Is Lease Options Legal In My State?

 “Are lease options legal in my state?” Generally the answer iss YES. However, as with many things in real estate, there are state and local regulations that apply. For instance, recent legal changes in Texas (a few years back) shortened the lease option period to six months. Some investors stay with this short time period while others convert the agreement to a land contract once the buyer has proven that he or she will reliably make the payments.

The intent behind most state and federal laws is protecting consumers that are less knowledgeable about contract law than investors are. A few rare investors unethically approach lease options with the intent to collect the option fee and soon evict the tenant on a small contractual technicality (keeping the nonrefundable option fee). That is plain wrong.

As an investor, you should begin by seeking out tenant/buyers that are most likely to successfully complete the purchase. And then, working with them to make it happen.

The right answer to the question “are lease options legal in my state?” is approaching the transaction as a win-win or win-win-win (sandwich leases) proposition. You want the tenant to complete the purchase, pay you a handsome profit and then move on to the next deal with a fully satisfied tenant/buyer in place. Think “word-of-mouth advertising” here. Your next tenant/buyer may well be the brother-in-law of the buyer you just made happy.

In all scenarios, consult your state to determine what laws govern lease options. That’s the only way of accurately knowing if lease options are legal in your state and what regulations apply.

Are Lease Options Legal in My State? - Understanding the Difference From a Land Contract

Most investors are familiar with the concepts of both the lease option and the installment land contract (also called contract for deed) but may not be completely familiar with some of the legal differences. The main difference that triggers other legal implications is the installment land contract is a completed sale from the beginning. However, the lease option is not a sale until the option is exercised.

A land contract is similar to how many people purchase cars on contract. The buyer is the outright owner. They are able to use the house, modify the house, and do pretty much anything they want with the house. However, the lender retains title to the house as security (much the way a car lender retains title) until the loan is repaid in full.

The buyer (owner) on a land contract gains the tax benefits and acquires the appreciated value. As well as being solely responsible for maintenance and repairs.

Contrast this with a lease option. With the lease option, the seller retains full ownership until the option is exercised. Through the legal contracts, I typically transfer as much of the responsibility for the property as possible to the lessee as the potential owner. However, ultimately, I am still legally responsible for the property as the true owner. I am also entitled to the tax write offs and depreciation a well as responsible for paying the property taxes. With the land contract and when the buyer exercises the option to purchase, all of this transfers to the new owner.

Are Lease Options Legal In My State? - What Laws Might Apply

In the past, sellers where able to slightly overlap the land contract concept with the lease option. Over the years, the laws have changed and they do vary from state to state. I'm not an attorney and I do not intend to give legal advice. I'm only providing some insight from my many years of experience. You should seek competent legal advice before trying any of these investing techniques.

In years gone by, the overlap took the form of the lessee making higher than market rent payments against the lease option. The seller would then apply a portion of these payments towards the down payment. This resulted in a reduction in outstanding balance. Just because you call it a lease option, doesn't make it a lease option in the court's view.

Some courts have ruled that when there is a reduction in the outstanding balance, that the lessee has an equitable value in the property. When monthly payments stop or other problems come up, what would have been a relatively easy eviction under the lease option can become viewed by the court as a foreclosure when equity value is deemed to exist. Therefore overlapping the lease option and land contract concepts is never a good idea.

Both concepts work well and should be used on a case-by-case basis. Deciding which is the most appropriate should be based on your thorough analysis of the cash flow, tax issues, and how much work either is going to require of you. Once you gain a complete working knowledge of both concepts and understand the laws in your state, you can still combine the two in other ways such as buying on a land contract and selling on a lease option. Another version is buying on a lease option and selling on a sandwich lease option or buying on a land contract and renting out the property.