Is Assignment Fee Tax Deductible??
Here's my question/scenario:
Seller Sam assigns a lease option to Middleman Max. Max finds Tenant Terry, to assume lease option. Tenant Terry leases property for 1-2 years with option to purchase after that time. Terry pays Max $5000 option money. Max , in turn pays $4000 option money to Seller Sam, after the deal is solidified. Seller Sam will continue to own and manage the property. Middleman Max has $1000 in his pocket and is on to the next deal.
Question: Is the $1000 (paid to Max) tax deductible for Seller Sam as a "professional service/fee"?
No. Since Seller Sam received $4K and did not pay anything to Max, no tax deduction accrues to Seller Sam. Seller Sam does not recognize the option consideration as income until either the option is exercised or the option expires.
Max has $1K net profit in this deal, taxed as ordinary income on his Schedule C and self-employment taxes are calculated on Schedule SE.
Terry has $5K invested here. If he exercises his option, the $5K is included in his cost basis for the property. If he allows the option to expire, he might be able to claim a capital loss on his Schedule D. If this happens, Terry should consult a licensed tax professional for specific details.
I have another question on this subject: if buyer bob purchases a build-to-sell property in 2005, pays middle-man max a $10k assignment fee, but does not flip the property until 2006 upon completion, how is the $10k assignment fee treated in 2005 taxes?
The seller who received the assignment fee would declare it as ordinary income in 2005.
Buyer Bob, who paid the fee, treats the fee as a component of his cost basis. When he flips the property in 2006, his profit becomes taxable income.