indididual owns land with a residence and farm located on the land. developer wants to purchase the land and put a shopping center on the land. a contract is consumated in which the prospective purchaser has the right to purchase the land within a three year period, after which the owner has the right to back out. for this priviledge, the buyer pays non-refundable deposits to an escrow fund that subsequently pays out monthly payments to the seller. if the propective buyer buys the property within the terms of the contract the deposits are applied to purchase price. this goes on for three years. at the end of the three year contractual period the buyer fails to buy the property and forfeits all the deposit money.
is there any way the deposit income could be considered capital gain income instead of ordinary?
is the income all reportable in the year that the contract runs out?
i assume that the farm income averaging method would have no relevance in this situation.
any relevant code section information would be greatly appreciated.
>>any relevant code section information would be greatly appreciated<<
I forget where to look it up. I think the sale of an option is capital gain if the underlying property is a capital asset. Apparently your case calls for installment treatment with zero basis.
(b) Failure to exercise option. If the holder of an option to buy or sell property incurs a loss on failure to exercise the option, the option is deemed to have been sold or exchanged on the date that it expired. Any such loss to the holder of an option is treated under the general rule provided in paragraph (a) of this section. In general, any gain to the grantor of an option arising from the failure of the holder to exercise it, and any gain or loss realized by the grantor of an option as a result of a closing transaction, such as repurchasing the option from the holder, is considered ordinary income or loss. However, for the treatment of gain or loss from a closing transaction with respect to or gain on the lapse of an option granted in stock, securities, commodities or commodity futures, see section 1234(b) and ?1.1234-3. For special rules for grantors of straddles applicable to certain options granted on or before September 1, 1976, see ?1.1234-2.
>>would the payments then be treated as ordinary income<<
A capital lease is treated as a purchase, so you would allocate any payments to basis, gain, and interest in the normal way. Report on Form 6252 if appropriate.
I can't answer about the seller remaining on the property. It depends on what the contract says. Is he a tenant, a caretaker, a partner or co-owner, a squatter.... ? Maybe he is just protecting his collateral, or maybe he is retaining all his ownership rights and obligations until some future event.
Well, okay I guess if that is what the contract says. Doesn't quite sound right to me. At least from the buyer's point of view it looks like he no longer has the right to sell it to anybody he pleases.
Go ahead and treat it as ordinary income from an option. Just don't try to avoid capital gains when he sells later by saying the low residual price was an arms-length transaction at FMV.
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