You started this thread with the question: “what can I do legally to encourage my buyer to buy the house later (AFTER 12 months from my original purchase) rather than sooner?”
After that opening, there is no way to convince me that your INTENT from the beginning was to hold the property for long term production of income. The IRS will look to your actions and pattern of activity to define your INTENT. Actions that may suggest your intent include: your marketing to sell (rather than rent), your reluctance to hold property for long term rental use, and the preponderant character of your real estate activity, and other tests the IRS will apply to determine your intent.
I am told that there is a tax court case where the taxpayer bought some vacant land, then put it on the market for sale. The land stayed on the market for ten years before a buyer came forward to purchase the property. After a couple of years, the taxpayer was no longer actively marketing the property, but he never cancelled the sale listing. The taxpayer claimed investment tax treatment was in order because he held the property for ten years. The IRS countered that the taxpayer always intended to sell the property. The fact that the property was always for sale during the ten year holding period supported the IRS position that the property was held primarily for resale to customers and not for production of income or future appreciation. The transaction was recharacterized as a dealer disposition.
In the same vein, when your property is always for sale (via lease option), I am firmly convinced that the IRS will consider that your INTENT was always to sell the property. Equate your lease option activity (when that is your only real estate activity) to a Rent-to-Own furniture store. The furniture is just inventory (or merchandise) to the business. The rental is just incidental to their real intent to sell the furniture.
The tax code has a lot of grey in this area, too. Aggressive taxpayers will assert that the rental of their property is their primary intent. They will claim that using a lease option technique allows them to collect a little higher than market rent and is a filtering device to locate a better quality tenant. Structuring your lease and option as separate agreements may help support this position. Retaining all the responsibilities of an owner-landlord such as performing minor repair and maintenance, paying the property taxes, and purchasing a landlord hazard insurance policy further strengthens this position. Structuring your lease-option agreement such that the tenant buyer is responsible for repairs, maintenance, homeowner’s insurance, and/or property taxes weakens this position.
I just choose not to push the envelope, hoping to win at tax audit roulette. Remember, I am tax conservative on this point.
We are currently putting together our first lease option contract on the house we just bought. Tenant/buyer wants 12 months term. This means that we may have to keep the house for less than a year form our original purchase or slightly longer than a year. Question: how does that duration effect our tax and if it does what can I do legally to encourage my buyer to buy the house later (AFTER 12 months from my original purchase) rather than sooner? Thanks!
I am tax conservative on the question of dealer status. I would say your sale of this property is a dealer disposition even though you are using a lease option agreement to facilitate the sale. As a dealer disposition, your profit on the deal is taxed as ordinary income (not capital gains) regardless of your holding period.
There appears to be a lot of case law on the dealer status issue, and it all boils down to the taxpayer’s intent. Given that the tax codes define a dealer disposition as “Any disposition of real property held primarily for sale to customers”, immediately “selling” your property after acquisition on a lease option is evidence of intent to sell the property rather than hold it for the long term.
I know that others will disagree with my position, but, as I stated, I am tax conservative on this issue.
For some time, I thought no one would bother to answer.
Now, you said ?immediately “selling” your property after acquisition on a lease option is evidence of intent to sell the property rather than hold it for the long term?. We actually BOUGHT the house, rather than getting it under lease with the option to buy. Does that help?
If not, then would our intent be interpreted differently if, say, we had a straight renter for 6 months before leasing the house to our current tenant/buyer and giving her option to buy?
When you offer to “sell” your recently acquired property, you are demonstrating an intent to resell for profit rather than holding for the production of income or long term appreciation. How you acquired the property does not matter here, only that you are offering it for sale.
The fact that your sales technique involves a lease option agreement is evidence to me that you always intended to sell the property rather than hold it long term.
Holding your property as a straight rental would help establish your intent to hold the property for an investment purpose; but, (here’s the catch) establishing a pattern of activity of selling all your acquisitions will help reinforce the IRS position that you are acting as a dealer to real estate.
Best not to play games with the IRS here. Either you are in the business of flipping property (even when you always sell on lease option) or you are a landlord holding your property for long term rental use.
Remember that I am very conservative on this question.
Thanks again for taking the time to comment. It is really helpful for us as beginners in this very complicated but nonetheless extremely exiting game. When I look at the situation from solely logical perspective I almost agree with you. But then I remember that it?s my money we are talking about and that makes me play the devils advocate just a little bit more. This time I would like to challenge you notion that we ?always intended to sell the property rather than hold it long term.?
I remember reading somewhere that only less than 25% of all options to buy a house are actually exercised by tenant-buyers. Is this statistics wrong? If it isn?t, then could this be used as a justification that we actually intend to hold our property for long term rental use?
Any thought on the subject will be greatly appreciated. If we can convince you, then IRS has no chance of taking our money!