Rent to Own

[Vanessa]

My tax client finished a rent to own agreement in 2016. At that time the title to the house was signed over to the couple that had been renting it from them. The house that they were renting had been set-up for depreciation. I guess my question is what happens to the undepreciated basis in the house? My clients reported the income each year as rental income.

[kathyc2]

It sounds like you have an installment sale rather than rent income.

[Vanessa]

This is how it was set up in 2008. I just started preparing the return this year.

[kathyc2]

This is how it was set up in 2008. I just started preparing the return this year.

I would say the first step would be to get a copy of the original agreement. It seems like if they reported the full amount as ordinary income they would not have underpaid tax but may have overpaid if some should have been at LTCG rates. If the total that they received was less than their tax basis, they may have a loss this year. To correctly calculate it you would need to determine what of the payment should have been for interest- the higher of what is stated in contract or imputed. If you determine there is a reportable loss, make sure the "renters" are not a related party.

[Roland Slugg]

It may have been an installment sale from the very beginning, or it may have been a deferred payment arrangement.

You didn't say if the renters/buyers still owe an additional sum now that the lease has been changed to a sale, or if the rent paid to date represents the entire amount the sellers will receive.

If there is still a balance to be paid, treat the property as sold in 2016, and report the gain on the installment basis. The depreciated basis in the house will be the unrecovered cost.

If there is no additional amount to be paid, or if there was but it was all received in 2016, then report the sale on F-4797. This may produce a loss ... perhaps a rather large loss ... and that's fine. It refects the economic reality of the overall transaction, even if some might quarrel with the tax reporting. If the renters/buyers were under no obligation to continue to rent or eventually purchase the property, than I think the way is was handled was reasonable. I don't think the IRS will take issue with it either, if they ever question it.