Expert: John Stancil, CPA - 2/13/2006

Question
We are buying a new home.  We have not sold our current home yet, but we have someone (a friend of the family) interested in it.  My husband has thought about selling the house on a "rent-to-own" contract.  The friend would still put a down payment on the purchase price, and then make mortgage payments to us (we would then send the payments on to our bank).  My question is, do we claim the down payment as income on our tax returns?  We are using the money to put down on the new home.  Also, will the payments our friend makes to us be considered income?  We were just going to have him pay our mortgage payment amount.  We aren't looking for any other profit than what our home is worth.  Thank you for your help!  

Answer
Cindy,

Thanks for your question.

You need to consult an attorney or real estate agent and determine if you are renting the house or selling it.  What you have described is a hybrid between the two, and that does not work for tax purposes.  It needs to be a sale or a rent with option to buy.  Some states allow what is referred to as a "land contract" sale which is basically what you seem to be seeking.  But a land contract is, at the heart, a sale.

If you have lived in the house for 24 of the past 60 months as your principal residence, you will not owe any tax on up to $500,000 of gain from the sale, assuming the transaction qualifies as a sale.  However, you will be taxed on the interest received from your buyer.

If the transaction is characterized as a rental contract, the "down payment" would likely be characterized as a deposit with no tax consequences.  The payments he makes to you would then be characterized as rent which is taxable to you.  However, you may deduct expense involved in the rental, including depreciation on the house.  However, if you sell the house outside the 24/60 month window, you would no longer qualify for exclusion of the gain on the sale.

Hope this helps.

John Stancil, CPA