Lease with option to purchase house - Is it a sale or rent?

Client purchased several houses that he is renting with option to purchase. He is mostly doing this for friends and family who can't get financing. So he buys a property and he has an agreement that is "Lease with purchase option" drawn up for the friend or family member. Each agreement is as follows:

Tenant pays 10k down as consideration for landlord to not sell to anyone else for 3 years
Tenant pays all repairs
Landlord pays insurance, but tenant has to reimburse landlord for the insurance (so in other words the tenant really pays for it but it's in the landlord's name)
Tenant pays monthly "lease" for 6 years, and at anytime during the 6 years he can exercise the option to buy for $70,000 (less any "lease payments" made and pay the balance then. Or - if they just pay the monthly amount for 6 years - they own it with no extra money due at the end. Now if the tenant quits paying or moves out - he's basically like any other renter - property belongs to the landlord and the tenant gets nothing back.

The amount of the total if they pay the entire 6 years amounts to 70,000 with 5.5% interest.
So for tax purposes - is this a rental or is this an installment sale? Title does not transfer to the tenant/buyer until the entire amount is paid for.

Looks like an installment sale to me -- because the purchase price does not reflect FMV.

I agree with installment sale, particularly with the interest component and the $10k "option" down payment. Here's a good little article:

https://www.ccim.com/cire-magazine/articles/lease-option-or-installment-sale/

Rev. Rul. 55-540 provides guidelines to be used in determining whether a particular contractual arrangement constitutes a purchase or a lease. It states that the arrangement is a purchase if one or more of the following conditions is/are present:

(1) Portions of the periodic payments are made specifically applicable to an equity to be acquired by the lessee;

(2) The lessee will acquire title upon the payment of a stated amount of “rentals” which under the contract he is required to make;

(3) The total amount which the lessee is required to pay for a relatively short period of use constitutes an inordinately large proportion of the total sum required to be paid to secure the transfer of the title;

(4) The agreed “rental” payments materially exceed the current fair rental value. This may be indicative that the payments include an element other than compensation for the use of property;

(5) The property may be acquired under a purchase option at a price which is nominal in relation to the value of the property at the time when the option may be exercised, as determined at the time of entering into the original agreement, or which is a relatively small amount when compared with the total payments which are required to be made; and

(6) Some portion of the periodic payments is specifically designated as interest or is otherwise readily recognizable as the equivalent of interest.

It looks like several of these conditions are present. I agree with the others that this is an installment sale.

My guy this year has lease to purchase on three custom homes, one of them have a $10,000 deposit. After seven years it can be purchased for for $140,000 - the deposit and a small portion of the monthly payments. I do not think the #6 would ever allow this to be a sale - not close to being nominal. So all is called rent, an if it closes with the offset comes out of the rent. The other two were for purchase have more nominal deposits with the same split for the monthlies, I am still going for all rent until the closing for/if sale!! The end purchase prices even with the offsets is still $100,000+.

He thinks most will be renegotiated!!

One question I have here is about timing. I don’t disagree that it smells like a sale, but then we have this:

Tenant pays 10k down as consideration for landlord to not sell to anyone else for 3 years

It’s that 3-year clause that might need some exploration. What exactly happens when the 3-year clock stops ticking? I find the facts to be potentially confusing. On the one hand, seems the landlord could sell the property to anyone after 3-years. But then we have this:

Tenant pays monthly "lease" for 6 years, and at anytime during the 6 years he can exercise the option to buy for $70,000

Is this clause more or less acting as a right of first refusal, as to purchasing the property by the tenant?

Is this the deal: In the first 3-years, if there is a real sale, landlord can only sell to the tenant pursuant to the tenant exercising his purchase option. After 3-years, the tenant still has the purchase option, but the landlord could sell to anyone. It’s just that landlord can’t sell to anyone IF the tenant is notified of the pending sale to the outsider and the tenant therefore decides to exercise his purchase option.