Bookkeeping for Master Lease Option

[Michael Myers]

Hey guys, interesting situation here. We just got some properties under a master lease option. We paid the lease option down payment and are taking over operation. We structured the contract in such that we realize the monthly loan pay down over the term of the lease option, so at the end of the term we will only owe what is remaining on the in-place loan (our lease option down payment was the difference between the purchase price and what is still owed on the seller's loan).

My question is: how do I account for this in my bookkeeping? Is the lease option money an expense, or do I log it similar to a down payment on an asset? And what about monthly payments: are they simply classified as a lease expense, or is there some funny business due to the split between principal and interest since we are essentially decreasing our final purchase price with each month paid?

Hope you can help! Thanks!

[Steve Vaughan]

Cool. Haven't seen an MLO in a while. I'm no CPA but here's how I'd do it. 

The consideration you paid for the Option is like a down payment tax-wise.  Irrelevant except to your overall cost basis unless you later don't exercise your Option and close the purchase. 

The lease payments are just that.  The lower price you pay later is to your cost basis.  

Rents come in, lease payments go out, what you actually pay for it in the end plus improvements you make and consideration paid is your cost basis.  Keep it simple👍

[Michael Myers]

Quote from @Steve Vaughan:

Cool. Haven't seen an MLO in a while. I'm no CPA but here's how I'd do it. 

The consideration you paid for the Option is like a down payment tax-wise.  Irrelevant except to your overall cost basis unless you later don't exercise your Option and close the purchase. 

The lease payments are just that.  The lower price you pay later is to your cost basis.  

Rents come in, lease payments go out, what you actually pay for it in the end plus improvements you make and consideration paid is your cost basis.  Keep it simple👍

@Steve Vaughan thanks for the input! That’s what I was thinking, but wanted to make sure I wasn’t missing anything.
I'm guessing I then don't take any depreciation until I exercise the purchase option, at which point I start depreciating on the normal 27.5 yrs for SFR based on my final cost basis which includes my initial option money.

[Steve Vaughan]

Yep, can't depreciate until you own it.  Then your total cost minus land value / 27.5👍

[Bill Walston]

So...I'm not privy to your specific tax situation, but based on what you've laid out in your post this reads more like a purchase than a lease with an option.  The Service would look at substance over form.  If you haven't already, you should check with your accountant on how he suggests you "book" this transaction.