A lease with an option to purchase, also known as a “rental option”, is a common real estate contract. The important issue of income tax in lease option transactions is whether the tenant rented the property or, as an economic reality, an installment sale took place before the tenant exercised the call option. Owner as seller. For the landlord, the tax consequences of marking the lease option transaction as a sale are as follows: however, there is no certainty that the tenant will exercise the option. If the tenant can prove to the IRS that the reason for the lease option is that a sale was not possible due to economic conditions, the lease option is likely to be maintained. As Michael P. Sampson says in Tax Guide for Residential Real Estate: “. If you can prove that the reason for the lease option is the impossibility of a cash sale due to economic conditions, the form of the transaction as a lease option will likely last. This would be the case, for example, if your goal is to tie up the property during a tight money market, in the hope that you can get institutional financing in the option period.
“When a lease option is treated as a sale, there are two important tax implications: Because the tax treatment of a purchase transaction is so different from a lease transaction, it is important to understand the factors that can cause the Internal Revenue Service (IRS) to characterize a lease option transaction as a sale. Principles of Real Estate Practice in Arkansas contains the Fundamental Principles of National and Arkansas Real Estate Law, the principles and practices required for basic competence as a real estate professional and under the Arkansas Licensing Act. It is based on our highly successful and popular national publication Principles of Real Estate Practice, which is used in real estate schools nationwide. In Joppich`s case, Ms. Joppich purchased $65,000.00 worth of vacant land in a residential subdivision from the developer. The serious money contract required the buyer to give the developer the opportunity to buy back the property if the buyer did not start building a home within 18 months of completion. Upon conclusion, the buyer and developer signed an option contract, which states in part: “Given the sum of ten and No. / $100 ($10.00) (“Option Fee”) paid by the Promoter in cash, the receipt and sufficiency of which are hereby acknowledged and acknowledged, buyer hereby grants the Promoter the exclusive right and option to purchase [the Property]. ». The ten dollars were never paid.
Ms. Joppich later filed a lawsuit to determine that the option agreement was unenforceable because the ten dollars had not been offered or paid. The Supreme Court based its view that the option was enforceable on a legal treaty called restatement (Second) of Contracts, which states: “(1) An offer is binding as an option contract if (a) it is written and signed by the bidder, recites an alleged consideration for the submission of the bid, and offers an exchange on fair terms within a reasonable period of time …”. The following example is found in the reprocessing: “A maintains and delivers to B a written agreement “for a dollar paid by hand,” which gives B an option to purchase described land of A for $15,000.00, with the option expiring six days later at noon. The fact that the dollar is not actually paid does not prevent the offer from being irrevocable. One commentator quoted by the Court characterized restatement as a position that “a false consideration of nominal consideration is sufficient to support the irrevocability of an offer as long as the underlying exchange is fair and the offer must be accepted within a reasonable time.” It should also be noted that the Joppich case involves a ten-dollar option check. There are many references in the notice to “nominal” considerations. The comment in the reformulation refers to the “delivery of a dollar or peppercorn” as “a trivial formality.” The public seems to be clearly saying that one dollar, ten dollars or a peppercorn are nominal, but is $100.00 or $50.00 nominal? That is an open question. Other economic circumstances. In addition to the rental value and the price of the option, other economic factors may be considered in determining whether a rental option should be marked as a sale for tax purposes. When analyzing lease option transactions, each of the following factors was considered evidence of a sale: Although the lease option is a valuable strategy in many situations, it must be used with great care.
There is always a risk that the IRS will view the lease option transaction as a sale and the lease as a mere financing instrument. Rents well above market rents, combined with an “advantageous” option price, indicate that the transaction is likely to be marked as a sale and that rent payments are in fact payments in instalments on the purchase price. Therefore, rent payments and the price of the option should be determined by the parties based on market values and rents for similar properties. And parties should be willing to justify their rent and purchase price estimates if the transaction is subsequently challenged by the IRS. The rental value and value of the property can be best determined by independent expert opinions. Conditions. Rent payments are only deductible for a property that the tenant does not own or own equity. Two factors suggest that a tenant acquires an interest in a property: Tax implications for tenants and landlords If the IRS flags the lease option as an installment sale for income tax purposes, it is assumed that ownership of the property was transferred at the time the tenant gave the landlord payment of the option and the lease began. This schedule significantly changes the tax consequences for the tenant and landlord […].