REVENUE PROCEDURE PROVIDES OPTION METHOD OF ACCOUNTING FOR RENT-TO- OWN CONTRACTS.

Rev. Proc. 95-38

SECTION 1. PURPOSE

This revenue procedure implements an administrative decision of the Commissioner to provide an optional method of accounting for certain rent-to-own contracts (as defined in section 3).

SECTION 2. BACKGROUND

.01 Sections 61(a)(3) and (5) of the Internal Revenue Code provide that, except as otherwise provided by law, gross income means all income from whatever source derived, including gains derived from dealings in property and rents.

.02 Section 1.61-6 of the Income Tax Regulations provides that gross income includes gain realized on the sale or exchange of tangible property.

.03 Section 1.61-8 provides that gross income includes rentals received or accrued for the use of personal property.

.04 Section 1231 provides for the treatment of section 1231 gain as capital gain and section 1231 loss as ordinary loss.

.05 Gain or loss on the disposition of property held both for sale and lease is not treated as section 1231 gain or loss. See Rev. Rul. 80-37, 1980-1 C.B. 51.

.06 The characterization of a transaction as a sale or a lease for federal income tax purposes is based on the facts and circumstances of each transaction, including factors such as the intent of the parties as evidenced by the contract entered into by them and whether the burdens and benefits of ownership of the property have passed to the purported purchaser. See, e.g., Larsen v. Commissioner, 89 T.C. 1229, 1267 (1987); Haggard v. Commissioner, 24 T.C. 1124, 1129 (1955); see also Rev. Rul. 55-540, 1955-2 C.B. 39. This characterization is determined by an examination of each individual transaction.

.07 In a typical rent-to-own transaction, a rent-to-own dealer enters into a contract with an individual for the use of consumer durable property for a period of not more than three years. The individual is under no legal obligation to make all the scheduled payments under the contract, but may acquire the property if all the payments are made. Typically, a substantial portion (and in many cases, a majority) of a rent-to-own dealer's contracts terminate with the return of the property to the rent-to-own dealer.

SECTION 3. DEFINITIONS

.01 A "rent-to-own dealer" is a person that, in the ordinary course of business, regularly enters into "rent-to-own contracts" with customers for the use of "consumer durable property," provided that a substantial portion of those contracts terminate and the property is returned to such person before the receipt of all payments required to transfer ownership of the property from such person to the customer.

.02 "Consumer durable property" is tangible personal property generally used in the home, including televisions, video cassette recorders, stereos, camcorders, appliances, furniture, washing machines and dryers, refrigerators, and other similar consumer property. Consumer durable property does not include, for example, real property, aircraft, boats, motor vehicles, or trailers.

.03 A "rent-to-own contract"

(1) is a contract between a rent-to-own dealer and a customer who is an individual;

(2) is for the use of an item or items of consumer durable property;

(3) is titled "Rent-to-Own Agreement" or "Lease Agreement with Ownership Option," or uses other similar language;

(4) denominates the rent-to-own dealer as the "lessor" and the customer as the "lessee," or uses other similar language;

(5) provides for a weekly or monthly payment period and a level payment rate;

(6) provides that legal title to an item of consumer durable property remains with the rent-to-own dealer until the customer makes all the weekly, or monthly, or early purchase payments required under the contract to acquire legal title to the item of property;

(7) provides a beginning date and a maximum period of time for which the contract may be in effect that does not exceed 156 weeks or 36 months from such beginning date (including renewals or options to extend);

(8) provides for level payments within the 156-week or 36-month period that, in the aggregate, generally exceed the normal retail price of the consumer durable property plus interest;

(9) provides for payments under the contract that, in the aggregate, do not exceed $10,000 per item of consumer durable property;

(10) provides that the customer does not have any legal obligation to make all the weekly or monthly level payments set forth under the contract, and that at the end of each week or month the customer may either (a) continue to use the consumer durable property by making the next weekly or monthly payment, or (b) return such property to the rent-to-own dealer in good working order, in which case the customer does not incur any further obligations under the contract and is not entitled to a return of any payments previously made under the contract; and

(11) provides that the customer has no right to sell, sublease, mortgage, pawn, pledge, encumber, or otherwise dispose of the consumer durable property until all the payments stated in the contract have been made.

SECTION 4. SCOPE

This revenue procedure is limited solely to rent-to-own contracts entered into by rent-to-own dealers for consumer durable property, as these terms are defined in section 3.

SECTION 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.

SECTION 6. COST RECOVERY

See Rev. Rul. 95-52, this Bulletin, with respect to the recovery through the deduction for depreciation of the cost or other basis of consumer durable property subject to rent-to-own contracts.

SECTION 7. MANNER OF MAKING CHANGE OF ACCOUNTING METHOD

The tax treatment of rent-to-own contracts provided in this revenue procedure constitutes a method of accounting. A rent-to-own dealer currently treating its rent-to-own contracts in a manner inconsistent with this revenue procedure (e.g., as sale transactions) must seek the Commissioner's consent if the dealer wants to change its method of accounting to treat such contracts as provided in this revenue procedure. A change in method of accounting for rent-to-own contracts within the scope of this revenue procedure is a change of accounting method to which sections 446(e) and 481 apply, and must be made in accordance with Rev. Proc. 92-20, 1992-1 C.B. 685.

SECTION 8. INQUIRIES

Inquiries regarding this revenue procedure may be addressed to the Commissioner of Internal Revenue, Attention: Office of Assistant Chief Counsel (Income Tax and Accounting) CC:DOM:IT&A, 1111 Constitution Ave., N.W., Washington, D.C. 20224.

SECTION 9. DRAFTING INFORMATION

The principal author of this revenue procedure is Edward Schwartz of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue procedure, contact Mr. Schwartz at (202) 622-4960 (not a toll-free call).