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.