Buying a house with life tenant - how to price?

Question

Hello everyone,We are buying our landlord's house (2 floors) we both live here on separate floors. As part of the agreement, we will let our landlord stay for life. We will not be able to sell or rent the space our landlord lives in. He is around 68 so that can be another 30 years before we have full control and value. Is there any special way to price the property?

Joe Splitrock · Answer

@Maxym Le Deux it was unclear exactly how this would be structured, but it is one of two ways:

1. He is a tenant and pays fair market rent. You would want to build in annual rent increases into the lease. You could hold back money in escrow to pay rent for a period of time. You can't take a discount on the purchase price as compensation for rent, unless you claim it as income. Or you follow option 2.

2. If he is not paying rent, then he is not a tenant. That means you don't have a rental property and you can't claim any expenses on your taxes. IRS is pretty clear on this, without income there is no business.

Also be aware since the owner is selling a rental property, he has to pay taxes on the non-owner occupied portion. If he is discounting the sales price in exchange for rent, that would not affect his capital gains if he is his side away in exchange for rent.

Bottom line, you need to be very careful how you legally structure this because the sale and rental income need to taxed. Even if he "lives there for free" in reality he is not living there for free because he discounted the sales price in compensation. IRS doesn't care what form the compensation comes in, they need to collect taxes.

Theresa Harris · Answer

Are you able to charge him market value for rent?  Not sure I'd buy a place like that where you can't sell it while he's living there.  Also what if he needs to move to a seniors home at some point?

Nathan Gesner · Answer

In 1965, aged 90 and with no heirs left, Jeanne Calment signed a life estate contract on her apartment with notary pubic André-François Raffray, selling the property in exchange for a right of occupancy and a monthly revenue of 2,500 francs (€380) until her death. Raffray died in 1995, by which time Calment had received more than double the apartment's value from him, and his family had to continue making payments. Jeanne Calment commented on the situation by saying, "in life, one sometimes makes bad deals".

If your Landlord lives to the average age of 78 and the value of his rent is $700 a month, you will lose $84,000 in uncollected rent by charging him nothing. How much do you project to gain in appreciation during that same period? Keep in mind the $84,000 doesn't include any rent increases over those ten years and there's a good chance he could live 20 years more.

Yes, you could gain appreciation, but I predict you every dollar earned in appreciation would be lost in uncollected rent. This means you're sitting on an asset that has gained zero value during the time span he lives, and there's a good chance it could actually lose value. How do you make it work? The best option is to buy the house and then rent it back to him. You should be able to buy it below market and then rent it to him below market but require small increases each year, comparable to cost-of-living increases (2% - 3% average). This will prevent you from falling too far behind and losing too much if he lives longer. For example, $500 today may be $765 in 20 years. You'll still be losing a TON of money on rent income because rents will likely double or triple in those 20 years, but at least you're not losing it all.

You have to really crunch the numbers and figure out a happy medium that works for you if he lives for ten years, 20 years, or even 30 years. And what if your life situation changes and you have to sell in 15 years?

Chris Pasternak · Answer

Would you buy this property under that stipulation if you weren't already living in it?

Have you considered this might be a  short sighted motivation on your part to avoid the pain of having to move?

Aaron W. · Answer

@Maxym Le Deux

You can consider building in automatic rent increases of a certain percentage annually. Your goal should be to stay at least close to market rent but definitely above inflation.

Kevin Sobilo · Answer

@Maxym Le Deux, cheap cheaper cheapest! lol

A legal life estate would not prevent you from selling it legally, but from a practical standpoint make it so difficult you probably won't be able to find a buyer.

One other issue is that you're "property" is ONE thing, not TWO. So, I believe the seller could move in with you!

I think a legal life estate is often used with estate planning where older parents deed their house over to their children but retain a life estate so the children can't boot them out before they die.

I personally would not get into a deal like this. The seller can take money and rent the unit back from you and you could give them a long lease at a favorable rate or even for free.

Also, keep in mind if you are buying with a loan that the legal life estate could affect the appraised value and not allow you to get the loan.