I don’t know if I’m so excited about real estate anymore just thinking about the tax issues…
I am planning on buying a property, and then offering it for a lease purchase for $12,000 down, an extra $200 a month on top of the rent and the leasee gets to purchase the property in 3 years for an estimated purchase price established at the time of the lease (using about 10% appreciation estimate per year).
My question is… If this lease purchase works and I actually get the $12,000 down, do I have to pay taxes on this money this year? Or, do I pay taxes on it when it is sold three years from today? Would it then qualify for the 1031 rollover?
On a sidenote, I have read in the forums that I should have a rental agreement and a separate lease purchase agreement – separate documents. Are there legal reasons I should keep these separate? Any advise is GREATLY appreciated!!! Thanks everyone!
The reason behind the separate docs is not to confuse the deposit on the lease with the non-refundable payment on the purchase option. In court the judge or jury may see an easy connection between the two and award the tenant the option money in any lease dispute.
I believe the option money received would be income and would be taxed. I hope you get a better answer about this however.
Option money is not taxable until the option expires or is exercised. It would go on your books as cash in the bank but also a current liability since you will have to show it as income at a future point. Of, course you can show it as current income if you wish.
On the issue of 1031 you have to own it, no sandwich leases, and you have to rent it out. If you do something like a lease purchase for over 3 years the IRS may consider it a sale. If you are a good investor buying below market rather than hoping for appreciation then why would you not want to get at the profit sooner.
Phew, thanks so much for your answers. This is my first transaction and I’m very excited about it. And you are right, why wait for a long time to get the income.
Just one more thing, I have read that it is very important NOT to indicate on any documents that this is a purchase… However, a speaker at a local REIC told us that there is a “lease to purchase” type of transaction that is very lucrative. Have you heard of this and do you agree?
Here is the situation. The lease purchase is set up where the tenant/buyer signs a contract to purchase the property in 3 years. The price is determined based on an estimated appreciate value. There is a downpayment amount (about 5-7%) that goes towards to purchase price. The rent payments (including the additional amount of $200 that goes towards the purchase) must be on time or else the contract is cancelled. The three years is considered an “escrow” period. At the end of three years, the property is his/hers at the originally determined price (with the option for reappraisals from both parties if requested by the buyer).
Please help as my partner wants to do this lease purchase… Have you heard of this “lease purchase” (not lease option) and do you think it is legally sound?
You have a lease agreement and a purchase agreement.
When you sell on a lease/purchase you are obligated to sell and the purchaser is obligated to buy. You have to be careful though cause it can cause problems if the purchase price is too far ahead of the appraisal value when it comes time to purchase. This would mean that the LENDER would not fund the loan for your buyer and he/she would have to come up with the extra money which can mean a battle. If this happened to be the case (this happened to me on a condo in NJ) you can simply adjust the purchase price to fit the appraisal should you want to. I had to drop my purchase price by 10K to fit the appraisal…Voila - done deal.
When a lease purchase contract is properly structured the tenant may be able to write of payments as interest and/or property taxes. As far as the IRS is concern the dwelling needs to be their primary residence and they must be contractually obligated to make the payments do the repairs and everything else the owner would do.
In return you can usually get a higher downpayment or montly payment. Similar to a CFD.
The difficulty with L/P is that when you give them these privledges you may be opening yourself up to them having equitable interest. There are some gurus selling their programs that they say the occupant can write off these things but come right back and say that if they default then they are just renting.
May work fine until the judge says you can’t have it both ways and declares that they must be foreclosed. If it takes months to do that you still have payments to make. In a divorce, bankruptcy or other legal proceeding they claim equitable interest and you title is tied up in a court proceedings. For that reason many investors do not like L/P or complex L/O agreements.
With the exception of Gatten’s EHT I would steer clear of certain contracts unless you and your attorney fully understand the ramifications of that contract. This should be an attorney that would defend you in court not just review your documents.