Taxation of Lease-to-Own Contracts
Lease-to-own contracts are becoming increasingly popular in today's real estate market. These are rental agreements where the tenant pays a fixed monthly rent plus an additional amount that gives the tenant the option to purchase the property at some future date. The tenant may also be required to make lump sum payments that are applied toward the purchase price.
So, how are these arrangements taxed? The base rent is clearly rental income, but what about the option payments or the lump sum payments? As so much in tax law, the answer is, "It depends." If the payments are nonrefundable, then they would be treated as additional rental income. Basically, the payments are just additional rent in exchange for the purchase option being held open by the seller/landlord.
But what if there is a written agreement to apply the payments to the purchase price if a sale occurs AND the agreement provides that the payments will be refunded to the tenant if the sale does not occur? In that case, the payments look a lot more like prepayments of the purchase price (also known as a conditional sales contract) rather than additional rent. If so, the advance payments would be credited to the purchase price if/when the sale occurs. Thus, there would be no taxable income to the seller (and no deduction to the buyer) in years prior to the year of sale.
Accel | 06/04/2013