RTO Option Contract Credit Installments

[cwsherman]

Hi Everyone, I am new to the REIN family. I'm seeing a lot of controversy regarding the accountIng of the credit installments on an RTO. Are these installments treated as income or trust deposits during the interim period prior to formal verification of deposit for the lender? Many articles from prominent investors are indicating it is income. If the spread on the deal supports such "withdrawals" then it is recognized net income I'd think. If it is a trust deposit, then it wouldn't make sense to treat this as accounts receivable as it would be taxable. In addition, If a trust account is established from the get go, then the buyer/tenant has established equitable interest which You don't want to do. What is the right way to account for these installments?

 

[GaryMcGowan]

There are many ways to look at it.

On one hand it is rent until the T/B has exercised their option to purchase. Some T/B will not and some will take longer than others.

 

[smmcguire]

"If it is a trust deposit, then it wouldn't make sense to treat this as
accounts receivable as it would be taxable. In addition, If a trust
account is established from the get go, then the buyer/tenant has
established equitable interest which You don't want to do. What is the
right way to account for these installments"



As your question has yet to be answered, you are correct in assuming what is the legal direction of such a distinction " Equitable Interest ". I believe you would be best served to direct this question to the ASK AN EXPERT section and direct it to Barry McGuire, or seek some type of legal opinion.

I would be interested in the answer as it pertains to the RTO/LTO.

Steve

 

[Sherilynn]

It really depends on how your Option agreement is written, and depending on how they are written you may have a choice as to whether you would like to account for deposits as current income or a current liability against income which has not yet been earned.



If your deposits are refundable, then the deposits should be counted as a liability (like prepaid rent would be) and only transferred into income when the transaction completes (at which point the income has been earned). If your deposits are non-refundable (or mostly non-refundable) then you have a choice.



There are pros and cons to each method. If you count them as income now, you must pay taxes on them now. This may however reduce your tax bill later. If you count them as a liability, then you have more cash on hand now.



The main thing is to be consistent. Once you have chosen to count them as income, then you should always count them as income.



BTW, option credits are not like security deposits in that you do not need to hold them "in trust" unless you want to establish them as being purchase deposits. Only then would they constitute "equitable interest." Again, the wording in your contracts is important here. Barry McGuire's "Deal ready documents" could be a worthwhile investment for you.

 

[cwsherman]

Hi Sherilynn,



Thanks for the detailed reply. I now understand the difference in the two choices with regards to accounting, and the respective ensuing connection to the contract engaging the Optionee. I will look into Barry McGuire's literature as you suggest as well.

 

[Sherilynn]

My pleasure.