Real property

[natiro]

My client owned commercial property which was used as capital contribution to an LLC with another partner. The LLC used the property for their business. In 2006, the LLC disolved and the property was distributed back to my client. As part of the dissolution agreement, my client granted a 2 year lease with -0- rent to his former partner.

My client then sold the property later in 2006 to another party. As part of the sale, client had to pay to the buyer the fair value of the remaining lease, about $24,000. During 2006, client incurred about $2,000 of expenses relating to the property (repairs, utilities, fees, etc.)

So, where should these transactions be reported? There was -0- rent income so I'm not sure it's appropriate to report the $2,000 on Sch E. Or is it? Or should it be reported as misc itemized (investment expense)?

Also, I was going to include the $24,000 of rent paid at closing to the buyer in selling expenses. Does this sound right?

I'm tired, obviously can't think straight, and am counting the minutes until Tuesday, as I'm sure you all are.

Thanks for your help!

[Gene V]

I don't think I can help you. But I thought I would bring you up to the top of the list.--I'm sure one of the smarter ones on this board would be glad to jump in.

[Snaggletooth]

Real Help

I don't have any answers for you Natiro, in fact, I feel like I know you very well and if it's something YOU don't know, then I won't have a clue either.

So no real help from me either. I just wanted to temporarily delude readers that I was really smart by posting a response.

[George Boutwell]

The Shell Game

>As part of the dissolution agreement, my client granted a 2 year lease with -0- rent to his former partner.<

OK, so we know what is under that shell. What is under the other shell? What did your client get in return for foregoing two years' rent? Where did you put that on his tax return? Maybe he really did receive some rent, right? Which solves the problem of where to claim the rental expenses.

>As part of the sale, client had to pay to the buyer the fair value of the remaining lease, about $24,000.<

Your client didn't have to do anything. What he chose to do was reduce the selling price by $24,000 from what the property would have been worth, had it not been encumbered by the lease. He's trying to say he paid rent because it looks like a deduction from ordinary income, rather than from capital gain. That dog doesn't hunt.

[natiro]

Response to George

No, my client did not get any rent and is not hiding anything. The disolution agreement is in writing and that's part of it. The agreement was negotiated by both parties and their attorneys. It was a contentious disolution and my client got the building back. The value put on the building when he got it back was the same value as when he contributed it. In fact, the value had increased by about 40,000. So I guess he did get "something", but it wasn't rent. The building comes back to him at its basis. So I'm thinking that there would be no imputed rent here.

The rent "paid" to the buyer is on the closing statement. My client is not trying to get away with anything and is trusting me to report the transaction correctly. My client did not reduce the purchase price by the rent. He paid the buyer the rent (through closing) that the buyer would have received from renting the commercial space for the remaining lease term had there actually been rent to receive.

I will either report the rent expense as a selling expense or a misc itemized deduction as investment expense. I will probably report the expenses incurred during the year as investment expenses because it's the most conservative reporting (although I usually don't tend to be very conservative.)

In the end, either way I report it makes no difference in current year taxable income because there will be -0- tax. However the decision does affect the NOL carry forward so I'd like to get it right.

Your rush to judgement about my client trying to get away with something, and what he is or isn't telling me, surprises me. I asked for some input on a situation that I spent quite some time researching to no avail. I have to say that I sometimes find the tone of answers on this board to be arrogant and insulting. I appreciate all the help I usually get when I post a question and I learn from the other posts. Sometimes though I get tired of the tone.

Thanks anyway.

[George Boutwell]

==The dissolution agreement is in writing and that's part of it. The agreement was negotiated by both parties and their attorneys.==

Unfortunately, the IRS was not a party to the negotiations. Most agreements are in writing, and most parties to contracts and their lawyers want to use language that will minimize taxes on both sides, even if the substance does not match the form. So what's your point?

==My client did not reduce the purchase price by the rent. He paid the buyer the rent (through closing) that the buyer would have received ==

This reminds me of the "gift of equity" questions elsewhere. I read it on the Internet, so it must be true; I read it on the closing statement, so that's what we get to call it on the tax return. The fact is that your client sold for a lower price because the value was impaired by the lease, and he is now trying to pay more long-term capital gains tax at a lower rate so that he can deduct some phony ordinary-income expenses.

[natiro]

George

"This reminds me of the "gift of equity" questions elsewhere. I read it on the Internet, so it must be true; I read it on the closing statement, so that's what we get to call it on the tax return. The fact is that your client sold for a lower price because the value was impaired by the lease, and he is now trying to pay more long-term capital gains tax at a lower rate so that he can deduct some phony ordinary-income expenses."


As I said in my last post, my client is not trying to get away with anything. We are not reporting any phony ordinary-income expenses. There is -0- taxable income in 2006 no matter how I report it so we're not trying to get a better tax rate on the transaction. How I report it will have an affect on furture years because it will impact the NOL carry forward. That is why I posted.

In my research I focused on whether or not the rent paid at closing would be legitimately considered a selling expense. I'm not clear that it is. The gross proceeds are reported on a 1099-S so I'm obviously not going to reduce those.

The fact is that in essense my client collected rent in advance and is turning it over to the buyer just as it happens on many rentals that are bought and sold. It's just that in this case there was no actual rent collected. Haven't any of your clients with rentals sold their property mid-month so that the closing statement shows a transfer of rent collected from the seller to the buyer? Do you consider this a reduction in the selling price due to a value impairment caused by the lease? Why would my situation be any different? The value was not impaired by the lease. The property will be commercial rental property to the buyer. The property is already rented out. The seller is transfering the rent to the buyer. I would think that rather than impair the value, the fact that the building already has a 2 year tenant (with 18 months remaining at the time of the sale), would be of value.

As to your statement:

"I read it on the Internet, so it must be true; I read it on the closing statement, so that's what we get to call it on the tax return."

I rarely make a move without researching an issue if I have any doubt. In fact, when I can, I try to support my decisions with code and regs, which I often site in my responses to questions here, as rare as they are. I never believe anything I read on the internet.