Lease Option Money..how Is It Taxed
I have a question on how the money received through a lease option contract is taxed.
1) The option money you receive up front. Is it considered rent? Or do you wait until the option is exorcized and show it as a down payment on the purchase price.
2) The rent credit given to the tenant. Is that taxed as rent income or held in a escrow account until the purchase.
3) What if the lease option is for greater then one year.
Thanks in advance.
If you are a dealer to real estate for this lease option deal, then rent credits and option consideration are taxed as ordinary self-employment income when either the option expires, or the option is exercised. The length of the option term does not matter. Capital gains tax treatment does not apply to a dealer disposition.
If you are NOT a dealer to real estate for this lease option deal, the tax treatment is a little different..
Option consideration is not recognized as income until the option is exercised, or the option expires.If the option expires, option money that is forfeited by the tenant buyer is recognized as a short term capital gain, EVEN IF the option period is longer than one year.
If the option is exercised, then the option consideration in included in the proceeds of the sale and is taxed as a capital gain in the year when the property is sold. Long term capital gain if the holding period for the property is greater than one year; short term capital gain, otherwise.Rent credits are trickier. Technically, rent credits are also not recognized as income until either the option expires or the option is exercised.If the option is exercised, the rent credit is included in the proceeds of the sale and taxed as a capital gain as part of the total profit on the sale.If the option expires, then the rent credits are recognized as rental income and taxed as ordinary income.As a practical matter, however, the bookkeeping for rent credits can get cumbersome. Many investors will just recognize the rent credit as rental income when received, then reduce the taxable profit on the sale of the property as a seller concession for the amount of the rent credit given.