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Rent-to-own reporting




I have a new client that started a retail, rent-to-own business. Never have dealt with the rental industry before. Individuals rent consumer products (TVs, furniture, etc) by the week. If they stop the weekly rent the merchandise must be returned. The consumer contract is typical for their industry and reflects the 7-day rental. The customer can buy the product any time they want for a specified price, which, of course changes over time. Question - There are significant services related to the rental activity. Employees, delivery, retail location, etc. I assume that revenues from this activity appear on the business tax return as "Sales" rather than on a rental schedule as "rental income". Does that sound right?

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I think you will have rental income and depreciation of the items being rented. When a purchase is made the item is booked back to inventory at NBV and you book a sale with COGS. Its all ordinary income so recapture provisions do not apply. All of this is trade or business income, not treated as passive rental income.

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Schedule C

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Does anyone know how would income be booked from a typical RTO transaction? I looked at Rev. Proc. 95-38 and am a tad confused. Would the company report income as it is received on the contract? Must the company be on the overall accrual method? In the RTO contract, I can't imagine that the entire gain would have to be recognized at the beginning of the contract. The taxpayer will depreciate the rented asset over 3 years pursuant to Section 168(e)(3)(A)(iii). Any help with determining how income is reported for tax purposes would be appreciated as the RTO is confusing me.

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REV. PROC. 95-38 SEC. 5. TAX TREATMENT .01 A rent-to-own dealer may report the income, gains, and losses from rent-to-own contracts within the scope of this revenue procedure as follows: (1) Income (other than gain or loss described in section 5.01(2)) derived from those contracts is included in gross income as rental income pursuant to sections 61(a)(5) and 1.61-8; and (2) Gain or loss on the sale or other disposition of consumer durable property (including gain or loss from an early purchase payment described in section 3.03(6)) subject to those contracts is not treated as section 1231 gain or loss. .02 The tax consequences of transactions structured by the parties as leases will be analyzed under applicable law without regard to this revenue procedure if: (1) The transactions are not within the scope of this revenue procedure; (2) The rent-to-own dealer does not report all items of income, gain, and loss from the rent-to-own contracts as specified in section 5.01; or (3) The rent-to-own dealer does not apply the tax treatment described in section 5.01 of this revenue procedure to all its rent-to-own contracts within the scope of this revenue procedure."
Are the contracts being treated as leases or not?

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My understanding is that the IRS has retreated on their assault that the RTO contract constitutes an installment sale and that income must be recognized upfront. I believe that Grauel Enterprises, I think of the 10th Circuit, asked the IRS for a ruling back in the 1990s regarding this very issue and, for the life of me, I can not find anything authoritative confirming this issue. I know that Grauel signed onto the ABC Rentals case, through an amicus curiae, but that case did not address the installment method. There is very little authoritative literature about RTOs that I can find and, obviously at lot at stake. I believe an RTO can use the cash method and the IRS would be very reluctant to upset this apple cart unless the "keep rate" is less than 50%. I'll be darned if I can find anything to hang my hat on.

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Sorry, I meant to say that the "keep rate" exceeds 50%.

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"rentals received or accrued" is from Reg 1.61-8, I would interpret that to mean as received and or due, therefore, the total contract is not reported until paid or the payment is due. The other option is if the contract is treated as a lease under local law.

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The events that fix the right to receive income under the accrual method of accounting occur when: (1) the required performance occurs, (2) payment is due, or (3) payment is made, whichever happens first. The payment is not due until?

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REV. PROC. 95-38 SEC. 5.01 is exactly what I described above in simpler terms. Sorry I didn't have time to find a cite. Thanks for that RoyDaleOne.

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RDO .... the typical contract is three years and payments are made weekly. The difference with the RTO industry is that the customer is not obligated for any payments beyond the one made last week. At the end of this week the customer chooses to to make a payment or return the goods. The IRS has tried, in the past, to recharacterize the transaction as an installment sale. If a company has a track record of most contracts going to completion the IRS would have ammunition to mount that assertion. My understanding is that more than 50% of contracts never reach their three year conclusion because they are returned or purchased outright during the term. I can't see any reason why an RTO dealer couldn't use the cash method as the revenue from the store is expected to be less than $1,000,000. Any flaws in my choice of the cash method?

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There is an or "received or accrued" so it follows under the accounting method of the taxpayer it would be received for a cash method taxpayer or due under the accrual method.

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So would you would you put the sale/cash-optioned RTO assets? Schedule A (CGS) or Form 4797? Schedule A never works out mathematically because the NBV of the inventory/RTO assets is getting smaller each year. If you could subtract depreciation on Schedule A it could work out mathematically. But Schedule A wants you capitalize depreciation.