I would have treated the rent credit as additional option consideration and therefore a deposit against the purchase price. Option consideration is not taxable until the option either expires or is exercised. If the option is exercised, the option money is included in the sales price of the property sold.
The reason here is that I pay tax on rent income at my marginal tax rate. If I treat the rent credit as a deposit, then it becomes part of the profit on the sale and subject to capital gains taxation when the option is exercised – a much lower tax rate for me. Of course, if the option expires, then the option consideration is ordinary income to the seller.
Since you already reported the rent credit as taxable income, then just increase your basis accordingly to show a $4800 smaller profit on the deal.
I am not a tax professional. Suggest that you review this strategy with your tax advisor.
You are lease/optioning a house to a Tenant/Buyer with the following terms:
$100,000 sale price;
$5,000 option consideration which is applied toward purchase price if the Tenant/Buyer buys the house;
$1000 monthly rent with $200 monthly rent credit;
Lease/Option period - 24 months;
Assuming that the Tenant/Buyer get the financing and buys the house at the end of the 24 month period; the Tenant/Buyer pays you $90,200 ($100,000 - $5,000 - $4,800 rent credit). What is the sale price as far as the I.R.S. concerned? Is it $100,000 of which $4,800 you didn’t received or $95,200 which you did received?
Thank you for your time and consideration about this question.
Actually I would differ with Dave in his answer below.
My belief is that option consideration is an adjustment to the sellers cost basis upon exercise. So assuming that the sale price is $100K, and option consideration is $5K?.the sale price is $95K?but YOUR cost basis is adjusted $5K lower.
The question is about the treatment of the $4800 in rent credit. IF you treated that as option consideration?.then the sale price to the buyer would be $90,200?.and YOUR cost basis would now by adjusted $9,800 lower.
On the other hand, if you treat the rent credit as rent?and therefore paid tax as you received it?.the purchase price to the buyer would be $90,200?.and YOUR cost basis would only be adjusted $5K lower.
Whether you do it as Dave mentioned below, or as I have outlined, the profit is still the same.
Note that I?m not a CPA, so check my comments with one.
The sale price in your contract is $100K. While, you apply option consideration and rent credits to the purchase price, the seller still paid $100K when the option is exercised at the end of the option period.
Note that you DID receive the $4800 rent credit in monthly installments of $200 a month.
Thanks for your reply Dave, however, since the income tax on the credit rent was paid for each of the two years as rental income. Then why should a seller pay income tax on it again when the Tenant/Buyer exercise the option at the end of the option period?