Lease Option and Long-term Capital Gains Tax

I know that if you take over a property subject to and keep it for a year, when you sell, you pay long-term as opposed to short-term capital gains. In a lease option, however, isn’t it structured as if I’ve only owned the property for one day, therefore meaning it would be short-term (assuming there’s a profit made)? If so, how can I work around this? Thanks!

It sounds like you are buying these properties to sell for a profit. You may be using the subject to method as an acquisition technique, while the lease option facilitates the sale and lengthens your holding period; but, your intention is always to sell the property, collect your profit and move on to the next opportunity.

If this is an accurate assessment, then you are just “flipping” property and you will be treated as a dealer to real estate. As a dealer, all your profits are ordinary income – not capital gains. Since capital gains tax treatment does not apply, the holding period is irrelevant. Your profit is ordinary income no matter how long yhou have held the property.

If you are doing this as a sole proprietor, then your income is self-employment income. In addition to ordinary income taxes, you will also be hit with self-employment income taxes. This is just at the federal level. If your state has a personal income tax, then adding that tax liability to your federal tax liability will likely push your total tax hit on your net taxable flipping income to 50% or higher.

Dave 50% WOW! Will the IRS treat you any nicer if you operated under an LLC? or anything else that would be better. Herbster

As a general rule, LLCs are tax neutral. That is, your income tax liability does not change just because you have an LLC.

Dave, thanks for the reply. I was planning to take over some homes subject to and I would hold them for over a year, thus allowing me long term capital gains. After that one year I’d be able to sell without being tagged a “flipper.”

How does this work if I don’t hold title for a year. If sub2, I’m fine, but what about leasing with an option to buy? Thanks!

Like I said in my first post, buying Subject to and selling on a lease option is still flipping the property. Lease optioning for a year before selling does not change the tax treatment. It is still a dealer disposition and capital gains tax treatment does not apply.

Okay, thanks. I guess I’ll have to reconfirm what I read because I always thought that I’d get the long-term (which is why I questioned your first post). Well, I do appreciate the reply. Now I’ve got some more finagling to do!

I’m just curious now, does everyone here just suck it up and pay the tax, or are people renting them out only?

tj, There’sa lot to be said about CASH in hand. Flip em and go on to 2 more. Herbster

Hey, Herbster! Haha, yeah, I guess you’re right! But, I heard that once you start getting dubbed a “flipper,” then even when you rent one out for years and eventually sell they’ll still charge you the high tax rate, no?

Common and widespread misconception.

If you keep good records on each investment property you sell, acting as a dealer on some transactions should not “taint” your investment property sales. Many suggest that you conduct your flipping activity within a business entity that is separate and distinct from your other investment activities to avoid the possibility of tainting.

You may have also heard about a dreaded stigma called “dealer status”. There is no such thing. You may have also heard that once you are “tagged” as a dealer, all your property sales henceforth are dealer dispositions. Not true. Another scare tactic used by the entity gurus to promote their products.

Really? Well that’s good news then!

Recently I’ve found myself staying away from real estate books and trying to not read too much on this forum and not listen to real estate news. Why? Because right now I’m advertising and talking to sellers; doing exactly what I need to do to buy houses. And that’s all I need to do right now. I don’t need to learn too much more information because, for now anyway, it will bog me down.

I want to get moving, hit a wall, and only then learn how to climb over it. If I look for walls now, I might never move anywhere. :anon

You don’t set out in your car and just drive until you run out of gas. When you run out of gas it costs you time and maybe money, creates stress, and certainly inconveniences you.

Why treat your real estate investing the same way?

If you know about the wall and know how to avoid it in the first place, it will be a lot less expensive for you in the long run.

Have a question, If I set up rent to own for a year, how do I pay the tax. Rent to own has intention to flip the property so it could fall into ordinary income tax,but the term is 1 year so if the tenant/buyer exercise the option at the end of contract I would hold the property more than a year which could use capital gain tax.
Thank you for your inputs.

If you have been following the posts in this thread, then you have to understand that when you are flipping property, your sale is a dealer disposition regardless of how long you held the property or what sales technique you employ as an exit strategy.

Capital gains tax treatment does not apply to a property flipping business. The “property” is inventory or merchandise to your business and the income from the sale is always ordinary income, never a capital gain even if you sell after holding more than one year.

The lease option depends upon the person and his flexibility.
Make sure you sign with a agreement.

As a general rule, LLCs are tax neutral. That is, your income tax liability does not change just because you have an LLC.

How does this work if I don’t hold title for a year. If sub2, I’m fine, but what about leasing with an option to buy? Thanks!