How are option fees taxed?

[Ernie Hogue]

Hi BP community. I searched in the Tax and Legal forum, but didn't see this question answered specifically. I am trying to determine how lease option up-front option fees are taxed. My understanding is that they are reported as "Miscellaneous Income" to the IRS, but I can't figure out how this income is categorized. It seems that is might be classified as rental income (therefore passive) under Sect 1.61-8 of the Treasury regs, but I am way out of my area of expertise here.

Can anyone who has successfully completed lease-option projects or has experience with reporting your option fees provide an outline of how those fees were treated for tax purposes?

Thank you in advance,

Ernie

[Ashish Acharya]

Originally posted by @Ernie Hogue:

Hi BP community. I searched in the Tax and Legal forum, but didn't see this question answered specifically. I am trying to determine how lease option up-front option fees are taxed. My understanding is that they are reported as "Miscellaneous Income" to the IRS, but I can't figure out how this income is categorized. It seems that is might be classified as rental income (therefore passive) under Sect 1.61-8 of the Treasury regs, but I am way out of my area of expertise here.

Can anyone who has successfully completed lease-option projects or has experience with reporting your option fees provide an outline of how those fees were treated for tax purposes?

Thank you in advance,

Ernie

In a simple option to buy real property, one person (the “grantor”) grants to another person (the “holder”) the right, for a fixed period of time, to buy the real property under stipulated terms. In exchange, the holder pays the grantor an agreed-upon sum. For the grantor, the main tax benefit is that he or she receives the amount paid for the option without incurring income tax at that time. That's because there are no tax consequences to the grantor until the option lapses or is exercised.

If the option lapses (that is, the holder chooses not to buy the real estate), the grantor has income equal to the amount paid to him or her for the option.

If the option is exercised by the holder (that is, the holder buys the real estate), the sale proceeds for purposes of determining the grantor's gain or loss on the sale of the real property includes the amount the grantor received for the option.

The grantor's tax deferral can only be achieved if the agreement is a true option.