Do you have to pay taxes on money paid during a seller rent-back?
September 29, 2009 9:31 PM Subscribe
You buy a house in California. You agree that the seller can stay up to 2 months after escrow closes (a "seller rent-back") if they make your (PITI) payments. Do you need to pay income taxes on the money they pay toward your PITI? Also, what was your "seller rent-back" experience?
We are buying a house in California. The sellers (who are very nice) want the option to rent the house beyond closing while they look for a house to buy (e.g., a seller rent-back or Residential Lease After Sale [RLAS] agreement) for up to 2 months. If they stay beyond escrow, they will pay our PITI, say $100/day for the sake of convenient calculations.
Suppose they stay 20 days and pay $2000 toward our PITI during that time.
Is that $2000 considered our income for tax purposes? In other words, would we (in the 25% federal and 9% state tax brackets) need to pay taxes on that $2000, effectively reducing it by one-third?
I understand we can deduct our interest and mortgage insurance payments from our taxes, does that mean this comes out in the wash?
What was your experience with a "rent-back" or a Residential Lease After Sale agreement?
We are buying a house in California. The sellers (who are very nice) want the option to rent the house beyond closing while they look for a house to buy (e.g., a seller rent-back or Residential Lease After Sale [RLAS] agreement) for up to 2 months. If they stay beyond escrow, they will pay our PITI, say $100/day for the sake of convenient calculations.
Suppose they stay 20 days and pay $2000 toward our PITI during that time.
Is that $2000 considered our income for tax purposes? In other words, would we (in the 25% federal and 9% state tax brackets) need to pay taxes on that $2000, effectively reducing it by one-third?
I understand we can deduct our interest and mortgage insurance payments from our taxes, does that mean this comes out in the wash?
What was your experience with a "rent-back" or a Residential Lease After Sale agreement?
No advice on the tax issue, but I have rented back to a seller for one month after closing (in Texas). It was fine until I showed up at the house at the appointed time with a load of stuff to move in and... they weren't done moving out. They were very nice people, too.
It wasn't a huge deal because they were literally only a few hours behind, but it was annoying. It would have been a big deal if they had needed a couple of extra days because my movers were due the next morning and my lease was up. If I could go back and do things differently, I probably would have scheduled more slack between their move-out date and my move-in date, and I would have checked up (legally) on their moving progress in the day or two before their move-out date.
Fortunately, nothing about the arrangement required me to act like a "real" landlord, except that I did hold on to their deposit until they were moved out. No major appliance failures or anything that would result in an insurance claim occurred during the rent-back period. You may want to ask your realtor/agent how that sort of thing would play out.
posted by scatter gather at 11:36 PM on September 29, 2009
It wasn't a huge deal because they were literally only a few hours behind, but it was annoying. It would have been a big deal if they had needed a couple of extra days because my movers were due the next morning and my lease was up. If I could go back and do things differently, I probably would have scheduled more slack between their move-out date and my move-in date, and I would have checked up (legally) on their moving progress in the day or two before their move-out date.
Fortunately, nothing about the arrangement required me to act like a "real" landlord, except that I did hold on to their deposit until they were moved out. No major appliance failures or anything that would result in an insurance claim occurred during the rent-back period. You may want to ask your realtor/agent how that sort of thing would play out.
posted by scatter gather at 11:36 PM on September 29, 2009
My experience as someone who has been on both sides of this situation: Make it as expensive as you possibly can for the people who are staying. That's not to be mean, but to make damn sure they go as quickly as they can. When we rented back, we paid for a month at roughly double what that house would have rented for on the open market (though it was a daily rent, and we only paid for the days we were there), and if we weren't out the rent went up to $400 a day (ten years ago, now) with a one-week maximum extension. We did something similar when we bought and allowed the seller to stay for a few days.
The high but not insane rent insures they want to move out, and the insane "penalty" rent makes damn sure they're ready before that day arrives. I think it is also customary to require a reasonably hefty deposit so they can't rack up rent and then just skip town. I think we required pretty much all of the rent + penalty as a deposit, and gave them back what they didn't use.
Be darned sure you do a thorough walk through to make sure fixtures and such are left behind if they're yours, and that no new damage is present. Sometimes a long-term resident will come to think of things like chandeliers or other fixtures as "theirs" when they go with the house unless other arrangements have been made, and depending on how well they considered they did on the sale, they may not be harboring the gentlest feelings towards the new owners.
Cannot advise on any tax stuff, sorry.
posted by maxwelton at 3:06 AM on September 30, 2009
The high but not insane rent insures they want to move out, and the insane "penalty" rent makes damn sure they're ready before that day arrives. I think it is also customary to require a reasonably hefty deposit so they can't rack up rent and then just skip town. I think we required pretty much all of the rent + penalty as a deposit, and gave them back what they didn't use.
Be darned sure you do a thorough walk through to make sure fixtures and such are left behind if they're yours, and that no new damage is present. Sometimes a long-term resident will come to think of things like chandeliers or other fixtures as "theirs" when they go with the house unless other arrangements have been made, and depending on how well they considered they did on the sale, they may not be harboring the gentlest feelings towards the new owners.
Cannot advise on any tax stuff, sorry.
posted by maxwelton at 3:06 AM on September 30, 2009
I'm not a tax guy or a lawyer, and I don't live in CA, but I think this is likely taxable income. ROU_Xenophobe may be correct that your final tax liability may not reflect this source of income, but he appears to be incorrectly implying you need not report it simply because the incoming value matches some other value on your balance sheet.
Your tenants (yes) are paying rent (yes). Rent is money paid you for the use of your property. There's even a specific line on your tax form for income from rent. What reason do you have to believe that, in this situation, money paid you for the use of your property does not constitute rent?
If they write you a check or stuff bills in an envelope, and the money comes to you, then it's income. The fact that the amount they're paying you is equal to a bill payment you have is immaterial, as is what's written on the memo line of the check. It's money you're receiving. With only a scant few exceptions, if money passes through your ownership and control, you must declare it as income. How you dispose of the income may allow you to write some or all of it off, but it certainly must be reported.
On the other hand, if they're sending their payment directly to your mortgage holder, then you may not be liable for it. Of course, given their druthers, the IRS would have you include the appraised value of the two dozen cookies your neighbor made you last week... so, get a tax guy.
posted by Netzapper at 5:07 AM on September 30, 2009
Your tenants (yes) are paying rent (yes). Rent is money paid you for the use of your property. There's even a specific line on your tax form for income from rent. What reason do you have to believe that, in this situation, money paid you for the use of your property does not constitute rent?
If they write you a check or stuff bills in an envelope, and the money comes to you, then it's income. The fact that the amount they're paying you is equal to a bill payment you have is immaterial, as is what's written on the memo line of the check. It's money you're receiving. With only a scant few exceptions, if money passes through your ownership and control, you must declare it as income. How you dispose of the income may allow you to write some or all of it off, but it certainly must be reported.
On the other hand, if they're sending their payment directly to your mortgage holder, then you may not be liable for it. Of course, given their druthers, the IRS would have you include the appraised value of the two dozen cookies your neighbor made you last week... so, get a tax guy.
posted by Netzapper at 5:07 AM on September 30, 2009
he appears to be incorrectly implying you need not report it
I didn't mean to imply anything like that, only that they shouldn't need to worry that they'll effectively only be receiving 2/3 of the rent.
so, get a tax guy.
Eh. Schedule E seems simple enough, and it appears that everything would cancel. Really the only hard part seems to me to be remembering to split up your mortgage interest and related deductions between Schedule A and Schedule E.
posted by ROU_Xenophobe at 6:06 AM on September 30, 2009
I didn't mean to imply anything like that, only that they shouldn't need to worry that they'll effectively only be receiving 2/3 of the rent.
so, get a tax guy.
Eh. Schedule E seems simple enough, and it appears that everything would cancel. Really the only hard part seems to me to be remembering to split up your mortgage interest and related deductions between Schedule A and Schedule E.
posted by ROU_Xenophobe at 6:06 AM on September 30, 2009
Response by poster: Wow, thanks so much for all the helpful answers!
I've read the Schedule E form and instructions and I'm still unsure whether this would be reported as income or not. From the Schedule E instructions re: Line 3:
"If you received rental income from real estate (including personal property leased with real estate) and you were not in the real estate business, report the income on line 3."
It seems that I should be reporting it if "received" but as Netzapper pointed out, this money would be sent directly to the title company who would in turn send it to the lender and insurer. I would not receive the money at any point, but it would be paying for a property I own.
@maxwelton:
We will be asking that the seller agree to an additional $1000 if they stay beyond the end of November because we have a lease which ends on November 31. This would not quite cover our moving expenses and the trouble it would cause us to move twice and find another place to live for a month, but more seems unfair to them in a way.
Still very unsure about the tax issue, thanks for any additional replies and feedback.
posted by unclezeb at 7:08 AM on September 30, 2009
I've read the Schedule E form and instructions and I'm still unsure whether this would be reported as income or not. From the Schedule E instructions re: Line 3:
"If you received rental income from real estate (including personal property leased with real estate) and you were not in the real estate business, report the income on line 3."
It seems that I should be reporting it if "received" but as Netzapper pointed out, this money would be sent directly to the title company who would in turn send it to the lender and insurer. I would not receive the money at any point, but it would be paying for a property I own.
@maxwelton:
We will be asking that the seller agree to an additional $1000 if they stay beyond the end of November because we have a lease which ends on November 31. This would not quite cover our moving expenses and the trouble it would cause us to move twice and find another place to live for a month, but more seems unfair to them in a way.
Still very unsure about the tax issue, thanks for any additional replies and feedback.
posted by unclezeb at 7:08 AM on September 30, 2009
If they are sending it directly to the title company, then it stands some chance of not being income--although it could still be a gift of equity, which might be counted as income. You need to ask a tax guy. Somebody who can look at the specifics of the situation and offer you professional advice.
Also, personally, I'd be very wary of having the tenants send the check to the title company. You're being insufficiently paranoid here. If you're expecting to be compensated by the tenants sending money to a third party, you have effectively no confirmation or oversight of the process. What happens when December 1st rolls around, and they say, "Oh, yeah, we absolutely sent the check," just as they and their moving van drive away to Toronto?
You need to collect a security deposit in excess of the total possible rent, or just have them pay up front. Trust me... if landlords didn't demand security deposits, nobody would pay their last month's rent. And all you have is the last month, ya' know?
posted by Netzapper at 7:17 AM on September 30, 2009
Also, personally, I'd be very wary of having the tenants send the check to the title company. You're being insufficiently paranoid here. If you're expecting to be compensated by the tenants sending money to a third party, you have effectively no confirmation or oversight of the process. What happens when December 1st rolls around, and they say, "Oh, yeah, we absolutely sent the check," just as they and their moving van drive away to Toronto?
You need to collect a security deposit in excess of the total possible rent, or just have them pay up front. Trust me... if landlords didn't demand security deposits, nobody would pay their last month's rent. And all you have is the last month, ya' know?
posted by Netzapper at 7:17 AM on September 30, 2009
Response by poster: @Netzapper:
In the end it looks like I will have to ask a tax pro, just hoping someone here dealt with a similar situation and might know already.
As for suddenly becoming a temporary land lord, I am no worried about "rent collection": the owners are moving to the same neighborhood, they bid on a house blocks away but didn't get it and are bidding on another today (also very nearby). Also, I understand the Title company will inform me and my real estate agent if the payment is not received in advance which would void the RLAS and allow immediate transfer of possession ... though I'm not sure about that. The seller's and their agent are local, I'm not concerned as much about getting "rent" as I am about getting into the house sooner rather than later, which is why I think an increase in "rent" after some period would be helpful for letting them know that we want to move in at that point. I think you are right about collecting a security deposit though, it was not included in the RLAS and it should be.
posted by unclezeb at 8:44 AM on September 30, 2009
In the end it looks like I will have to ask a tax pro, just hoping someone here dealt with a similar situation and might know already.
As for suddenly becoming a temporary land lord, I am no worried about "rent collection": the owners are moving to the same neighborhood, they bid on a house blocks away but didn't get it and are bidding on another today (also very nearby). Also, I understand the Title company will inform me and my real estate agent if the payment is not received in advance which would void the RLAS and allow immediate transfer of possession ... though I'm not sure about that. The seller's and their agent are local, I'm not concerned as much about getting "rent" as I am about getting into the house sooner rather than later, which is why I think an increase in "rent" after some period would be helpful for letting them know that we want to move in at that point. I think you are right about collecting a security deposit though, it was not included in the RLAS and it should be.
posted by unclezeb at 8:44 AM on September 30, 2009
I'd be very wary of having the tenants send the check to the title company
Me too. I would have them pay you in full for the expected rental period at closing. Under normal circumstances, this would just mean that the check they get cut at closing is smaller than it would have been.
As far as a tax professional goes... if your taxes aren't especially difficult, I'd just do my taxes with the Schedule 3 filed and without the Schedule 3 filed, with best guesses for the year's income and the like. For me, this would take at most half an hour, but your situation might be harder to figure out. This should give you a reasonable sense of the maximum possible savings if there's some way to not report it, and if the tax guy fees are larger than that amount...
posted by ROU_Xenophobe at 10:16 AM on September 30, 2009
Me too. I would have them pay you in full for the expected rental period at closing. Under normal circumstances, this would just mean that the check they get cut at closing is smaller than it would have been.
As far as a tax professional goes... if your taxes aren't especially difficult, I'd just do my taxes with the Schedule 3 filed and without the Schedule 3 filed, with best guesses for the year's income and the like. For me, this would take at most half an hour, but your situation might be harder to figure out. This should give you a reasonable sense of the maximum possible savings if there's some way to not report it, and if the tax guy fees are larger than that amount...
posted by ROU_Xenophobe at 10:16 AM on September 30, 2009
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posted by ROU_Xenophobe at 10:07 PM on September 29, 2009