Mortgage interest?

[Rocky]

A young client searched for a house he could afford to purchase. Finally found a place he could call home with a "lease to buy arrangement". I have yet to look at the closing papers to see just how it is written, but he told me that everything he is paying at this time is interest.

How is this method of creative financing going to play out and what exactly do I have to look for in his closing papers? It really sounds alot like a land contract with a 5 year balloon. The seller will have to claim the income regardless of what it is called, but will the buyer be denied the mortgage interest deduction?

[Unregistered]

Denied

See TC 1995-479.

[Rocky]

Are you sure?

The memo you cite regards tax-deferred home sale and replacement wherein the the judge emphasized the passage of title is the most important factor in determining when a home is bought or sold.

But, in the case of a land contract where the title does not pass until the contract is paid in full, the interest is still deductible, being a seller financed arrangement.

Pub 523. Seller-financed mortgage. If you sell your home and hold a note, mortgage, or other financial agreement, the payments you receive generally consist of both interest and principal. You must report the interest you receive as part of each payment separately as interest income...

"or other financial agreement" with all of the creative financing used now to move homes I'm wondering if this could not fall under this "other financial agreement" category.

[jainen]

it is just rent

>>everything he is paying at this time is interest<<

Since he has not borrowed any money, the payments could not be interest. They are, as labeled, lease payments. If at some point he commits to buying the property, that will be a different story. For now, it is just rent.

[sea-tax]

>>everything he is paying at this time is interest<<

Since he has not borrowed any money, the payments could not be interest. They are, as labeled, lease payments. If at some point he commits to buying the property, that will be a different story. For now, it is just rent.

More likely than not it is rent as Jainen has stated . I however would look closely at the paperwork or contract and read through it. You would be surprised as to what clients can come up with.

[Rocky]

not looking good

Yes, I'm doing preliminary reading so that when he does present me with the paperwork I'll know what I'm looking for. So far it does not look good if in fact it is written as a lease purchase/ lease option (is there any difference between the two?)

I'm wondering now if the seller is aware of the fact that this is not an actual sale for Sec.121 purposes. I wonder how many young people get into these arrangements thinking that since they are now "buying" a house they will receive the tax benefits usually associated with such.

Thanks for helping me think this through, hopefully I'll be receiving his documents soon.

[Rocky]

jainen

You do not borrow money on a land contract either, but you do pay interest, correct?

[jainen]

principal and interest

>>You do not borrow money on a land contract<<

A land contract is a seller-financed SALE. Unlike a lease option, the buyer is obligated to complete the purchase by paying both principal and interest.

[Rocky]

ok...

Is there a difference between a "lease purchase" and a "lease option" or are they just different names for the same instrument?

Thanks,

[Rocky]

I found it...

Comparison of Lease Purchase and Lease Option

With both the Lease Purchase and Lease Option, you have two agreements: a lease and either a Purchase Agreement or a Lease Option Agreement.

The main difference is that with a Lease Option, you have the legal right to purchase the property for a fixed period of time, but are not required to purchase the property. With a Lease Purchase, you have a definite Purchase Agreement stating that you will buy the property for a certain price and terms by a certain date. You are more locked into the transaction with a Lease Purchase.

[jainen]

taxpayer wins on this issue

Fannie Mae and Freddie Mac now offer plans called Lease Purchase. The have a number of new protections for the buyers, but they are still a lease with an option. The bank can't foreclose because the "borrower" doesn't own the property.

The payment is set at the same amount as a market rate mortgage, even for someone with bad credit who wouldn't qualify for a mortgage. Part of the payment is rent, and part is credited towards a potential down payment. The purchase price is established at the time of signing--maybe not such a good deal when property values are falling, but the buyer doesn't have to exercise the option.

At present I don't know of any specific authority to deduct mortgage interest in such a case, but it doesn't sound too far fetched and I wouldn't be surprised if some day a taxpayer wins on this issue.