I have owned a rental home and have been renting to the current tenants for a number of years. They have wanted to purchase the home and we have had a 'rent to own' option agreement. I have always reported the income as rental income for tax purposes. Now that they have finished paying for the house and the title has been transferred I am wondering how I will handle the taxes for this year. This will be the first year that they have not made any payments and I wonder if there is a form that I need to file that shows the change of ownership and how/if I need to explain to the IRS this situation since I will no longer show the house on my taxes.Thanks
I see a problem here. You sold that house a long time ago on an installment contract. So the IRS could go back and make you change how the income was reported for all of those years that you received payments from these current tenants. The IRS will not have any problem arguing this lease arrangement is actually a sale especially when there is no final payment for the title to the house to pass.When you change ownership in sale, which is what you have, the Form is 4797. The problem is what do you use as selling price? Reporting a sales price of zero and taking a loss for the remaining basis could raise a red flag.Removing a rental property from your tax return in of itself is not a big deal. It happens a lot when people convert their rental homes to personal residences, so not reporting the taxes probably won't raise any red flags with the IRS. In terms of the deducting the taxes, you don't have to do anything in terms of telling the IRS.Paul
You sold that house a long time ago on an installment contract. So the IRS could go back and make you change how the income was reported for all of those years that you received payments from these current tenants. The IRS will not have any problem arguing this lease arrangement is actually a sale especially when there is no final payment for the title to the house to pass.It looks more like a lease option than an installment sale (wherein there is a change of title at the time of a down payment). I is only unusual to the extent you allowed the option to run until the house was paid for. So report the sale of your rental property on form 4797, showing the agreed upon sale price. Calculate an adjusted basis from your original purchase price plus any improvements over the years. See my post of 11/25/01 for more details. you will still need a sch E to report income and expense up to the date of sale. And also note, this is not a do it your self tax return, so be careful where you go for help.
I may have forgfotten to verify that the brain was engaged before opening my mouth. I now realize that I do not know how the principal payment portion of lease option payments are reported as they are received. But I still believe that this is a lease option rather than an installment purchase. Hopefully someone will enlighten us.
Please forgive my ignorance-I'm new at taxes. Trying to learn. SO Going through the same thing now myself. I've been going over the publications I've seen recommended here and saw :From pub 527 Page two under Rental Income:Lease with option to buy. If the rental agreement gives the tenant the right to buy your rental property, the payments you receive under the agreement are generally rental income. If your tenent exercises the right to buy the property, the payments you receive for the period after the date of sale are part of the selling price.My situation:My property became a rental this month. He may plan on buying it in spring. Probably will have a selling price of $7,000. So if i'm reading this right, this will allows me to claim the 500.00/mo he's giving me as rent. And when and if he decides to buy that is when I fill out the form 4797. Am I completely missing something? This seems to easy.Esther
It certainly is a sale. The question is if it was an installment sale or you just holded a mortgage during the time that they were paying for it. This could be determined in the form that the sale was structure.It is not a rent-to-own option agreement since at no time they had to buy the house for a set price. The price and payment terms were set at the time that such agreement was sign. therefore, it becomes an installment sale
The debate on this topic is the transaction really a disguised sale. There are alot of factor that the IRS will look at. One of the big factors is if the contract has an option to buy--what is the selling price? This needs to be state up front in the contract.In the orginal post there was no selling price stated in the contract, so that makes it a sale from day one.Here would be an example of lease which turns into a sale. The lease states that you pay 500 month rent with the option to buy the property for $25,000. The $25,000 represents FMV of the building. Since there is no obligation to for the tenant to buy the property it is rental until the tenant pays the $25,000, i.e. exercise there option to buy.If the contract read that you pay 500 a month with an option to buy at $25,000 but if you make rental payments equal to $25,000 then the property is yours. This is a sale.There are all sorts of factors the IRS will look at so trying to simplify it into general rules is very difficult.
The more I look at this sequence, the curiouser it gets. The origional post refers to “a 'rent-to-own' option agreement" (italics are mine). The post is silent as to whether a selling price is included in the agreement and whether all or only part of the rents paid were to be credited to the purchase price. It is also silent as to when the 'option' was exercised. We do not even know whether there was a written agreement. He implies that the deal was completed in 2000 (“this will be the first year that they have not made any payments”). Now he wakes up and realizes that he should have reported a sale in the year 2000. How should he take care of that?. Now what?Suppose he files an ammended 2000 return, taking the position that he had a lease option, with the full price having been paid prior to the exercise of the option (he has reported all payments as rental income over the years, in accordance with the guidance provided in pub 527). He includes form 4797 in his return showing a sale price of zero dollars, having received no payments after the buyer exercised his option. His gain is the depreciation allowed (or allowable) less his basis and any selling expense (title company fees, etc.). Having reported the option payments as ordinary income (rent), he has given up the benefit of capital gains treatment. How could the IRS object to that?Suppose the IRS looks at the above return and says “Hey wait a minute, that was an installment sale from the beginning. We cannot allege fraud, but we are going to disallow the rental expenses you claimed for this year and the past three years.” But they would also have to acknowledge that the “rent” received during that period was actually part return of capital and part capital gain (taxed at a lower rate). And of course the property tax and mortgage interest (if any) remain deductble on sch A as real estate tax and investment interest. So who comes out ahead if the IRS wins this contest?
The IRS is governed by the Internal Revenue Code. It doesn't matter if they will collect more or less tax from the transaction, so they have to follow the law.In an actual audit the an agent may cut a deal (or try and screw the taxpayer) and not follow the code but this case by case scenario. That is why cases have to go to court. If you sold the property, you would have interest income from the installment sale. The property taxes are no longer deductible because the tenant was actually liable for the taxes because he was the property owner. There could have been other expenses such maintance and utilities that were deducted which would be disallowed. If there still was a mortgage that rental, it would have to me investment interest (which maybe limited) because it can't be home mortgage interest.
I think maybe we got into debating each other and ended up not really helping you with your situation. One thing is clear. There is no way to give you specific guidance on the "right" way to deal with this matter based upon the limited information which you provided. But I believe that, in your place, I would get (carefully chosen) professional help and file an ammended 2000 return showing the sale for zero dollars (since you have already reported all the payments as ordinary income and paid the tax). I suspect that in the end there would be little difference in tax owed whether the deal was viewed as a lease option or as an installment sale. Either way they can only go back three years, unless they allege fraud (which they really cannot do if you do file the ammended return. But they might do so if you do not report the sale).It is very important to remember this about income tax matters. All those millions and millions of words of regulations and rulings are subject to interpretation. It is not your repsonsibility to devine what the IRS view will be and file accordingly. Rather it is your right (I view it as an obligation!) to attempt to pay the lowest possible tax within the law. Bottom line the important thing is to report the transaction. How you report it is much less important, and the method I suggest is the simplest (no need to ammend your returns for 1998 and 1999). Good luck!
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