By James A. Gage
There are some interesting and lucrative
advantages of using options as both an optionor and optionee
of real estate. Generally speaking, option money is not
taxable to the optionor until the option is exercised,
expires or is abandoned. I.R.C. Section 1234 (subject to
"dealer" rules, discussed below). If it expires or is
abandoned, it is taxable to the seller as ordinary income at
the time it expires or is abandoned.
A personal residence sold under lease/option
may still qualify for capital gains
exemption. Under the 1997 Tax Reform Act,
gains from the sale of a personal residence
seller are exempt so long as the gain is less
than $250,000 ($500,000 for married couple). So long as the
lease was incidental to the sale, court decisions have held
that the property would still qualify as a personal
residence and not a rental. See,
Solaris v. Commissioner,
776 F.2d 1428 (9th Cir 1985).
The lease and option payments made by the
tenant are not tax deductible if the property
is used as a residence. If tenant purchases
the property, his option payments (including monthly rent
credits) become part of his tax basis in the property. The
tenant's option payments may be deductible as a capital loss
if the buyer is an investor. For example if you lease/option
a home to live in, consider using your LLC to take the
sublease to yourself individually. If you
don't exercise the option from your corporation,
have the corporation treat the option money
it paid as a loss.
Take A Loss On Your Personal Residence
As you may know, you cannot take a loss on
your personal residence if you sell it for less than your
basis. You can, however, take a capital loss on an
Move out of your house and lease/option it to
a tenant/buyer for a few years. Report it on
your Federal income tax return as a rental on
schedule "E." You may now be able to take
a loss when the tenant exercises his option
Make certain that you make this transaction
it look legitimate; the IRS is keenly aware
that people in down real estate markets try
to "fudge" rental agreements to accomplish a
loss on their personal residences.
Watch Out For "Dealer" Classification
If you are an active real estate investor,
you should be aware of what the IRS calls "dealer status."
If you also buy and sell real estate on a regular basis, you
may be considered a "dealer" in real estate properties. A
dealer is one who buys with the intent of reselling rather
than for investment.
There is no magic formula for determining who
is an investor and who is a dealer, but the IRS will balance
a number of factors, such as the purpose for which the
property was purchased, how long the property was held and
how many deals the investor did in relation to other income.
If you take option consideration on a "dealer" property, you
cannot defer taxation of option consideration under Section
1234 of the Code.
Occasionally, but rarely, the IRS will
reclassify a lease/option as a disguised sale. This is
more common with equipment leases where the
lessee makes rental payments for a number of years then has
the option to buy at the end of the term for a nominal
such as $1.
IRS looks at the terms of the deal and the circumstances
surrounding the deal to determine whether a sale was
intended. For example, if the tenant is paying the taxes and
insurance, this looks more like a sale. If a substantial
part of the payments on the lease are credited towards
purchase, this also looks like a sale. If the option price
year rather than increases with the market. .
. well, you get the idea - it if looks like a
duck and it quacks like a duck, itís a duck!
Most of the reported cases wherein the IRS
reclassified a lease/option as a sale involved long-term
leases. Thus, a lease/option of only a few years with your
tenant is not likely to
be re-characterized as a sale. That's why we
give tenant/buyers 1 year leases so there will not be an
issue down the road.
"You are who you are and where you are because of what you
have put into your mind."
For more information or pricing please do not hesitate to
call or e-mail. I can be reached at :