Lease Options

First, let’s start with the lease option, which is really two things, a lease and a purchase option. A lease is a contract for the use and possession of land, creating a landlord/tenant (or “lessor/lessee”) relationship.

A purchase option is a unilateral agreement wherein the optionor (“seller”) agrees to give the optionee (“buyer”) the exclusive right to the purchase the leased premises. The option price is generally set at a fixed price at the inception of the lease, although it does not have to be. At any time during the option period (which generally corresponds to the lease period), the tenant can exercise his option to purchase.

An option is not the same as a regular purchase contract, which is a bilateral agreement. A bilateral contract legally binds both parties to the agreement, whereas an option only binds the seller. An optionee is not bound to buy; it is his option do so (or not to do so).

A lease with option arrangement is not a sale, but rather a landlord–tenant relationship. In rare cases, a court may re–characterize the transaction as a sale if it looks like a sale. Furthermore, the IRS does not classify a lease option as a sale until the option is exercised (see, Tax Court Memorandum 1999–11).

Contract for Deed

A contract for deed (aka “installment land contract”) is an agreement wherein the buyer makes installment payments on an arrangement similar to an automobile financing. The seller holds legal title to the property as security for payment, while the buyer has “equitable” title. When the buyer pays the full amount due under the contract, the seller delivers legal title to the buyer.

Equitable title gives the buyer the right to live in the property, improve it, rent it and otherwise enjoy all of the benefits of ownership. However, since the buyer does not have legal title, he cannot use it as collateral for a home equity loan (although in some states, banks will lend against an equitable interest in a contract for deed).

The IRS generally treats a contract for deed as a sale, which means the buyer has the tax benefits of ownership. Thus, the payments of interest that are made by the buyer in possession are deductible as “mortgage interest,” even though the buyer does not have legal title to the property. A contract for deed seller must report the transaction as an installment sale on form IRS Form 6252. Once sold, the seller cannot claim depreciation or any other tax benefits of the property. If the buyer defaults on the contract and the seller exercises his legal option to reclaim the property, the tax code treats the transaction as a foreclosure.

The legal process for repossession of the property is not entirely clear in every state. Some state statutes (e.g., IL, TX & PA) clearly spell out the process, which is somewhat more involved than an eviction, but clearly less burdensome than a full–blown foreclosure. In most states, the process is not clearly defined, so courts deal with a buyer’s default on a case–by–case basis.

Which is Better?

In summary, the lease option is a landlord–tenant relationship until the purchase is complete; the contract for deed is a sale at the inception of the agreement. In rare cases a court may re–characterize lease option transaction as a contract for deed, but this is limited to situations where the transaction looks like sale (as in the case of a long–term lease option with a declining balance purchase price).

Which formula is better? It depends on the situation and your goals.

A lease option transaction is not a sale, so you will benefit from market appreciation if the tenant declines to exercise his option to purchase.

A contract for deed sale will allow you to get more a down payment from the buyer, since it “feels” more like a sale. In higher–priced neighborhoods the rents may not command enough rent to cover your underlying mortgage payments.

A contract for deed sale will allow you to collect interest payments, which are generally more than you could collect in rent. On the other hand, a property sold is already sold for tax purposes; thus, you cannot use a 1031 tax–deferred exchange on a property sold by contract for deed when the buyer pays off the debt balance. The entire balance paid on the contract will be due as a capital gain, which can be a huge tax liability if you have a low basis in the property. Furthermore, a defaulting buyer on a contract for deed is generally harder to get out of the property, particularly in a court proceeding.

Summary on the Pros and Cons of Each

In summary, the benefits of lease options are…

Legal control of the property
Ability to claim depreciation
Ability to defer gains by 1031x

The downside of lease options are…

Less money down
Less of an incoming payment
Continued landlording responsibility

The upside of the CFD is…

More money down
Higher monthly income
No landlording headache

The downside of the CFD is…

Potential tax hit
Transfer tax due at sale

You must decide on a deal by deal basis which transaction works best for you in terms of work involved, tax issues and, most importantly, cash flow. And, be flexible and know how to do both types of transactions; you can buy on a contract for deed, then re–sell on lease with option. You can buy on lease/option, sell on lease/option. You can buy on contract for deed, then rent the property out. There are multiple strategies you can use and the more you learn the more you earn!

Article written by William Bronchick, Esq.

As of the first week of March, the Miami-Dade County auction website Miamidade.realforeclose.com has registered almost 4,500 bidders from within Florida and nearly 750 bidders from other states and other countries. The website is run by Realauction.com, which is handling the home foreclosure auction websites of ten Florida counties, including Miami-Dade.

As of the first online foreclosure auction in Miami in January, Miami-Dade is now auctioning off about 7,000 foreclosure properties a month, up from the only 750 foreclosures a week the county has been handling at the courthouse.

In the past, auctions can only be done three times a week because of lack of staff. Now, the online auctions are done every day from Monday to Friday. Anyone interested can just visit the Miami website and look at the online auction schedules and look at the addresses of the properties, the assessed values, judgment amounts and the maximum bids. They can also check if the auctions have been canceled or rescheduled.

According to Harvey Ruvin, the Miami-Dade County Court Clerk, the online Miami foreclosure auctions are set to cut about $250,000 per year from the county budget, just in time because Ruvin had to cut the court budget by 18 percent and terminate 150 court employees.

Ruvin explained that he really pushed for the online auctions because foreclosure cases have been overwhelming the county court at a time when many judges have retired without replacements. In the years preceding the foreclosure crisis, the county was processing only about 6,000 foreclosures per year.

Now, foreclosure postings have increased many times over. Just for the first two months of this year, more than 9,000 foreclosure cases have already been filed, in addition to the thousands that have not yet been processed.

The online foreclosure auctions in Florida have made Florida the pioneer state in holding judicial foreclosure auctions online. Realauction.com, which was first hired to auction off tax certificates, is now auctioning off property foreclosures online in ten counties in Florida.

Three of the other Florida counties running online public auctions are Polk County, Palm Beach County and Broward County.

In addition to cutting workload and employee work hours, the online Miami foreclosure auctions also eliminate common courthouse auction problems such as the bullying of newcomers by veteran bidders and the broadening of access to all interested home buyers.

Article From Real Estate Pro Articles – Written by : John Cutts, a Miami Real Estate Investor.