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Author: Opv1419 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121219  
Subject: Rent-to-Own vs. Outright Sale of Home Date: 7/27/2012 1:00 PM
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My brother proposed a question to me this morning. Some years back he purchased my share of the old family homeplace and became sole owner of the property. He rented the property for several years; however, at some point the renter (his son) expressed an interest in purchasing the house but didn't qualify for traditional financing options. Consequently, my brother made arrangements to basically carry the loan himself in the form of a rent-to-own arrangement.

In short, since at the point the rent payments meet the total agreed-upon sale price the rent payments will have already been taxed, and the related expenses (repairs, property taxes, insurance, etc) will have already been factored in to the taxes due, how does ones income tax return correctly reflect the sale of the home at the point the house is legally conveyed?
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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 116452 of 121219
Subject: Re: Rent-to-Own vs. Outright Sale of Home Date: 7/27/2012 1:23 PM
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My brother proposed a question to me this morning. Some years back .... Consequently, my brother made arrangements to basically carry the loan himself in the form of a rent-to-own arrangement.

Ah, a perpetual tax favorite. The intersection of "some years back, basically, and this morning." It's never pretty. God forbid it would have occurred to someone to ask questions back then.

So which is it, rent to own, contract for deed, or owner-financed sale? Anything in writing that would help? And the biggie, how has your brother been dealing with this on his returns?

Phil
Rule Your Retirement Home Fool

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Author: Opv1419 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 116453 of 121219
Subject: Re: Rent-to-Own vs. Outright Sale of Home Date: 7/27/2012 1:54 PM
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So which is it, rent to own, contract for deed, or owner-financed sale? Anything in writing that would help? And the biggie, how has your brother been dealing with this on his returns?

Phil
Rule Your Retirement Home Fool


Thanks. There is actually no formal document that addresses the sale of the house. All he has is a standard Rent-Lease Agreement, which includes no language concerning the sale. So, in effect my brother has just informally agreed to convey the house to his son at the point the cumulative rent paid equals the agreed-upon sale price. Accordingly, my brother has been reflecting all rent payments each year as rental income.

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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 116454 of 121219
Subject: Re: Rent-to-Own vs. Outright Sale of Home Date: 7/27/2012 3:02 PM
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There is actually no formal document that addresses the sale of the house. All he has is a standard Rent-Lease Agreement, which includes no language concerning the sale. So, in effect my brother has just informally agreed to convey the house to his son at the point the cumulative rent paid equals the agreed-upon sale price. Accordingly, my brother has been reflecting all rent payments each year as rental income.

Not a lawyer here, but at some point they really ought to drop a few bucks on one to make sure things are done properly. There's something rattliing around in my gin-soaked brain about the "Statute of Frauds" and the requirement that everything regarding the transfer of real estate has to be written.

On the tax side, I'd welcome input from the pros, but it sounds to me like the transfer will be a gift equal to the market value of the house, with a basis and holding period equal to your brother's, which will reflect depreciation, which he should have been claiming as a rental expense, assuming the son has been paying market rent. Once the son has owned the property for 2 years he'll qualify for the exclusion of gain should he sell.

Phil
Rule Your Retirement Home Fool

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Author: Opv1419 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 116455 of 121219
Subject: Re: Rent-to-Own vs. Outright Sale of Home Date: 7/27/2012 4:57 PM
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Not a lawyer here, but at some point they really ought to drop a few bucks on one to make sure things are done properly. There's something rattliing around in my gin-soaked brain about the "Statute of Frauds" and the requirement that everything regarding the transfer of real estate has to be written.

I tried to warn my brother at the time that there would be tax implications; however, it didn't sink in. He was only focused on finding a way to help his son purchase the house in the absence of traditional financing. He now realizes the error of his ways.

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Author: irasmilo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 116456 of 121219
Subject: Re: Rent-to-Own vs. Outright Sale of Home Date: 7/28/2012 12:46 AM
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Based on the info provided, I agree with Phil that the transfer would be a gift. As Phil alluded to in his initial response, other fact patterns could lead to different conclusions.

Ira

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Author: foo1bar Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 116457 of 121219
Subject: Re: Rent-to-Own vs. Outright Sale of Home Date: 7/28/2012 1:57 AM
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Based on the info provided, I agree with Phil that the transfer would be a gift. As Phil alluded to in his initial response, other fact patterns could lead to different conclusions.

And I'd add that it's quite possible to change those facts today - at least assuming that it's still a few years until Junior has paid enough money.

Junior and Senior could talk to a CPA about how to do this best to minimize taxes - and they have a couple of options that I can see.

1> Keep on renting house to Junior, and in N years gift it to him.

2> sell the house to Junior now with an installment loan held by Senior. Senior can sell it for less than the current fair-market value, but that portion would be a gift.

2a> sell it for current fair market value (dead of sale, etc), but gift $13K worth of the interest and principle to Junior each year. (or potentially $26k - Mr. Senior and Mrs. Senior each gifting Junior $13K)
Why $13k each year? Go read up on gift tax limit.
If Senior is sure he won't use up his lifetime gift tax exemption of $1M, and is OK with filling out a gift tax form to show how much over $13K he gave, then that's an option too - using up some of the exemption... But I'd probably go with $26K/year and avoid the extra paperwork if Junior was willing to go with it.


3> talk to a lawyer about what would be required to have the sale dated as of some previous date - whether you can simply put into writing the verbal agreement that had been reached and date it as of the date of that agreement. Of course as of the date of sale, the tax treatment changes, so if it was during 2011 then Senior *AND* Junior need to redo their taxes for 2011.


BTW: I'd *guess* that when it is sold and Senior is carrying the note, that if the note is recorded (like all mortgages should be) Junior gets to claim the mortgage interest deduction. Even if Senior gifts him the $ to pay it. (OTOH, I think it's income for Senior, even if he gifts Junior the money to pay it)
And when the note is written, they'll have to make sure that the interest is more than what the minimum interest would have to be - they'd have to use this table to make sure it's more:
http://www.irs.gov/taxpros/lists/0,,id=98042,00.html

(And I don't know how to read that table - but the CPA should be able to use it to give advice on making sure the interest rate is above the minimum required)


BTW: to the OP: Good luck telling Senior that he needs to get this squared away.

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Author: JeanDavid Big gold star, 5000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 116458 of 121219
Subject: Re: Rent-to-Own vs. Outright Sale of Home Date: 7/28/2012 9:18 AM
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Good luck telling Senior that he needs to get this squared away.

Yes, and do it soon.

A friend of mine, not especially old, was diagnosed with lung cancer. She was dead four weeks later. Another friend of mine dropped dead at age 28 from a cerebral hemorrhage. It took only a few seconds.

You never know, so putting it off is not a wise move.

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Author: Opv1419 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 116459 of 121219
Subject: Re: Rent-to-Own vs. Outright Sale of Home Date: 7/28/2012 11:34 AM
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BTW: to the OP: Good luck telling Senior that he needs to get this squared away.

Thanks for the input. In fact, I told my brother just yesterday evening that, in the event of his untimely death, all of his good intentions could prove to further complicate an already sticky situation. I'll continue to encourage him to resolve the situation sooner rather than later.

Thanks to everyone for the help.

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