Pros and Cons For Sellers (Rent to Own)

A – Seller Benefit: There are significantly more buyers than sellers with lease-options. The buyers who are serious are not dummies. They are often more connected to the neighborhoods and understand market values of the homes better than the real estate agents selling homes there. When a lease-option is structured properly you will be surprised at the buyer demand for the property no matter what its value or location.
B – Seller Benefit: The tenants will usually treat the house as if they own it since they will probably buy it when the lease-option terms are up. The importance of screening potential tenants is something that landlords must learn. The same concept is valid for lease-option homebuyers. The lease option applicants that I have seen tend to treat their houses well, since they would like to own their own home someday. I’ve had good experiences with lease-option tenants except one. Since I failed to conduct a thorough check on my applicants, this was my own responsibility.
C – Seller Benefit: If you apply a portion of the rent as a credit towards the overall purchase, the tenant will generally be willing to pay higher than market rent. The tenant who chooses a lease option knows that it is a good bargain; hence they are ready to pay a rent which is higher when compared to the market rent for a similar house. How much more? I don’t possess this knowledge. Start at 10% more, but realize it can often be even higher than this. People who enter into lease-option agreements realize that this is an excellent way for them to have the home they have always wanted. Even if it isn’t the home they want to stay in forever, it will allow them to improve their Fair Isaac Corporation (FICO) credit score and improve their overall financial situation so they can qualify for a mortgage loan in the future.
Lease option sellers also need to record all monthly rents they receive as rental income on Section E of their 1040 income tax forms. The IRS cannot claim a landlord didn’t report all rental income if a tenant chooses not to utilize their purchase option. The landlord can equalize the rental income making it essential tax-free by using the Schedule E form, which accounts for the rent received less the applicable expenses for lease-option property such as insurance, property tax, repairs and depreciation.
D – Seller Benefit: When a tenant decides to purchase the property, they will be given an “adjusted sales price” which is the gross sale price minus the rent credit that was accrued while they were leasing the property.
Depending on the circumstances, especially when you are the lease option buyer, it may be advantageous to negotiate for the buyer to pay for all repair bills. As a lease-option buyer, it is wise to have complete control of what happens to the property so that you can decide how and when to make repairs and improvements.
E – Seller Benefit: One of the advantages for the seller is getting the non-refundable money for the option and possibly pre-paid rent as well.
To have a valid option to purchase a property, the buyer-tenant will have to pay a form of non-refundable option consideration, which is usually money. One dollar would be sufficient.
Experience shows that if the amount of option money is higher, there is a greater possibility of the tenant to purchase. I usually try to get several thousand dollars in non-refundable option money as an incentive to the buyer. These funds act like a security deposit in a regular rental agreement, except that deposits cannot be refunded with a lease-option.
Until the exercising of the purchase option, the option consideration money does not need to be reported as income to the IRS. This is because if the money is used as part of the buyer’s down payment part of it becomes non-taxable return of investment and the other portion is taxable capital gain. The non-refundable option money becomes taxable income to the landlord if the tenant decides not to buy the property.
Some tax advisors will recommend the option for the money to be reported to the IRS in the tax year of its receipt by the property owner. Yet many don’t understand what to do if the option to buy is not exercised and the money has been reported and taxed as regular income. It is also unclear how to account for a situation where the property is purchased and a portion of the money is used as a non-taxable return of investment and part of it becomes capital gain.
F – SellerBenefit: Lease-option buyers will ultimately pay the maximum for the option purchase price. As a long-time seller of houses using lease-options and determining my option purchase price on recent sale prices of comparable nearby homes, buyers have not questioned the prices I have set. I make the price at the high end of the going rates for the location. Lease-option buyers are thrilled to find a lease-option, so often buyers won’t argue over the price or terms, unless they are unreasonable.
Sellers would probably prefer twelve-month lease options. However, as a buyer, the longer term you have the better so that the option purchase price is locked in and you have a better chance of cashing in on any appreciation of the property. My experience has shown that when the lease-option expires in 12 months many of the tenant-buyers are not ready to exercise their purchase option. I think that’s great!
At that time, we can renegotiate the (a) monthly rent, and/or (b) option purchase price. In a rising market, it is especially important. When selling, I have often extended an annual lease for up to as long as five years, but usually with different terms.
G – Seller Benefit: Throughout the terms of the lease, the person selling the property gets to take all tax deductions, including income and depreciation. Purchasers and real estate agents should strongly emphasize this point to potential sellers, for it is a great benefit to lease-option sellers. However, once the property is purchased, the seller has to report the sale on Schedule D of their income tax return and include any “recapture” of depreciation that may have been deducted while the property was rented.
It is important for the seller to remember the major tax benefit of Internal Revenue Code 121 if the house or condo has been their principal residence. The seller who has lived in his home for at least twenty of the last sixty months before selling it, then he is eligible to claim tax free capital gains to $250,000 and till $500,000 for a married couple who fulfill the occupancy test. This tax break will be lost to the seller if he uses the lease option for more than three years after moving away. It is highly recommended to consult with a tax advisor.
If an investor owns the lease option property, he can make a tax-deferred exchange under Internal Revenue Code Section 1031 when the tenant elects to buy the property. The property must be of equivalent value, combining cost and equity, in order to qualify to find out all the pertinent information, please check with the person who advises you on your taxes.
H- Drawback for Seller: There is no immediate sale for cash. A leash option is not a good idea if you need an immediate cash sale of your property. Although, if you are not in a hurry to sell but need revenue to cover the mortgage payment, taxes or other expenses a lease-option will give you all of the benefits explained previously.
If the property market skyrockets in value during the lease-option term, the tenant-buyer benefits. This is the reason why I recommend that owners only sign one-year lease-options. In order to avoid unforeseen difficulties, I would never advise entering into a lease option, which allows for the option price to be negotiated or determined by an appraisal. Instead, as the seller, be happy for the buyer if the market value goes up, even if you don’t receive absolutely top dollar for the property.