Posted by Ernest Tew on May 06, 2000 at 10:51:31:
Ordinarilly, the IRS doesn’t require us to pay taxes on more profit than we earn. If you are a dealer and sell a mobile home on terms, the profit is fully taxable because the IRS considers it earned.
When your buyer defaults and you get the home back, your tax basis becomes the balance that was due, as if you had purchased the home at that price. When you resell, you are taxed on the gain, if any. If you resell for what was owed when you got the home back, you will have no gain. The gain was paid when you sold it the first time.
If you are a dealer and sell homes for a large profit with a low down payment, you could find yourself paying more in income taxes than you collect from your buyers.
To prevent that problem, we enter into a net lease agreement (one document) and an option to buy (a second document) with our customers. However, the documents must be properly drafted for the plan to work. If the transaction too closely resembles a sale, the IRS will treat it as a sale.
Together, the two documents result in the customer having the same rights and responsibilities as a sale. Moreover, the buyers don’t have to pay a sales tax until they decide to exercise the option, at which time they pay only on the remaining balance owed. As a result, all the buyer’s cash “down payment” (we treat it as option money) applies to the price, thereby lowering the balance owed, payments, and interest cost. And, the seller gets to keep all the cash. Once buyers understand the program, no one objects.
Finally, since we have “leased” the home instead of selling it, there is no gain to pay taxes on. In the meantime, we take depreciation deductions that shelter some of the rental income.