Taxes On Lease Option?
Good Day to all:
I have a property that I bought for 70K, rehabbed for 20K and FMV is 150K. Question, I want to sell it on a Lease Option. Am I responsible for Cap Gains Taxes the year the contract is signed or is it deferred until we transfer deed, say 2 yrs down the road? Looking for a way to defer income, maybe a 1031?
Thanking all in advance for your comments. Have a great day, and make $$$.
Tom
I suspect from the information you provided that your sale will be treated as a dealer disposition. Even if you sell on a lease option, the sale will be a dealer disposition when the buyer exercises the option.
No capital gains tax treatment here. All your profit will be treated as ordinary income and taxed accordingly. Report income and expenses on Schedule C and calculate your self-employment taxes on Schedule SE.
1031 tax treatement does not apply in this case because the property is dealer realty.
Change your strategy a little to actually use the property for the production of income without the intent to resell, and then you will have more opportunity to capitalize on favorable tax treatments.
I'll always defer to Dave on tax advice, however, based on the current info provided, I'd disagree in this case.
If you own the property, and you L/O it, then what you've got is a rental unit that the tenant has an option to buy the place at a later date. If it takes the tenant longer than a year to exercise their option, then I can't see how that it would be classified as a dealer transaction.
Roger
Roger is right -
Depending on which state you are in -
if you sell ( flip) more than say - 4 ( or 6 ) houses in one year - than you are a
Dealer - and ordinary income tax apply -
Here you are not selling - first - you are leasing or renting for minimum 12 months or upto 3 years - rental property -
if they buy it at $150,000 - yes you have to pay capital gain taxes - which will be approx. $18,000 - but depends on your overall situation -
if you have no job - and have other business - or buy and rent four or sox more houses - the depreciation or negative cash flow after depreciation - will offset some of the
capital gain taxes - also you have to
add the Recapture of depreciation on this house -
Best thing is to Contact local H & R Block person - after April 15th - and discuss this matter - to understand and plan for next few years - how to structure the deal and avoid paying taxes -
You do not need to do 1031 exchange - as I understand it is expensive - you have to pay commission on both side -
one way to avoid is - if you like the area and house - move into the house and stay there for two years and one day - than sell it - and no
capital gain tax at all -
Also you can do an installment sale - i.e. have them get the mortgage for only $90,000 - and take a NOTE for
$60,000 at say 10 % interets for 10 years -
If you going to get involve as a Real EstateInvestor - full tim e job - and retire in Five years - you need to find a good CPA and discuss - all these -
Good luck -
Roger,
I would agree with you if the property had been in your rental inventory for some time and you decide to sell it to realize your appreciation.
In the original post, I got no feel that this property was acquired with the intent to hold for long term production of income. Instead, it was acquired (it appears) expressly to rehab then sell. In this instance, I classify this property as property held primarily for resale to customers. Lacking any concrete information to the contrary, this is a flip property. It makes no difference that a lease option technique is being used to facilitate the sale. It just does not pass my smell test for investment use property because it does not appear that the owner has any intent to hold the property long term for the production of income. His intent is to sell it as quickly as possible.
-----------------------------------------------------
Quote:Depending on which state you are in - if you sell ( flip) more than say - 4 ( or 6 ) houses in one year - than you are a Dealer - and ordinary income tax apply -champakshah,
The Internal Revenue Code is federal tax law and applies equally in all states. There is no state specific application to be taken here, unless you are referring exclusively to state income taxes. State law does not supercede federal law.
If there is still a question about some number of transactions it takes to be considered engaged in dealer activity, I refer you to Section 453(l)(1)(B) of the Internal Revenue Code which defines a dealer disposition as Any disposition of real property which is held by the taxpayer for sale to customers in the ordinary course of the taxpayer's trade or business. I maintain that the word ANY in the above definition means that dealer disposition tax treatment applies to even the first transaction.
Thanks to all! The information was more than I expected, but ALL very informative. Thanks! Dave and Roger, If I read your reply correctly, "when the tenant excersises their option" 2 yrs down the road, then I must pay the capital gains. Is this correct? I then assume that if I sell it on Land Contract, the capital gains would be payable the year that the sale took place, right? The same would hold true if I carried back a 2nd. All of my investing so far has been buy low, rehab and hold. I did buy this to rehab and sell. Thanks to everyone,
Good luck to all and make $$$
Tom
Quote:Dave and Roger, If I read your reply correctly, "when the tenant excersises their option" 2 yrs down the road, then I must pay the capital gains. Is this correct?Not quite.
I said NO capital gains tax treatment applies. Your profit is ordinary income, taxed at your ordinary income tax rate. All of the profit on the sale is taxable in the year of the sale (when the tenant exercises). Additionally, this property is not eligible to participate in a 1031 exchange.
Property flipping is an active income business. Report your income and expenses on Schedule C and calculate your self-employment taxes on Schedule SE.
I take a conservative stance on this issue. There are lease option guru's that claim you can take investment property tax treatment if your lease option is properly structured. They will claim that you are only using the lease option to get a better tenant, rather than facilitating a sale. You may be able to get away with this tactic -- for awhile. I don't care to play tax audit roulette.
Consult your own professional tax advisor for specific details.[ Edited by DaveT on Date 04/01/2004 ]
Thanks Dave for the clarification. I did know that it would be ordinary income based on the info I provoided. I too want to stay on the good side of the "auditor", so thanks for your conservative response.
Tom