Can I Deduct Interest on a Rent to Own?

Rent-to-own contracts allow people with poor credit or no down payment saved an opportunity to work towards homeownership. There are both benefits and downsides to signing this type of contract. Taxpayers in this situation often find themselves confused as to how a rent-to-own contract is handled for tax purposes.

Each rent-to-own contract is different but, essentially, the contract allows a person to rent a home that she eventually plans to purchase. A portion of the rent paid every month is set aside in a fund to become a down payment on the eventual purchase of a home. The contracts can vary in length but are three years long on average. A rent-to-own contract does not convey any ownership of the home to the renter until the contract ends and all stipulations have been met. The contract simply represents a legally enforceable option to purchase the house. If the renter defaults on payments, the contract can be voided and the renter evicted.

The Internal Revenue Service allows a deduction on personal income taxes for interest paid on a mortgage for those who itemize their deductions. To qualify for the mortgage interest deduction, you must have interest on debt secured by your first or second home. This can include vacation homes, for example. A rent-to-own contract does not represent an eligible mortgage in the eyes of the IRS because you do not have any ownership stake in the home before the end of the contract.

The federal government often provides credits to first-time or repeat home buyers as an incentive to purchase a home. At the time of publication, there are no current home buyer credits but that may change at any time. Rent-to-own contracts have never qualified for home buyer credits as title to the property has not transferred to the renter. Future versions of the home buyer credit may include these types of contracts.

If you have a rent-to-own contract and you have a home-based business, you may be able to deduct a portion of your monthly payments. To be eligible for the home office expenses deduction, your home office has to be your main place of business or you must see clients or customers there consistently. If your home office qualifies, you can deduct a portion of your household expenses, including your rental payments, against your business income. The portion of the payment that relates to the eventual down payment is not deductible.

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