Selling a Rental Home on a Lease Option: Can I offer to pay a portion of closing costs without violating DF?

4 Replies

I have a rental home that I now wish to sell.  I renovated it after my tenants vacated and it is now totally updated.  Unfortunately, it is priced a bit higher than the rest of the neighborhood and it has not sold yet.  I would rather rent it again versus lose money selling it below what I have in it.   I am considering doing a lease option on it.  If I am understanding correctly, I cannot offer a portion of the rent as a credit towards the price of the house because it would violate Dodd Frank.  Can I instead offer to pay a portion of the closing costs?  ie:  $100 monthly credit towards closing costs for each month that rent is paid on time up to X amount?

Also, my house is currently on the market with a realtor.  I was wondering if I should utilize the realtor in order to find a lease-option tenant and give them a portion of the option money or should I wait until after my contract is up and try to find lease-option tenants myself thus saving me the realtor fee?  I'm just not sure how easy/difficult finding a tenant buyer will be so any feedback would be appreciated.

$100 will probably be too much, don't know the price, but closing costs on the buyer's side may not be that much. 

Lenders will want the buyer to pay pre-paid items, appraisal, application fees, insurance binder and taxes. 

You can closing costs, you can also pay discount points on a loan to reduce the interest rate. You can pay for inspections and you might buy a home warranty for them! $100 can go a long way doing those things.

What you can't do is credit any payment toward the sale price, payments may not be applied to the price as that becomes a financing contract.

If you want to stay in good graces with your Realtor, I'd say talk it over with them. I wouldn't pay a large sum or upfront commission because your tenant could bomb out. Base it on money received. You can also agree to a sales commission when and if it closes.

Use two separate contracts, one lease and one option and don't tie performance by the buyer into any relationship between the two contracts, options can not require performance. 

At 10% equity in the deal, the buyer may establish an equitable interest that you will need to foreclose on with a lease-option, I suggest you take less as an option price. 

Short options can be renewed at an additional option price, such are voluntary for the buyer and the option price may be credited to the sale price without DF issues. For example, annual options being renewed. 

Make sure the price agreed will appraise out too. :)

Bill,

Thanks so much for your response.  It was just what I needed to know.

Hi @Sandy Uhlmann

Dodd Frank is important, so is the IRS.

Tax IRS - Tips to Avoid a Lease Option to be Re-Chararterized as a Disguised Installment Sale

1. The rent should be at or near fair rental value. Breece Veneer & Panel Co., 232 F .2d 319. Get a written opinion of the rental value from a qualified real estate professional.

2. Keep rent credits toward the option price to a minimum. Generally, 20% or less is considered reasonable.

3. The option price should be at or near fair market value. Get a written opinion of the market value from a qualified real estate professional. Breece Veneer & Panel Co., Ibid.

4. Try not to tie-in substantial lessee improvements with the option exercise.

5. Do not pass legal (or equitable) title to the optionee\lessee\buyer.

6. Demonstrate that you intend to do a lease-option and that you believe the rent and option price to be reasonable. See Benton, 197 F.2d, 745; Lester, 32 TC, 711. Use arm's length lease-option documents along with the counsel of qualified professionals.

@Brian Gibbons

Thanks for that insight.  I wasn't even considering how the IRS might view the transaction.  Your response is much appreciated.

Sandy

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