Tax Information for Renting With the Option to Buy

When you rent a house with an option to buy, commonly called a "lease purchase option" or a "rent-to-own" arrangement, you don't just get an option to buy. You also get the right to own the property some day and to claim the deductions on it. As long as you're renting it, though, your ability to claim tax deductions are limited.

Lease Payment Deductions

The Internal Revenue Service recognizes two major classes of deduction for your home. As long as you itemize your deductions on Schedule A, you can write off your mortgage interest and your property taxes. However, lease payments aren't deductible, even if you have an option to buy the property. You may, however, be able to claim a renter's credit if your state offers one.

Paying Property Taxes

Some lease options require you to pay the property taxes while you occupy the building. Even if you're doing this, you still can't write off the taxes you pay. The IRS requires you to own the property on which you pay taxes to write them off. Until you exercise your option, you aren't the owner.

When You Buy

The money you pay into your lease option comes into play when you become a homeowner. It gets added to your purchase basis, which you can then use to reduce your capital gains liability if you sell your property for a profit in the future. For example, if your purchase price is $150,000, but you also paid a $5,000 option fee and $250 per month for 24 months, your cost basis would be $161.000 -- the $150,000 purchase price plus the option fee plus the $6,000 in monthly accruals. This higher cost basis gets subtracted from your net selling price to determine your taxable profit at sale, if any.

Reclassification

Sometimes, the IRS steps in and reclassifies your rental with an option to buy as an installment sale. This would happen if the transaction is set up in a way that it really appears as if you bought the property, instead of having you rent the property and maybe buy it. In this instance, your payments would be treated as installment sale payments, and you could be able to deduct some or all of them. While this is relatively rare, terms like lease payments that are much higher than fair market value, clauses requiring you to repair or maintain the property above and beyond what a normal tenant would do, or a very low purchase price could all trigger a reclassification.