Margaret CPA in OH Posted February 3, 2017 Report Share Posted February 3, 2017 I've read several articles and still have questions about this particular client. LLC wanted to flip houses. First one didn't sell so rented for a year. In 2016, tenant expressed interest in buying so client put together this option that is royally screwed up (from the internet with their own touches, don't you know). Bottom line is they are now voiding this notarized contract to get to the bottom line. LLC wants, over 36 months, $45,336. This is $3000 deposit (forfeited if option not exercised) and 36 months of monthly payments of $1176 - $795 per month rent and $381 payments towards purchase (forfeited if option not exercised). So I believe the rent is rent and typical expenses applied against this over the time period; deposit and $381 monthly payments in escrow until option exercised so selling price is $3000 + $381x36=$13716, total $16,716. (Low income neighborhood...) Sale would be on exercise date and reported that year. It is also possible that it would be accelerated if tenant comes up with the money to total what client wants. Does this sound right? I have strongly urged client to cough up the $$ to have an attorney put this together and, oh by the way, get the required disclosure form. I just want to be sure that the accounting and tax reporting is correct and am really second guessing here. Thanks for input! Quote Link to comment Share on other sites More sharing options...
rfassett Posted February 3, 2017 Report Share Posted February 3, 2017 It sounds (and smells) like an installment sale. Irrespective of what they want and when, they have structured an installment sale. I would take the total cash flow and back into the sale price and the amount of interest that will be paid over the term. The options are meaningless and the seller would simply repossess the property in case of default. Understand that I am not a lawyer, but that is what I read into your description. I am with you, the client needs to take this to a contract and real estate attorney and get it fixed. I do not think I would do much with it until he does that. 3 Quote Link to comment Share on other sites More sharing options...
Margaret CPA in OH Posted February 4, 2017 Author Report Share Posted February 4, 2017 Thanks, Ron. I also first thought installment sale as the outcome desired would be the same except - except - how do I treat the $795 portion of each payment which client has defined as rent? And, if installment sale, how to treat the other, regular expenses of the 'rental?' How are the re taxes, insurance, etc. accounted for as they are paid by the client not the tenant? I won't know the total cash flow until it's over unless the client decides now what it will be and then how to determine the interest as that will have to be part of the payment? I do understand that the client would take back the property if contract not completed but, if so and no sale results, then how to account for what then becomes rent but has been reported as installment sale income? Amended returns? I know a lot of business equipment is rent to own or lease option to buy but are the interim payments considered rent or installment payments which wouldn't be known until the term period is up and the option to buy is exercised - or not? I'm thinking extension for both LLC (partnership) and individual returns while I go relearn accounting for these things. Maybe I can still find my advanced accounting text book Quote Link to comment Share on other sites More sharing options...
DANRVAN Posted February 4, 2017 Report Share Posted February 4, 2017 6 hours ago, Margaret CPA in OH said: Does this sound right? No, it does not sound right. I believe it has to be either a lease or a purchase, but can't be both at the same time. Whether it is a lease or purchase depends on the facts and circumstances including: -intent of parties -payments are above fmv of rent -who bears rights and risk of ownership -who pays insurance, property taxes -is renter building equity -property can be purchased by exercising an option that is nominal compared to the fmv of the property. Quote Link to comment Share on other sites More sharing options...
DANRVAN Posted February 4, 2017 Report Share Posted February 4, 2017 2 hours ago, Margaret CPA in OH said: I do understand that the client would take back the property if contract not completed but, if so and no sale results, then how to account for what then becomes rent but has been reported as installment sale income? Treat it as a repo on installment sale. Quote Link to comment Share on other sites More sharing options...
DANRVAN Posted February 4, 2017 Report Share Posted February 4, 2017 2 hours ago, Margaret CPA in OH said: And, if installment sale, how to treat the other, regular expenses of the 'rental?' How are the re taxes, insurance, etc. accounted for as they are paid by the client not the tenant? That's where the real estate lawyer comes in. In substance, it I agree with Ron, looks like an installment sale poorly drafted by without legal or tax advice. So what exactly is the option available for exercise by the tenant? Quote Link to comment Share on other sites More sharing options...
DANRVAN Posted February 4, 2017 Report Share Posted February 4, 2017 7 hours ago, Margaret CPA in OH said: Bottom line is they are now voiding this notarized contract to get to the bottom line. Not sure what you mean by that. Quote Link to comment Share on other sites More sharing options...
rfassett Posted February 4, 2017 Report Share Posted February 4, 2017 Margaret - I think you are overthinking this . You state in your original post that the total cash flow will be $45,336. Or at least that is what the LLC is expecting. Installment sales are always a shot in the dark when it comes to the question of the sale running its full term. All you have to deal with is what you know today. It sounds like a three year term. You know the real estate taxes and insurance - that portion of the payment would go into an escrow account and the LLC will pay them for its own protection - but out of the escrow fund. What really makes this stink for me is the $795 per month rent on a property valued at $16,716. If your guy is getting that kind of rent on property of that value, I want in on some of the action. Give him my contact info. BTW - I agree with everything DANRVAN said also. Quote Link to comment Share on other sites More sharing options...
Richcpaman Posted February 4, 2017 Report Share Posted February 4, 2017 You can call the "terms" in the contract anything you want... The $795 can be called "rent", but it is just part of the purchase price. IF I was the buyer, the whole thing sounds like a bad deal, and maybe they want to get out. You have a simple installment sale. Unlike a "normal" real estate settlement, title to the property does not pass until the property is paid for, and that does not happen, in this case, for 3 years. And it may not happen if the buyers back out, but the buyers lose their investment. Your client, the seller LLC, are playing the buyers like every late night shill about how to get rich in real estate..... The LLC can not have it both ways. They had a rental for at year, then they did an installment deal with the buyers. Treat it that way until the deal changes. Your client may not have any idea what they did, and may change things if they feel they are getting some sort of advantage, but hey, that is not unusual. Rich Quote Link to comment Share on other sites More sharing options...
Burke Posted February 4, 2017 Report Share Posted February 4, 2017 I don't have any problem with the $795 monthly rent - as long as that is supported by a separate lease agreement for the premises for a specified time, and which has no connection whatsoever to the eventual sale of the property. This means none of the rent can be applied against the sale. That does not appear to be the case with the facts as you state them. As presented, it is an installment sale. Period. Quote Link to comment Share on other sites More sharing options...
Burke Posted February 4, 2017 Report Share Posted February 4, 2017 What you are describing is an Option to Purchase. It is not a "rental." The payments specified are Option payments which can be held in an escrow account for the specified time in which the buyer is required to close the sale. If the Option payments are forfeited by the terms of the Option agreement, then they become Ordinary income to the seller who retains ownership of the property during the Option period. It is possible the Option payments are made in one tax year, and forfeiture occurs in a succeeding year. If that happens, the TP may have to file amended returns to report the income in the year received. If the buyer wishes to rent the space while this Option is in place, then he needs a proper lease which specifies that rent for a specified time and the payments cannot be applied to the purchase price. So you have 3 possible scenarios: 1. Lease 2. Option to Purchase 3. Installment Sale. The seller cannot "decide" which one of these scenarios it is, after the end of the period. It needs to be in writing up front in a properly-worded contract. 2 Quote Link to comment Share on other sites More sharing options...
Margaret CPA in OH Posted February 4, 2017 Author Report Share Posted February 4, 2017 Thanks so much for all this valuable input. It's interesting that rfassett calls this an installment sale; DNRVAN says lease or purchase depending (I'll get back to that); Richcpaman says installment sale; BURKE says 3 scenarios - lease, option to purchase, or installment sale. I thought I was fairly clear in the original post that the client LLC wants, over 36 months or less, $45,336. I also replied to Ron that my first thought was installment sale, too. So the intent of the parties is: for the current tenant to own the property, payments are above fmv of rent, not sure who bears rights and risk of ownership until time is up and deed passes (LLC I think would and would pay insurance and taxes), I assume the payments above fmv of rent is tenant equity unless tenant changes mind and I'm not sure about the option cost. For tax purposes the market value of the property is $15,000. The previous agreement they had was a promissory note for $37,000 at 9% interest so I provided an amortization schedule to prepare a 1099INT. Client then explained that really wasn't the intention. They meant the Lease with Option to Purchase with $3000 deposit, $40,000 option price paid over 36 months (option 'exercised' one month after prepared), with 0 of the rent paid applies as additional consideration to reduce the option price and a stated rent of $1176 per month. Client explained to me what I stated originally. They just want a total of $45,336 over 36 months or sooner. This began April 1, 2016. I'm just trying to figure out how in the world to account for the money LLC has already received. When I expressed all my confusion and strong suggestion to have an attorney do properly whatever it is, I was told they will 'void' the existing agreement but begin the 36 months April 1, 2016, but with the proper wording. I have copied the above comments and am sending to the client (hope you don't mind, no original names) to reinforce the necessity of doing this correctly. However, I still don't know how to account for the receipts and expenses already done in 2016. My head hurts. Rita, might you share some hugs this way? Quote Link to comment Share on other sites More sharing options...
DANRVAN Posted February 6, 2017 Report Share Posted February 6, 2017 I have some more thoughts on this. How much did your client pay for the property? Was the property rented before the deal on April 1, 2016? If so, for how much? About how much should the property rent for? You mentioned a tax value of $15,000. Do you mean that is the value for property tax purpose? Relax, you will get through this! Quote Link to comment Share on other sites More sharing options...
Margaret CPA in OH Posted February 6, 2017 Author Report Share Posted February 6, 2017 Thanks for asking. Client paid $15,000, foreclosure property, did remodeling themselves spending $6139 plus $1750 on appliances and labor. The property was rented beginning in March 2015 at $795 per month, same amount. I think that is fmv for this property in this area. Yes, the market total value on the county website is $15,000 as that was the last sale value. My guess is next valuation will be higher due to improvements but probably depends on the sale price. Client emailed yesterday after I sent the comments: I have sent the info to the Attorney so that he can create a new legal Lease option for the deal this document will replace the existing lease option. The installment sale was not executed correctly and will be cancelled. Once the new Lease option is created and signed, I will get you a copy. So we shall see what arrives. Client also states that he doesn't plan on needing an extension. Nice of him to let me know his timeline! Quote Link to comment Share on other sites More sharing options...
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