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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.
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, Bolaris 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 corporation
to take the lease/option, then 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 investment
property. 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 to purchase. Make certain that if
you make this transaction it looks 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.
IRS Reclassification
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
amount, such as $1. The 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 declines each year rather than increases with
the market . . . well, you get the idea - it if looks
like a duck, and it quacks like 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.
The
purpose of this newsletter is to stimulate thought
for our clients and professionals with whom we
network. One should consult with a qualified
tax planning professional prior to implementing
any tax planning strategies. If you
are a legal, insurance, real estate or mortgage
planning professional receiving this newsletter
or know of one, please contact our office to
introduce yourself and your services to us. We
are always seeking to grow our referral network
and expose professional services to our client
base. |
