Rent to Own Taxation?

Question

A new client (S-corp) started paying for some fitness equipment in 2005 but did not take any deductions for it (don't know why). In 2006 they made the final payments and now they own it outright, over time paying 30% of the original purchase as a "rental" interest per the invoice.

Since they did not take any deduction in 2005, how should I handle the 2006 rental payments? There was no buy out in the end, just out right ownership.

Thank you.

Answer 1

You can't take the interest paid in 2005 as a deduction in 2006. I think a reasonable approach is to take the stated percentage of interest in the contract and deduct that as loan interest for payments made in 2006, in other words, 30% of payments made in 2006.

The owners of the property have been depreciating it, probably over 4 years. When title transferred to the S-Corp, the remaining basis is the basis for depreciation by the S-Corp, starting with the date the equipment was paid off. It will be depreciated by the S-corp over the remaining useful life.

They have lost the previous interest deduction.

Answer 2

Don't worry so much about what your client reports or fails to report. They may have set a precendent that all of their purchases are deducted when they take ownership of the product they purchase. IRS doesn't care so much as long as reporting is consistant and all income is reported and deductions taken when and if allowed.
Your responsibility is to make sure that the money you receive is taxed in the appropriate period. If you are on accrual basis and you know that you will receive the remaining income in 2006 then you should have report all of your income in 2005.
If you carry your books on cash basis, you report income in the period you receive it. THe part of the payments you received in 2005 you would record in 2005. The balance of the receivable you would report as 2006.