Lease option needs to be treated as purchase this year

[Toben B.]

I can find many articles on how to structure a lease option so it does not look like a disguised sale, however I want my lease option to be treated as a sale in the year 2012.

Background: My personal house is for sale, and I have rented it out for nearly 3 years and placed it on the market. The only buyer wants to do a lease option, but I need to sell in the year 2012 so I don't pay capital gains on a house I lived in. (IRS rule is you have to live in a house 2 of the last 5 years to not pay capital gains on the sale of you personal home). The buyer has a credit problem and will put down a significant deposit, pay 6% etc and will get a new loan in 2-4 years. I owe some on the house so I can not create a mortgage on the property.

The IRS has come after some people and said their lease option was a disguised sale. I want the IRS to treat this as a clear sale now so I avoid capital gains entirely. No capital gains if I can sell in 2012, vs I have to pay capital gains if it sells 2013 or later.

How do I do this?

[Jon Holdman]

You should definitely discuss with your CPA. Maybe one of the CPA folks who post here will respond.

My understanding is that if you truly sell, even with an installment sale, it would qualify for the primary residence exclusion. I assume that's what you're dealing with. The two of five years rule. And that you're running out of the three year time limit to sell. I don't know for certain, but I believe even with the installment sale, you would get the exclusion of tax on the gains.

Keep in mind the three year time limit has nothing to do with calendar years. Its an exact limit starting from the day you move out. You must have lived in the place for 365x2=730 days out of the last 365x5=1,825 days before the sale. (I'm sloppy, the calculation is exact.)

With an installment sale, you only recognize the money as it actually comes in. Each payment is partly your basis, partly your gain, and partly interest. Depreciation comes into play, too. There was a discussion a while back on this topic. Here's that thread:

http://www.biggerpockets.com/forums/51/topics/64150-installment-sale-tax-treatment-question

Good luck figuring out how this works from that thread. All I know is that I don't understand it. I would discuss such as situation with my CPA and be sure he understood and approved what I was doing and then let him sort it out.