Lease Options - Who Pays For Big Repairs?

[Brandon Turner]

Hey Fellas and Ladies,

I'm working on an article about lease options and I'm not the pro at these, so I'm wondering:

If you do a lease option on a property, and the furnace goes out, there is a roof leak, or another fairly big issue - who pays for it?

If the owner... what if they don't?
If the investor... how do lease options even make sense, since big issues always seem to come up?


@John Jackson @Brian Gibbons @Bill Gulley thoughts? Anyone else a pro at lease options and want to jump in with thoughts?

Thanks!

[Bill Gulley]

Good morning,

Maintenance on any residential property is the responsibility of the owner as are taxes and insurance. Maintenance is a tax deductible item either as an expense or depreciated as an improvement under IRS Code, as you all know, for residential properties. All states view maintenance on residential as an owner's expense, regardless of what may be agreed to. Rents are to cover owner's expenses as a HUD requirement and a tenant is not to be held responsible for any repair or improvement to the leased premises. If any tenant pays for any repair, say arising from any emergency they are entitled to deduct costs paid from rents.

Tax wise, an owner would be having someone else paying for something that they are required to depreciate, when you take expenses as one deduction to income or over any period that they did not pay for that would be a tax fraud issue.

There are also insurance issues, in residential a tenant's policy does not cover the building or improvements. Saying repairs are to be paid by a tenant is or can be shifting an unfair risk of ownership to a tenant they may not insure against. If lightning strikes and blows up the electric stove, knocks out the well pump and fries the A/C such losses are covered under the owner's policy and collecting from a residential tenant for such losses just won't happen in front of any judge.

While agreements are made by owners without malice thinking they can reduce costs, no judge will enforce agreements that are illegal or invalid.

Commercial property is different as a commercial tenant may deduct expenses on a commercial property which is leased through their business. They may pay for maintenance, taxes and/or insurance. This is referred to as a "triple net" lease when the tenant pays all the expenses. The owner must adjust depreciation to reflect expenses paid by a tenant to avoid deducting costs not paid by them. Usually landlords retain some maintenance issues for major repairs, such as a roof or the exterior building.

A commercial tenant may acquire a hazard insurance policy under a lease, unlike a residential tenant as they may have such liability and therefore an insurable interest in the property and may include or exclude certain items, such as the exterior building and roof, which will be covered under an owner's policy.

As to the Option, no Option may require performance of any kind by the buyer/optionee to be performed over the term of the agreement. Totally unenforceable.

Glad to see Darrell uses two separate contracts as should be done with each standing on its own merits. This is an important aspect with lease-options as to financing and requiring an appraisal show the fair market rents in the computation of earned equity by the buyer which is done in the future and more often than not reduces the equity allowed by any institutional lender. The Option address the right to purchase and the equity gained from the Option Price. The Lease should be made at or close to fair market rents without any "rent credits".

Additionally, HUD views any lease of residential property 1-4 family as a residential lease. Unlike some lending arrangements, a lease by an investor is still a residential lease. For a lease to be seen as a commercial lease the property needs to be zoned commercial or have a commercial activity if not zoned or be 5 or more residential units.

Property lease arrangements that do not fall under HUD may be excepted from the above residential requirements, namely when a tenant lives in a home occupied as well by the owner. Seems there's always an exception to most rules. :) .