Rent back /post occupancy agreement

[Mastermind33]

Hi,

I've buying a house and the seller wants to execute a rent back agreement. The agreement is going to allow them to stay up to 120 days beyond (I realize this a mortgage no-no) the closing date. If the rent back cash (PITI) is not taxable, but a reduction in purchase price, what's the length of time that the IRS would deem this to be the case? 60 days? If it was open-ended someone could be in a rent back situation for 30 years and never claim profit? That doesn't seem right and contradicts what I've seen on this board.

Thanks for your input.

[Opus 17]

@Carl   @Hal_Al   @DoninGA 

There are other experts who may have better opinions than I.

The main issue is that most rent-backs are for the mortgage payment, and not true fair market value.  When renting at below fair market value, you can't deduct any expenses that are more than the rent, so reporting schedule E rent just creates paperwork that is of no ultimate benefit to you.  The IRS's ideas on what constitutes rental income don't have to align with the mortgage lender's idea of rental, so the fact that you might be in default of your mortgage for renting back more than 60 days won't, by itself, trigger the IRS to want a schedule E.  And even if the IRS did get wind of the arrangement and ask for a schedule E, you would only be showing zero net income.  (The final difficulty is you might have a small amount of depreciation that you could not deduct on schedule E but would have to deal with when you sell the house.  Someone else may have a better opinion on that.)

On the other hand if you are renting at or near FMV, you should definitely report the rental income and deduct your expenses.  You will obviously need to maintain full insurance coverage, and there may be other things you need to do do protect yourself.  If your "renters" can't find their own house in the next 120 days, you may find it unexpectedly difficulty to get them out, especially with COVID restrictions on eviction in most places right now.  

[Carl]

Not required to report, at least not as SCH E income. See topic 704 at https://www.irs.gov/taxtopics/tc704 for the depreciation aspects. All criteria are not met.

Does not meet item #2 which states "it must be used in a business or income producing activity". The buyer has no such business or activity. This rent back was a part of the sales contract/agreement. Not a contract separate from it.

Does not meet item #4 which states, "it must be expected to last more than a year". One issue here is that "it" is not clarified. Is "it" the business? (which the buyer does not have any such business) Or it "it" the asset? Either way, the asset is not required to be depreciated since the period of rent back started and ended in the same tax year with no intention of making a profit.