Lease w/option to buy

[Bees Knees]

I would like to re-post what is said on page 2 of IRS Pub 527:

"Lease with option to buy. If the rental agree-
ment 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 prop-
erty, the payments you receive for the period
after the date of sale are considered part of the
selling price."

Do you think the IRS was wrong when they published this statement?

[Jesse]

In my situation

The FMV of the building at the time the lease was drawn up is $109,100. So the buyout price at the end of the year is a "bargain" at $107,000, but I don't think the $2,100 is large enough to create a "disguised sale", again facts & circumstances. In this area $2,000 is very high for the lease of a downtown building, going rate is more like $900, but there is an existing business as well.

In my case there is also an upstairs apartment and the rent is paid to the original owner, not to my client so in effect she does not have 100% control of the building. I think this would also warrant a bonafide lease.

Flip side, if I break down the lease interest/depreciation/goodwill my client would actually get a larger refund because of EIC.

I just do not feel that this is a sale until the option to purchase is exercised.

[Unregistered]

With that info I would agree lease treatment is correct. It would be helpful if any differences between FMV and purchase price on questions of this nature were included in the intial post.

[Unregistered]

Mr. Beaujolais,

Please re-read the posts before spouting off irrelevant facts. Who mentioned anything about the parties intending for it to be a purchase? It is a lease with an option to buy. Since when is an option considered an intended purchase? Isn’t the very definition of an option something that could go either way?

The Pub you are quoting from deals with disguised sales, not options to buy. There is a difference. Disguised sales are contracts made to look like a lease with the intent clearly to be a purchase. A lease with an option to buy is not a disguised sale, unless the purchase price at the end of the lease is below market value or nominal.

Please re-read Pub 527 on Lease with Option to Buy and explain why that Pub says it is a lease until the option is exercised.

What if it is a disguised sale of equipment? Like buying for a dollar at the end?
Do you take section 179 as it is now purchase even though paid in future by installment?

[Bees Knees]

What if it is a disguised sale of equipment? Like buying for a dollar at the end?
Do you take section 179 as it is now purchase even though paid in future by installment?

A disguised sale is treated as a purchase because it is basically the same as a financed purchase. You can take Section 179 on equipment even though you took out a loan to finance the purchase. If the person later decided to stop making the lease payments, it would be treated the same as if you stopped making your loan payments and the finance company took back the property. If you are not required to finishing making the lease payments, that would be considered the same as debt forgiveness. And if Section 179 was taken on the purchase, the amount of debt forgiven would have zero basis making it fully taxable.

[Joe Btfsplk]

Conditional Sales Contract

I tend to agree with Bees Knees. I've been trying to get a feel for this since I recently bought a new home and am trying to do something with the former home.
I'm considering:
An ordinary sale with a mortgage company financing the deal.
Owner-financing under a contract for deed (since I still owe on a mortgage)
Renting the property until prices improve and the glut of homes for sale declines.
Renting with an 'option' to buy.

My thoughts:
If only a small part of the rent-to-buy monthly payment goes toward the purchase price, it seems that it is merely an option which may or may not be exercised.

If none of the rent is designated as part of the purchase price and the contract provides for a lock-in of a certain sales price, that would be even more likely to make it rent-only.

One drawback: If I rent it too long, then I would lose the homeowner exclusion on profit from the sale. The other side of the coin is that it might be better to pay the tax than to keep paying taxes, insurance and interest if the property stays on the market too long and prices don't go up.

I would appreciate any advice--not only on tax treatment but on the best approach financially assuming a soft real estate market which might last a long time.