Land Option

Today TaxMama hears from Jacqueline in the TaxQuips forum with this interesting question. “I own several acres of raw land. Several years ago a developer began to pay me a yearly amount for 4 years (as an option to purchase the land for a set price). I was advised not to report this income until the sale of land was final. The developer now has backed out of the deal and I retain full ownership of the land. How do I go about reporting this income now? The land never sold.”

Hi Jacqueline,

 That’s an interesting question. And I’d be interested to see some other opinions.

 Here are two ways to report the option.

 1) As sale of an Option.

Long Term Capital gain – The full amount of the payments you received.

Cost or basis – Zero.

It’s possible that this may generate a 0% tax, or up to 15%, if you report it on a  2010 tax return, depending on your tax bracket.

 2) Reduce the basis of the property. When you sell the land, your gain will be accordingly higher.

 Without doing some time-intensive research, I was not able to find a quick reference for you.

But I think either of these two ways to report the income will be acceptable to IRS.

 Let’s see if anyone else has some other ideas.

And remember, you can find answers to all kinds of questions about land options, and other tax issues, free. Where? Where else? At www.TaxMama.com.

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One thought on “Land Option

  1. David Toelkes says:

    Jacqueline,

    Has the option term expired? I know you said the option payments started four years ago and that the developer has no plans to exercise the option at this time.

    My assumption here is that you sold a long term option and collected annual installment payments against the sale price. My response assumes that the option has either expired or will expire this year.

    For the tax year that the option expires, you report the sale of the option on Schedule D as a SHORT TERM capital gain. This is a short term capital gain (regardless of the term of the option) because your holding period for the option was less than one year when you sold it (more likely you created the option and sold it the same day).

    If the developer had decided to exercise his option, then the option premium you received would reduce the cost basis of the property at the time of sale, and your profit on the sale of the option would be rolled into the long term capital gain (or loss) realized on the sale of the property and taxed at long term capital gain rates.

    If my first assumption is wrong, and you really sold a one year option that was renewed (resold) each year for three more years, then you have three separate options that have expired and one that has either expired or is pending expiration. For each of the past three tax years, amend your tax returns to report the sale of each expired option for the tax year of expiration. The option proceeds will be a short term capital gain in each instance. The option that expires this year will be reported on your 2010 tax return.

    As an aside, the option is a capital asset in the hands of the developer. If the developer sells his long term option to someone else before it expires, the developer would have a long term capital gain (or loss) on the sale provided he owned the option more than one year prior to sale.

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