Posted by Mark (SDCA) on June 06, 2000 at 09:13:04:
Yes, I suppose… First, if 100% of the “rent” is additional option compensation then that means the T/B is living in the property “rent free”. At that point, I think the most likely outcome is that the IRS re-classifies this from a LO to an installment sale and you have a taxable event. Personally, I don’t think either of those outcomes is all that likely.
Mark
How are you Taxed on the Rent Credit? - Posted by Soraya(SanDiego)
Posted by Soraya(SanDiego) on June 02, 2000 at 23:09:02:
I am confused about how rent credit, designated as Option Consideration, is treated for IRS purposes in the following example.
This is a real example. We wanted to ensure that the tenant buyer would exercise his option.
$250,000 condo
$1200 per month rent
100% rent credit (To be deducted off purchase price at end of year)
Buyer exercises option at $250,000 purchase price and lender allowed $14,400 rent credit to be considered option consideration.
Escrow reports the sale as $250,000 to IRS
How do I Report to IRS?
1- Don?t count rent for the year as income
2- Use monthly loan payments as expenses
3- What about the $14,400 rent credit/option consideration? Can it be designated as long term capital gains?
Seems to me that long term capital gains treatment would not fly with the IRS.
I would appreciate your input
Soraya
Addition Information needed to Clarify Problem!! - Posted by Soraya(SanDiego)
Posted by Soraya(SanDiego) on June 05, 2000 at 12:43:08:
Addition Information needed to Clarify Problem.
If Mr. Piper is reading this, this is information that you and I have already discussed. My post has gotten so much attention that I thought that it may be of value to others for me to mention the things that we discussed.
The tenant buyer is into the lease option 6 months. We told him if he wanted to exercise his option early we would agree to give him 100% credit for the last 6 months rent as well.
The deal closes this Friday June 9, 2000
We don’t call it rent credit in our option agreement we call it additional option consideration.
The property has been held since October 1997. Therefore hopefully we will not be considered a dealer and will be able to claim long term capital gain treatment with the IRS.
The problem is the bank allowed the entire 100% rent credit (we called it additional option consideration in our contract) to be considered down payment and therefore the buyer wants to leave the purchase price as $249,900 instead of discounting the purchase price by this additional option consideration- rent credit. (He needs this credit as part of his 5% down that he needs to get the loan.)
And escrow will inform the IRS that the purchase price is $249,900. (I was surprised that the lender would agree to allow the entire rent payment to be considered as option consideration. We did not plan on that.)
What we are worried about is that we are doing a 1031 tax deferred exchange and we are afraid that not only the 6 months of actual rent credit-option consideration will be considered boot but the other 6 months of rent credit-option consideration will also be considered boot rather than a discount on the purchase price. As I mentioned above, the lender is accepting the purchase price as $249,900 and allowing 100% of the entire year as down payment.
(If anyone is interested I will provide them with the name of that very flexible lender.)
It has been my experience that not all C.P.A.'s are well informed on creative transactions, especially when there is a twist in the transaction that we were not prepared for. So the reason for the post was to get ideas from more experienced investors so I could inform my C.P.A. what other people have done.
I was just advised about the lender allowing the entire rent to be considered down payment a few days ago and the buyer needed those credits to close. My C.P.A is out of the country so I have not been able to talk to him about this twist in the deal as of yet. And my thoughts are, “did I mess this one up or what”.
AND I want to thank everyone very much for your input.
Soraya
Re: How are you Taxed on the Rent Credit? - Posted by Mark (SDCA)
Posted by Mark (SDCA) on June 05, 2000 at 11:41:51:
The other posters have handled #3.
You are making #1 and #2 mroe complicated than necessary. Nothing is different than a straight rental just because this is a LO. All the rent must be declared as rental income on Schedule E. Any expenses you incur (repairs, maintenance, mortgage interest, insurance, property taxes etc) can be deducted from that rental income, also on Schedule E.
Hope this helps,
Mark
Re: How are you Taxed on the Rent Credit? - Posted by JPiper
Posted by JPiper on June 03, 2000 at 19:01:27:
Let me start by saying I?m not a CPA?.and this question should more appropriately be directed to one. But I?ll give you my 2 cents worth.
First, since this is evidently a 12 month option, your ?income? or ?rent credit? or ?option consideration? is going to stretch over 2 separate tax years in all probability. I?m gathering that this deal is not closing now or this year, otherwise you have already made a decision on how to treat this ?rent credit??.so your question may be moot.
Further, I believe your contract would come into play to some degree because the terms ?rent credit? and ?additional option consideration? to me take on a different meaning. So how your contract phrases this is important in my opinion.
Option consideration is not taxable until the option is exercised or expires. If it is exercised, my view of the correct treatment if you have treated it as option consideration (didn?t pay tax on it as rent), would be that it becomes an adjustment to your cost basis. The importance of this is that if it?s an adjustment to cost basis then if you?ve held the property long term, and if you?re not a dealer, the entire gain would be a long term capital gain?including the adjustment for option consideration. The credit given to the buyer of course would serve as an adjustment to the sales price.
Frankly I don?t handle additional option consideration in this manner even though I believe it to be correct. I think it?s a pain to track the option consideration in that manner. Normally my ?rent credit? is a small part of the rental payment. So instead, I treat the entire payment collected as rent, and pay tax on it accordingly when due. The rent credit then adjusts the sales price?.just as other closing costs would adjust it. I think this costs me a little in taxes, but I like the method better.
What bothers me about your situation is that you gave 100% rent credit. I think the IRS could potentially take issue with that?.and instead of viewing your deal as a lease/option, might construe it to be a sale at the outset, similar to a contract for deed. If that were the case then the tax treatment is quite different?.particularly if you happen to be a dealer. This is non-expert speculation on my part, and should be checked with your tax advisor. But the last thing I would want to do would be to give someone a 100% rent credit. That?s hindsight though.
If you had enough deal structured in this manner, I think the potential is there for the IRS to categorize you as a dealer?.since they might view this structure as a contract sale.
Either way, I would have wanted to pay tax on this sum as rent?.so that I filled out a Schedule E on the property. If the entire sum is considered option consideration then you have no gross income on the property. If you were to deduct interest costs, taxes, etc on this property, then this loss on the property would serve to adjust your other income. But I would certainly hate to 1) claim no income 2) suddenly sell one year later 3) have option consideration in the full amount adjusting the cost basis and 4) take an interim loss on the property 5) claim a long term gain and 6) later claim I had no sale to begin with. On audit I think all of these contentions when taken together would be a stretch.
Again, my preference is to pay tax on the monthly payment as rent?.and take my other deductions where appropriate, like interest etc. Later, the rent credit against purchase price would serve as a adjustment to the sales price. I don?t do one year lease/options, or give 100% credit.
Best bet?.talk to a CPA. My musings and concerns may be all wet.
JPiper
Re: How are you Taxed on the Rent Credit? - Posted by Dave T
Posted by Dave T on June 03, 2000 at 16:36:24:
In your situation, since the option was exercised, your rent credit is simply a downpayment against the purchase price – not rental income. The profit on your $250K sale price is taxable. Your $14,400 “rent” is just a downpayment received in monthly installments and is already included in your taxable profit.
Only in the event that the option is not exercised, would you treat the rent as income.
Long term capital gains tax treatment on your profit depends upon whether the property you sold was an investment property, a former personal residence, or business inventory (e.g. a “flipper”).
Consult your tax advisor for further guidance as it relates to your specific situation.
Re: How are you Taxed on the Rent Credit? - Posted by Laure
Posted by Laure on June 03, 2000 at 06:38:30:
I understand that Option concideration is not taxable income Until 1) the option is exercised 2) The option is expired.
As these usually carry over from one tax year to the next, I usually treat my Option money as rental income.
When entering the actual sale, the following year, since the option money reduced the cash at closing, your proceeds the second year would be less. As would your gain on the second year’s taxes.
I’m still waiting to see how my new CPA wants me to handle these. I have to call him on Tuesday and make sure I entered the sale into my books properly.
Laure 
Re: How are you Taxed on the Rent Credit? - Posted by JPiper
Posted by JPiper on June 05, 2000 at 12:35:28:
Not true. If 100% of the “rent” is considered “additional option consideration”, then one way to handle is that it is NOT taxed until the option either is exercised or expires.
This then begs the questions as to whether the other expenses are deductible I suppose…my CPA might want to add these expenses during this period to the cost basis of the property if the “additional option consideration” were handled as I described.
JPiper