Rent to own real estate

Discussion in 'Homesteading Questions' started by Mullers Lane Farm, Jun 7, 2004.

  1. Mullers Lane Farm

    Mullers Lane Farm Well-Known Member

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    Does anyone have any experience with a rent to own option for real estate?? (Either as a seller or a buyer??)
     
  2. bare

    bare Head Muderator

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    Do you have specific questions?
     

  3. boxwoods

    boxwoods Well-Known Member

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    called a lease-option

    Problem is, that there is no law that will enforce the seller to sell or the buyer to purchase at the end of contract. If the value of the property goes up, the seller might opt to ask more money for the property.
     
  4. RAC

    RAC Guest

    You can write whatever you want in the contract as far as purchase price, and enforce it like any other contract. What you might have a problem with down the road is say real estate prices dropping in the area and the bank appraisal not coming out to your original price.
     
  5. bare

    bare Head Muderator

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    What is a lease-option? A lease option is a combination real estate rental, sales tool and finance technique. It is most frequently used with single family rental houses. But it can also be used with condominiums, commercial properties, vacant land, and even entire apartment buildings. The property is leased for a fixed period, such as 12 or 24 months, with the tenant having the option to buy the property at a fixed price. The amount paid for the option can be any sum agreed upon by the landlord and tenant.

    Sometimes the option can only be exercised after a fixed date, such as after the home seller becomes 55 and qualifies for the “over 55 rule” $125,000 home sale tax exemption. Unless so specified, the option to purchase can be exercised at any time during the lease term. Most lease options include a rent credit whereby part of the rent is credited toward the purchase price when the option is exercised. If the tenant does not exercise the option, the rent credit is lost.

    Pros and Cons of lease options.
    From the seller’s viewpoint a lease option rents the property to a high-quality tenant who usually treats the property very well because the tenant expects to own it someday. The lease option rent is usually higher than market rent, thus providing adequate income for the seller to make the mortgage payments and pay operating expenses. The option price also is usually at the top of the market value range. Since there is always a shortage of lease-options, tenant-buyers are often willing to agree to an option price at, or sometimes slightly exceeding, the current market value. However, it’s best not to get greedy if you are the seller.

    During the lease term, the landlord is entitled to the income tax deductions for expenses such as mortgage interest, property taxes, insurance, repairs, and even depreciation. You should consult your tax advisor Before entering into a lease-option if you plan to use either the “rollover residence replacement rule” tax deferral of Internal Revenue Code 1034 and /or the “over 55 rule” $125,000 home sale tax exemption of Internal Revenue Code 121.

    If the seller gives the tenant-buyer an adequate rent credit toward the purchase price, the tenant will usually buy the property rather than walk away from the rent credit. Typical rent credits range from 10% to 100% of the rent paid. The higher the rent credit (and the non-refundable option money), the greater the probability the tenant will exercise the purchase option.

    From the buyer’s viewpoint, lease options are especially advantageous because little up front money is all that is required to move in. Usually, just the first month’s rent plus the nonrefundable option money is all that is required to move in. A major advantage is the buyer gets to try out the property before purchasing. However, since the tenant-buyer has not yet exercised the purchase option, the buyer is not entitled to any income tax deductions for the residence.

    During the rental period, the owner normally remains responsible for paying the mortgage, property taxes, insurance and repairs. However this is negotiable.

    I closed a lease option last year with a tenant who had rented under a lease option about five years previously. He had built up almost 20,000 in rent credits which was more than enough for a down payment. Giving them the option of exercising their option or losing their rent credits and moving out got them off the pot. They realized that they would be crazy to lose their rent credits.

    Make the terms reasonable. One to three percent of the asking price is usually sufficient for a lease option and should not be enough to scare off potential buyers.
    33% rent credit is fair to both buyer and seller.


    By the way, you could report the full rent received each month as rental income on Schedule E of your income tax return each year. When the option is exercised, since the rent credit income has already been reported to the IRS, you then subtract it as a sales expense. If the tenant doesn’t exercise the option you’d have to report the option money as ordinary taxable income.

    What should be the term of the lease option? There is no right or wrong answer to this question. As a seller you should probably never agree to a term longer than 24 months and should gladly renew the lease option, reserving the right to raise the rent and increase the option purchase price. If you were the buyer you would look for as long a term as possible.
     
  6. Jena

    Jena Well-Known Member

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    I sold my house in California using a lease/option. The buyer's had some credit issues that would clear up during the lease time. I was also in a position where I had to do something FAST, so I did the deal.

    This was our deal.

    2 year lease. They paid $1000 per month rent. $125 per month went into a seperate savings account of mine. They had no control over that account, but could ask to see the statement at any time. They paid $1 for an option to buy when the lease expired. If they chose not to buy, I kept the money in the account. If they chose to buy, I was to forward the money to the escrow company (California uses escrows for real estate transactions) to credit towards their purchase money. They still had to come up with the rest of closing costs and down payment besides the money I was holding.

    In this case, because of their credit issues, I had it written in that if they were unable to secure a mortgage due to credit, that I still got to keep the money. I figured it was extra incentive for them to be good about their spending. Normally you would want something in there to address that possibility. If they try in good faith to get a mortgage, but cannot, then usually I think they get their money back. This is something to think about as interest rates are liable to rise in the near future, which could put your buyer out of a mortgage.

    We had a purchase price set, but you can also put something in there about that. If prices are likely to rise significantly, you might not want yourself locked into a low price. You can always have your purchase price set to be the appraised value at whatever future date.

    Here in the midwest, they do "rent to own" things that are not like lease/options that I am familiar with. I think landlords do this to avoid paying property taxes on the property, because they make these open-ended deals with folks who probably won't ever buy the place. Check with an attorney in any event.

    Jena
     
  7. RAC

    RAC Guest

    Just to tack onto what Jena said--it is great for people who have credit issues because it allows them over time to establish credit by paying their rent and other bills on time. Also good for the seller when they own the property outright, if they want steady income as opposed to lump sum. Make sure you have a "no-prepay penalty clause", if possible, although it is common for a prepay penalty in these sales for like the first year or two (which may not be an issue if you can't get conventional credit anyway).

    However, there are some shady types who deliberately prey upon people with credit issues, hoping they can't pay on time. Don't extend yourself just to buy a home only to lose it.
     
  8. Mullers Lane Farm

    Mullers Lane Farm Well-Known Member

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    Thanks for your replies. This helps a lot.

    I really would like to just sell this place and be done with it. I'm tired of having to go in and fix damaged woodwork, stained carpet, bathrooms & kitchens that look like they haven't been cleaned in a year or two.

    There are too many things to do on our own homestead that I'd rather put the time, energy and money into.

    Thanks again everyone.
     
  9. bethlaf

    bethlaf Homegrown Family

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    i think if you get your attornet to write up the contact, have it signed and notarized you will be ok , screen the people well !!!!!!
    anything makes you nervous, say sorry, i dont think it will work , remember you STILL own the home !!!, and yes, put a clause in the contract for breach , i knew of some losers in Wis who would do this, they would trash the place and leave, and they had no repercussions, cause it wasnt a true "rental"
    be carefull be safe !
    dont rent to anyone you dont like !
     
  10. Jolly

    Jolly Well-Known Member

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    We've got a guy down here, who is literally getting rich doing this kind of stuff.

    An attorney, he continually looks for properties that fit his niche - usually suburban, or rural properties fairly close to the city (and where he thinks growth will occur). He will buy the property, doing all the legal work himself. He will then rent it out, on a ten, or fifteen year lease.

    Part of the renters lease money goes towards the purchase of the property. The leasee is responsible for all repairs, and upkeep of the property. At the end of the contract period, the leasee will own the property.

    Here's the catch: How many people do you know that stay in the same place for 10, or 15 years? You vacate the property, you lose any "equity" you may have in it. You get behind in your payments 90 days, you are evicted, and lose all "equity" in the property.

    It does give people with poor credit the chance to own property, but those are exactly the kind of folks that you want to take this property. They are going to pay a higher rent than is normal for the market, and the chances of the owner losing the property are slim.
     
  11. RAC

    RAC Guest

    "you get behind in your payments 90 days, you are evicted, and lose all "equity" in the property."

    This happens with regular mortgages too. Nothing different there.

    When you do lease-option the renter is responsible for just about everything as far as maintenance.

    What Jolly mentioned is kind of strange, as far as the 15 years part. Also, the "vacate and you lose all the equity"--is that vacate for ANY reason? Usually, the option is only a window of 1-2 years, then you have to decide whether to buy or not, and at that point you enter into a mortgage. This almost sounds like just a plain lease.
     
  12. Jena

    Jena Well-Known Member

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    That's the "rent to own" thing I've seen out here. It is a rip-ff for the tenants, but they usually don't recognize that. The people I've seen in this type of deal are usually lower working class and they think this is the only way they will ever own a home.

    I think the landlords who do this are just trying to be landlords without the responsibilities of it. I would not participate in this kind of deal.

    Jena
     
  13. Bruce in NE

    Bruce in NE Well-Known Member

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    bare,


    Sometimes the option can only be exercised after a fixed date, such as after the home seller becomes 55 and qualifies for the “over 55 rule” $125,000 home sale tax exemption.

    What's this "over 55" tax exemption? Never heard of it before.l..

    bruce
     
  14. bare

    bare Head Muderator

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    Bruce, The financial and tax information I posted was current as of one year ago. I can't tell you that it is current information at this time, which is why one should always consult with a financial advisor and a tax person before entering into such an agreement. This stuff is constantly in flux. If my impression is correct, the over 55 years old rule and 125,000 has doubled in the last two tax seasons.

    Melissa on the Countryside forum is a tax preparer and could possibly enlighten us all if you could intice her here.
     
  15. featherbottom

    featherbottom Well-Known Member

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  16. Kirk

    Kirk Well-Known Member

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    The over 55 exemption does not exist anymore. Here is the new rule.

    By Robert J. Bruss, Tribune Media Services
    If you sold your principal residence after May 6, 1997, or plan to do so in 1998, you can reap up to $250,000 per qualified seller in tax-free profits.
    A married couple filing jointly can claim up to $500,000 exempt profits if both occupied the home at least two of the last five years before the sale. However, only one spouse need hold title. Two unmarried co-owners who both meet the two-year ownership and occupancy requirements can each claim $250,000 tax-free principal residence sale profits.

    What Is A Principal Residence? A principal residence is the taxpayer's primary dwelling, usually where he or she votes, files income tax returns, works, has a driver's or business license, and spends the most time (except for temporary absences, such as vacations). But a taxpayer cannot have more than one principal residence at a time. Under this new tax law, found in new Internal Revenue Code 121, each spouse can have a separate principal residence if they spend the majority of their time apart. But part-time vacation homes usually won't qualify as a principal residence.
    Profit Opportunity: Become A Serial Home Seller. This new $250,000/$500,000 home sale tax break can be used once every 24 months. The result is a new tax-free profit opportunity for buyers of fixer-upper houses, who buy at a bargain purchase price, move in, fix up the house to add profitable improvements, then sell after 24 months.
    There is no limit to the number of times this tax break can be used. Even home sellers who used the old, now-repealed "over 55 rule" $125,000 tax exemption or the also-repealed rollover residence replacement tax deferral rule can use the new $250,000/$500,000 exemption.

    Another option than rent to own is land contracts. In some states they make sense, in others they don't. With a land contract the buyer takes control and responsibility for the property and the seller acts as the bank. The plus for the seller is they can charge higher interest rates and sell the property faster. The buyer often has credit issues but can get into a land contract faster, with less money down and no credit check. At a later date the buyer may refinance to a traditional mortgage using the equity they have built as a downpayment. Often the land contract is set up with a balloon payment at 5 years, that way the seller only has to deal with it for a set period of time. When the balloon is due the buyers must get new financing or forfiet the house, the seller has the option of renewing the contract if the buyers have been prompt payers.

    Kirk
     
  17. RAC

    RAC Guest

    From Kirk:

    "Another option than rent to own is land contracts. In some states they make sense, in others they don't. With a land contract the buyer takes control and responsibility for the property and the seller acts as the bank. The plus for the seller is they can charge higher interest rates and sell the property faster. The buyer often has credit issues but can get into a land contract faster, with less money down and no credit check. At a later date the buyer may refinance to a traditional mortgage using the equity they have built as a downpayment. Often the land contract is set up with a balloon payment at 5 years, that way the seller only has to deal with it for a set period of time. When the balloon is due the buyers must get new financing or forfiet the house, the seller has the option of renewing the contract if the buyers have been prompt payers."

    That is very common with seller-owned properties--I've never seen that term (land contract) used in connection with it though, usually they're just referred to as being "owner-financed" with in this case, a balloon. Btw, there's nothing that stops the banks from charging higher interest rates except for competition from other banks (and they also get all the money from the fees). If you have bad credit you will not get the lowest rates from the bank, anyway.

    You can close in a week or so with a conventional mortgage if you have worked before with a lender (so everything is on file already) and can get any inspections you want taken care of in time. As to credit checks, unless the seller is really seedy and wants you to default, they will run a credit check on you, just to see how much of a risk they really want to take, and what they're getting into with the buyer.

    And always remember, if something is offered ONLY with owner financing, there may be issues with getting a bank mortgage later (as in, you can't). Something to think about.
     
  18. Mullers Lane Farm

    Mullers Lane Farm Well-Known Member

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    Bare, I followed all your post except for the 'lease option'. Is this extra money paid up front to be able to lease it?? What is it used for?

    So usually, a leased property has a higher monthly payment and the extra money is set aside for the down-payment??

    Would you happen to have a sample of a simple lease agreement?
     
  19. OUVickie

    OUVickie Well-Known Member Supporter

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    Make sure you get a good written contract if you do this.
    We made the mistake of thinking we had an agreement like this and the idiot didn't pay his property taxes on the place for 3 years. One day a couple showed up with a receipt for the place - they had been awarded the bid at an auction of property for delinquent taxes. We never rec'd anything at our address from the County because they send it to the owner and he hadn't given them a new address in 3-4 years. We had ten days to move and that was only because the new owners felt sorry for us and we're being generous. :(
    So if you do something like that make sure you find out if the owner's owe back taxes or have ANY liens on the property or you will get royally duped on the deal.
     
  20. RAC

    RAC Guest

    The extra money paid up front on a lease with option to buy is to pay for tying up the property in advance of a potential sale. In other words, you're paying say $5000 to keep it off the market for the duration of the option (usually one or two years). You may buy it, you may not, but you're keeping someone else from buying that property during that time, so that is what the owner is being compensated for.