L/O- tax treatment? - Posted by Ben (NJ)

Posted by JPiper on March 06, 2001 at 23:11:22:

That’s right. I get a security deposit and option consideration. When I’m discussing my deal with a potential tenant/buyer I don’t confuse the issue with this…I talk about the “upfront money”. But when the paperwork is done, I have both. Again, if you want to look at it this way, the security deposit could be viewed as the tenant’s price to leave if they leave the property in good shape…rather than having them angry over possibly losing all their money. On the other hand, if they default, it’s going to be non-refundable anyway. If they exercise, the security deposit can be rolled into the purchase.


L/O- tax treatment? - Posted by Ben (NJ)

Posted by Ben (NJ) on March 05, 2001 at 07:26:48:

I acquired a house which I would like to sell immediately
but due to short term capital gains treatment, I plan to rent it for a year and then sell it. I have someone willing to do a lease with an option to buy at the end of the year. Someone mentioned that this may be subject to IRS challenge
as a constructive sale, done solely to circumvent short term capital gains regs. Is this true? Does anyone know about this?

Re: L/O- tax treatment? - Posted by Bud Branstetter

Posted by Bud Branstetter on March 05, 2001 at 11:31:40:

George Yeiter spoke at the Dallas AIREO meeting last year. He had a list of things to do to structure it as a lease and not a sale. Some of those things Jim mentioned.

I would be surprised if someone were doing a couple houses a year that got cashed out it would trigger the question. Have it be your primary business and they are likely to look at you.

Not to suggest anything like a PACtrust but it does have the advantages of being an investment. If you buy cash then refi before putting it into the trust. The buyers get all the home owner advantages. The tax write off for the occupant has pased audits. You still depreciate but have the advantages of a sale-money and no maintenance.

Re: L/O- tax treatment? - Posted by JPiper

Posted by JPiper on March 05, 2001 at 11:02:41:


This is a subject that I?ve given considerable thought to. I would say that STRUCTURE of the lease/option is all important as to how the IRS will view the transaction.

Now here?s an interesting question to get this ball rolling. How would the IRS know you?re doing a lease/option to begin with? The rental will be reported on Schedule E, just like any other rental. Let?s assume that you?ve done your lease and option on separate forms. Let?s assume you?re audited. And let?s assume that your tax advisor gives you this advice: ?Do not answer a question that isn?t asked?. Now how does the IRS auditor come up with the idea that you?ve done a lease/option to begin with? Interesting question eh? Does he ask to see your lease? If so, you provide your lease, a lease which makes no mention of an ?option?. Just a rhetorical question really, but something to think about.

There have been various cases regarding when the IRS views a transaction as a ?sale?, versus when they view it as a ?non-sale?. I recently posted one such case in the last month or two?.you might try the archives if they?re working. But I think the idea is to structure your transaction in a way that it is not a sale.

  1. I think it?s good advice to keep the lease and the option on separate forms. The idea to me here is that they are separate transactions. There is a lease. And there is an option to acquire the property. This may be important in an eviction?.and it may be important at some point for taxes.
  2. I like to write a one year lease. Why? That?s the standard lease in the United States. I use my regular lease. It has a renewal clause in there. Believe it or not, it also allows me to terminate the lease with a 30 day notice. Yikes! Does that sound like a sale to you?
  3. I have a clause concerning the security deposit I collect. And another clause concerning the forfeiture of said deposit (in accordance with state law). I think this is important because most leases in the US have security deposits. And think about it?.the security deposit money can later be rolled into the purchase?or it can be refunded IF the tenant returned the property in good condition and did NOT breach the other conditions of his lease. In many cases this security deposit money will end up being ?non-refundable? in a sense.
  4. The lease restricts who can live in the property. Sound like a sale? No pets permitted with written permission from the landlord. No improvements made without written permission from landlord. Where did the bundle of ownership rights go?
  5. Various rules and regulations are attached to my lease?.just like any other lease.

Note that the idea in the above, and probably others that don?t come to mind right now, is to restrict the benefits of ownership that an OWNER would typically have.

Now the option. I like to keep this short too?.and I will renew it. I just don?t refer to the renewal in the option agreement. Keep the ?rent credit? small. Do not apply the option consideration to the ?downpayment?. Apply it to the purchase price when and if they exercise the option. Do not execute a purchase/sale agreement simultaneous with your deal. A good example of an option form is Bill Bronchick?s form. I like it and use it myself with a few modifications. (I do not use his lease?.I use my regular lease suited for my state.)

Do NOT have the tenant pay the taxes. You pay them (and price your lease payment accordingly). You pay the landlord insurance on the property (have a clause requiring the tenant get renter?s insurance?.do owners get renters insurance?). Association dues? You pay them.

I think you get the idea. You do a separate lease, and a separate option. You make sure your lease looks like a rental. You won?t have a problem in my view because SALES don?t look this way?.they confer the benefits and burdens of ownership.


Re: L/O- tax treatment? - Posted by Redline

Posted by Redline on March 06, 2001 at 20:54:51:


OK, just to clarify …

When you’re doing a L/O you charge a security deposit in accordance with the lease AND you also collect non-refundable option consideration in accordance with the option? I’d never heard this mentioned before by anyone else and sounds good in terms of keeping this looking like a straight lease (option is separate).


Taking notes… - Posted by LeonNC

Posted by LeonNC on March 06, 2001 at 01:22:04:

at 2:21am in the morning. Good stuff! Thanks Jim


Thanks, I am printing this out… - Posted by Ben (NJ)

Posted by Ben (NJ) on March 05, 2001 at 11:33:21:

it’s definitely a “keeper”.