Deposit on property sale

[Gretel]

Client receives deposit, not in escrow, (35%) on sale of property in 2005. Closing is a year later in 2006. Final payment is in 2006.

I think it's all income in 2006 and the first payment in 2005 is considered a deposit. If first payment is considered income, how would I report it, since there is no sale to report yet?
It actually would be better to report income in 2005 and 2006. Any thoughts?

[jimmcg]

Deposit v Income

What are the written contractual terms re the deposit? Is deposit refundable in whole or part if closing does not take place.

[JG EA]

If an option to buy...

In pub 523 it says to add the amount of the Option to buy to the selling price if the option is exercised. If it is not exercised, put on line 21 in the year the Option expires.

[Gretel]

Option

Thank you, both. I guess, Option is the right term here. It helps to find answers if you have the right question.

As of right now I don't know if deposit is refundable or not. I'll find out. My logic tells me if it is not refundable it's income in year received. If it is refundable it's income in year of sale.

On the other hand, if option to buy is reported only in year of sale or expiration of option, then it will need to be reported in that year accordingly, right? So, no way of reporting it in year deposit was actually made.

[JG EA]

Right

I think that is right.

JG

[geekgirldany]

I hope you don't mind me posting in your thread Gabrielle as I am encountering something similar. I had made post about it.

Client sold a house on a lease/purchase agreement. Got 15,000 down and then is going to receive $1000 a month. $800 is rent, $200 goes towards principal. I know this is a little different from yours... but I'm wondering if this $15,000 might be an Option also and should not be reported until the sale is completed in 2007? The $200 going towards principal for the sale makes me lean to a installment sale though.
Let me add that none of the principal payments or $15,000 is refundable if he doesn't buy. This does reduce the original purchase price down to around $136,000.

What do you guys think?

As you say Gabrielle the right question can help answer the question. Again hope you don't mind me posting in your thread.

[Bees Knees]

If the person cannot get any of his principal back for failing to carry through with the purchase, then the entire payment is treated as a lease until the option to buy is exercised.

The only way it could be argued as both a lease and a sale is if the $200 per month principal is refundable should the sale not go through.

[Gretel]

As you say Gabrielle the right question can help answer the question. Again hope you don't mind me posting in your thread.

Well, I was a bit disappointed that Bees response was to your question and not to mine. Everyone hopes for an response of one of the big masters.

Geekgirldany, I am glad for both of us to look at the issue from more than one angle. It always is more benefitial than and helps to get a better grasp of the underlying issue. Have a good weekend.

[abby]

Thank you, both. I guess, Option is the right term here. It helps to find answers if you have the right question.

As of right now I don't know if deposit is refundable or not. I'll find out. My logic tells me if it is not refundable it's income in year received. If it is refundable it's income in year of sale.

On the other hand, if option to buy is reported only in year of sale or expiration of option, then it will need to be reported in that year accordingly, right? So, no way of reporting it in year deposit was actually made.

I think you have two situations - one is when the potential buyer is occupying the property and has an option to buy it - in that case, the payments made - even if later applied to the purchase - is rent and then will reduce the purchase price if the option is exercised.

If the money is just a deposit that gives them a first refusal type right to purchase, then I'd say it's like most other Prepaids - it sits on the virtual balance sheet until it is either accounted for in the purchase or released as a forfeited deposit. In both circumstances, here, I believe it would be accounted for in the year when it is determined how the dollars are to be applied - either as Misc Income or as Earnest Money in the Closing

In other words, I wouldn't amend the prior year to declare the income. It would be the same if you had a Security Deposit from a Tenant - even if you took it to pay back a prior year overdue rent, you would declare it in the year you determined that the deposit was forfeit.

My disclaimer: I may be missing a regulation particular to this circumstance, and welcome insight from others!

[geekgirldany]

If the person cannot get any of his principal back for failing to carry through with the purchase, then the entire payment is treated as a lease until the option to buy is exercised.

The only way it could be argued as both a lease and a sale is if the $200 per month principal is refundable should the sale not go through.

Thank you so much for answering It says on the contract that "Tenant/Buyer agrees to pay an upfront amount toward the purchase price at the beginning of the lease agreement of $15,000. Tenant/Buyer agrees that the total amount plus any other payments are made non-refundable going to the seller".

So what we are looking at is a deposit of $15,000 + 4800(24 months principal) = $19800. The selling price will be $140,200. This is the original selling price $160,000 subtracting the deposit $19800. Her cost is $149,500. So her profit is $9300. Which is what I am coming up with now. I'm rounding numbers off though. But I will probably go ahead and depreciate the house while renting. This will make the cost different.

Which makes me think... okay this is a lease/puchase... the purchase really won't be until 2007. This will make it better for the client because then this will be classified as a long term gain not a short term gain... so saving her taxes.

It just seems like if he backs out that doing a 6251 installment sale now, I'm not sure how you would even go back to adjusting it.

Thank you all for talking this over with me. Thank you Bees Knees. Sorry Gabrielle that the tax master answered me instead of your question

[Bees Knees]

Well, I was a bit disappointed that Bees response was to your question and not to mine. Everyone hopes for an response of one of the big masters.

Sorry for not responding, but I thought JG EA gave you an excellent answer.

It just seems like if he backs out that doing a 6251 installment sale now, I'm not sure how you would even go back to adjusting it.

I think a principal that might help here is that to the IRS, it is one or the other. I don't know of any situation where they would consider it both a sale and a lease. It is either or. Either the property was sold, or it was not sold. It is not a sale until it is a sale. What is it that makes it a sale? When all transactions have been completed that makes it certain it is a sale.