What is the proper treatment of seller rent back included in closing statement for purchasing a rental property?

[VM1]

There are two alternatives:

1. Show rent back as rental income 

2. Decrease the cost basis by the rent back (and not show it as rental income).

Which one is the correct alternative?

[PatriciaV]

Yes, you have two options for reporting a Rent-Back Agreement when purchasing a Rental Property.

1. Treat this as a reduction in the purchase price. This will lower your cost basis, which may be a factor when you sell the property in the future (increased gain on the sale).

2. Report this as Other Income on Line 21 of Form 1040. Most experts agree this is the more "correct" option. However, you are limited to reporting no more expenses than the income you enter for Line 21. See the instructions below for this option:

https://ttlc.intuit.com/replies/6686826

[zhongjp058]

Can you share any IRS reference for option #1, which states we can "Treat this as a reduction in the purchase price". Searched around Publication 527 Residential Rental Property and only see option #2.

Also if we can use option #1, does it apply to Primary Residence (not only Rental Property ) as well?

[PatriciaV]

Option #1 is an opinion based on professional experience. Please see the discussion on this post for more info: <a rel="nofollow" target="_blank" href="https://ttlc.intuit.com/replies/5520294">https://ttlc.intuit.com/replies/5520294</a>

[VM1]

Patricia, I haven't received any 1099-MISC in connection with the transaction. I have several expenses related to this income -- the annual depreciation, home warranty, home insurance, home inspection, car mileage, HOA etc. So I am doing Schedule E to show the income and expenses. Is that correct?

[zhongjp058]

@TurboTaxPatriciaV Thank you!

I trust the professionals but just want to make sure this option is safe without paying penalty to IRS, as I did not see IRS reference which states this is an option.

I went through Publication 523, page 13, Worksheet 2, Item 5, Determine your “basis adjustments” - which are the list that I can subtract from the cost basis. But I did not see an item regarding to the rent-back income. Also checked Publication 551, Basis of Assets, and did not find anywhere states it.

Can you help again to show me the section in IRS publication which mentions this rent-back income can be treated as reduction of the cost basis? Appreciate your help.

[PatriciaV]

@zhongjp058 There is no IRS reference for the cost basis adjustment. Per the post reference in my prior comment, this is a choice based on professional opinion.

[PatriciaV]

@VM If you wish to report expenses related to this income, you would choose to report the activity on Schedule E rather than as Other Income.

[zhongjp058]

@TurboTaxPatriciaV Thank you very much for your answers! It helps a lot!