Option Deposit Reporting

[Mark in St. Louis 0]

Dave,

 

I have a question about reporting option deposit monies and the effect of short vs. long term capital gains rates.

 

I have read that the money isn't taxable until either:

 

1) The tenant-buyer exercises their option to buy

 

2) The option to buy , and the related contract expires

 

Is this correct?

 

If yes, then wouldn't it always be in out best interest to have a lease-purchase contract that is for more than 12 months? Say, 13 months instead?

 

Since only about 25% ever exercise their option, the other 75% of option deposits could then be long-term vs. short-term capital gains. Correct?

 

Lets say I get to the point where I am doing 2 L-P deals every month. And the average option deposit is $3,000. That's 24 deals per year or $72,000 in option deposits.

 

At a 75% dropout rate, that's $54,000 that would be taxable at long term capital gain rates vs. the short term rate...if I do a 13 month instead of a 12 month L-P.

 

Am I correct in my thinking?

 

I don't honestly know what the short-term vs. long-term rates are. I was thinking that the max short-term is around 40% and the max long-term is around 15%? Am I close?

 

Thanks!

[Dave T 0]

I am told by a tax lawyer that when the option expires without being exercised, the option consideration will be short-term capital gains (always!) regardless of the option term.

 

I did not ask for a detailed explanation, but here is why this tax treatment makes sense to me.

 

When you sell a capital asset, your capital gains tax treatment is based upon the length of time you owned the asset prior to sale. If you consider the option to purchase a capital asset, then you are selling that asset as it is created -- very short ownership period. Therefore, you no longer own the asset -- the tenant-buyer does. Instead you have received consideration (money) in exchange for the asset. Under ordinary capital gains treatment, the sale of this asset is subject to a short term capital gain.

 

Just because you have deferred recognizing the income from the sale of the option does not change its short term capital gain character. The tax codes simply do not require that you recognize your income from the prior sale of the option until the option expires.

 

It is a different story for your tenant-buyer, however. As the owner of the capital asset in question (the option to purchase), he is theoritically free to sell that asset as well. In this case, the tenant-buyer's capital gain tax treatment of the sale of the option itself is determined by the seller's holding period -- longer than one year equals long term capital gains tax treatment.

 

This difference in the tax treatment of the income from expired options could affect the way in which you may choose to exit from a sandwich lease. As the master tenant in a sandwich lease, you own the option to purchase. If your holding period happens to be longer than one year, you can sell your option to another investor and take long term capital gains tax treatment. On the other hand, if your tenant-buyer wants to exercise his option and that forces you to exercise your option, then you really end up selling the property you just purchased -- a short term capital gain or ordinary income treatment applies.