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    #1

    Didn't Report Rental Income

    A new client---- Client Leased his home & property with an Option to Buy in a future year. Past tax returns show no Sche E-Rental, but client claimed the Mort. INT and Prop. Taxes he paid each year.

    PER LEASE AGREEMENT:
    Monthly Payment $1050.
    Amount to be applied if Purchased $721.74

    At Closing when my client sold the Rental to the Renter for $110,000. the Renter received a Buyer Credit in the amount of $33,921.78, that's 47 months x $721.74.
    The remaining balance was Seller Financing in the amount of $76.078.22 to be reported on Form 6242 Installment Sale.

    My question is What to with the Rental payments for those years that my new client never reported on this prior year tax returns and no depreciation ever was claimed?

    The Lease was effective as of March 2007.

    Please help!
    Tags: None
    #2
    Amendments

    You need to amend his returns all the way back to 2007, even though 2007 is technically a closed year and he won't get any refund he may have been due. But he may as well get the value for the open years since he has to recapture all the depreciation "allowed or allowable". Don't forget to amend the state if there is one also. I know that is probably not the answer you wanted to hear, but, as far as I know there is no way to "fix" this on the current year return alone.

    Comment

      #3
      Amend

      I don't know of anything that would be correct other than to amend the prior year returns. Even returns for closed years may be amended just there won't be any refunds forthcoming but that seems not to be a worry here. It is of course acceptable to claim any deductions and credits that got overlooked on the original return.

      I would recommend that you turn down the engagement unless your client is willing to pay you what you want to get paid for the amended returns. If you're more busy now than you will be after 4/17 there is no reason not to put off the amends but I'd take and cash the check for the entire job up front. If you're not as busy as you would like to be you can sweeten the deal by discounting your fee for the amends but on the other hand if you're not wanting that many new clients there's no reason to do that. The reason you want to insist that the amended returns get done is that tax scofflaw clients are money losers in the long run. If they will take their punishment so to speak then there's a chance they will reform their behavior and be good clients. If that doesn't happen you can always fire them. Remember that attorneys routinely work with clients who are willful serial law breakers and just want the penalties minimized and no one punishes the attorneys for doing so. We tax professionals however are increasingly at risk of penalties for ourselves when our clients are seriously noncompliant.

      Comment

        #4
        This might be an installment sale when the rent/installments began in 2007. It's hard to find information about this. I recently did an internet search since I had to evaluate a lease to buy agreement and was sure I printed/saved it, but can't find.

        My situation was a little different and it clearly was a lease agreement since client only got FMR as monthly payment.

        Comment

          #5
          Originally posted by Gretel View Post
          This might be an installment sale when the rent/installments began in 2007. It's hard to find information about this. I recently did an internet search since I had to evaluate a lease to buy agreement and was sure I printed/saved it, but can't find.

          My situation was a little different and it clearly was a lease agreement since client only got FMR as monthly payment.
          Pub 527:
          Other Sources of Rental Income
          Lease with option to buy. If the rental agreement gives your tenant the right to buy your rental property, the payments you receive under the agreement are generally rental income. If your tenant exercises the right to buy the property, the payments you receive for the period after the date of sale are considered part of the selling price.
          Actually I think this is pretty clear. There has to actually be a sale to have an installment sale. There actually has to be sale to count any of the money as a sale. So you report all the income as rental income until there is an actual sale. Then if you've filed a return based on this and the sales agreement designates some of the monies as a lease option then you record the sale and amend the year(s) for which it was counted.
          JG

          Comment

            #6
            Originally posted by JG EA View Post
            Pub 527:

            Actually I think this is pretty clear. There has to actually be a sale to have an installment sale. There actually has to be sale to count any of the money as a sale. So you report all the income as rental income until there is an actual sale. Then if you've filed a return based on this and the sales agreement designates some of the monies as a lease option then you record the sale and amend the year(s) for which it was counted.
            It is not that clear to me. The payments applied to the sales price being higher than the lease payments might be an indication that this is actually an installment sale. I found the website again that I ran into when researching my situation. I did not read again and I do not have an answer.

            CCIM Connections | The CCIM Institute
            http://www.ccim.com/cire-magazine/articles/lease-option-or-installment-sale
            Commercial Connections reports on the latest trends, current developments, member news, and successful business strategies in the industry.

            Comment

              #7
              Originally posted by Gretel View Post
              It is not that clear to me. The payments applied to the sales price being higher than the lease payments might be an indication that this is actually an installment sale. I found the website again that I ran into when researching my situation. I did not read again and I do not have an answer.

              http://www.ccim.com/cire-magazine/ar...stallment-sale
              Yeah, you are right - not clear at all. I had a very simple lease option that seemed to fit the simple action and I did just the way the rental pub said.

              TTB has the rules for lease of business assets. If lease payments are made under a conditional sales contract.... etc. That is still a contract. In my client's case it was just a verbal agreement. However, I can see in the article that you referenced, it is substance over form. And they made a point that the IRS could recharacterize something that was done.

              Actually that makes sense since we must look at equipment lease agreements and decide if it is actually a "sale" in order to decide whether to depreciate.

              Could we use the same criteria that is in this tax book article to examine a rental lease option to see if it is a sale or not?


              http://thetaxlibrary.com/thetaxbook-...?search=option to

              Wish I had read this before I posted how simple it all was.
              JG

              Comment

                #8
                Rental Income Not Reported

                I believe the Renter was paying FRV because the property included 2 Mobile Units with 3 Lots and the Improvements (a shop and barn).

                The Lease Option Agreement was to be renewed from year-to-year until the Renter decided to buy the property at the originally stated selling price, which was probably FMV.

                So, do you think that I should suggest to my new client that he Amend back to 2007 and then report the Installment Sale for 2011?

                Please advise me! Thanks to all the responders so far.

                Comment

                  #9
                  My inclination is to treat the prior years' payments as rent. There was never any guarantee (or requirement) that the client was actually going to exercise the option to buy. IMO, the seller just lowered the purchase price to accommodate the buyer when he actually made that decision. If he had not exercised that option, it would have expired, and the seller would have been looking for a new buyer.

                  Comment

                    #10
                    Yeah, I think so. too

                    Originally posted by Burke View Post
                    My inclination is to treat the prior years' payments as rent. There was never any guarantee (or requirement) that the client was actually going to exercise the option to buy. IMO, the seller just lowered the purchase price to accommodate the buyer when he actually made that decision. If he had not exercised that option, it would have expired, and the seller would have been looking for a new buyer.
                    This is all I can come up with as well. I have a client with one of these, and I have treated the payments as rent income. I fully expect the deal to fall through, so that helped me decide. I will admit that, cause we are all buds here.
                    If you loan someone $20 and never see them again, it was probably worth it.

                    Comment

                      #11
                      Rental Income Not Reported

                      Thank you all and Burke,

                      The situation is just as Burke stated. Also, the Renter was not able to obtain his own financing, therefore, the Lease Option To Buy.

                      Thank you all so much for your thoughts and Info.Really appreciate it!!!
                      Any other thoughts?

                      Comment

                        #12
                        Well...

                        Originally posted by taxjungle View Post
                        Any other thoughts?
                        Yes, you are the boss here. Tell the client his returns for 2007 - 2010 have to be amended. Intuitively, they already know you can't just omit income. Well, OK, I'm not sure about that last sentence.
                        If you loan someone $20 and never see them again, it was probably worth it.

                        Comment

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