academic point of view.

I notice that although the “big three” (Nilodop, Jeff-Ohio and SumwunLost) have decided that a quote from a United States Supreme Court case is not sufficiently authoritative here, none of you has cited any authority for your position.. The case is easily distinguishable on its facts. Please let us know if, after reading it again, you need more clarification. Hint - it involves date of transfer of formal and/or beneficial ownership. Second hint - there was no contingency as to whether ownership would transfer; it already had.

The case is easily distinguishable on its facts.

Agreed. In addition, Dave is acting like we have a fixed purchase price. We don’t. It’s T/B/D.