I.R.S. and Lease Options

Hello to everyone reading this post. I have some questions about Lease-Options and the I.R.S. I have read that if the lease-option is not structure correctly, it may be characterized as a sale. My questions are the following:

  1. If the I.R.S. deems it to be a sale, are you subject to capital gains tax at the highest rates (20-33%)?
  2. Is the investor subject to any financial penalities if the I.R.S. categroizes the lease-option transaction as a “disguised sale”?
  3. If the I.R.S. categorizes the lease-option transaction as a sale, and the investor is subject to capital gains tax, would the capital gains tax be paid when the lease option period expires or would the capital gains tax be paid in the current year that the investor files taxes?
  1. Let’s assume you are talking about an investment property sale. If the IRS deems the transaction to be a disguised sale, it will be an installment sale. The tax rate will be the capital gains tax rate that would apply if the sale were reported as an installment sale in the first place.

If, instead, you are talking about flip property, then the IRS will apply the tax treatment that should have been used at the time. Profits on flip property are taxable in full in the year of the sale. Installment sale tax treatment is not allowed for flip property. The tax rate is your ordinary income tax rate, and, payroll taxes may also apply to your sale profit.

  1. Depends upon how the IRS treats your case. If you can convince the IRS that you made an honest mistake, that you were not attempting to evade taxes, then back taxes and accrued interest may be your only liability.

If the IRS charges you with tax evasion, then your penalty could be 100% of your profit and you will still have to pay the back taxes with interest.

  1. If the I.R.S. categorizes the lease-option transaction as a sale, then there is no “option” to expire as far as the IRS is concerned. Your sale is an installment sale on the date you entered the agreement. Back taxes can be assessed at any time, usually as the result of an audit, and you will be given a timetable to pay the IRS. No, the IRS won’t wait until you file your next tax return.

Just my layman’s opinion.

Thanks for the information Dave T.