Lease-Option May Help Sell House
QUESTION: We are trying to sell our house and are having difficulties finding qualified or interested buyers. Recently, we received a contract that meets our price but contains language to the effect that the purchasers will lease our house for a period of up to two years with an option to purchase at the end of that period. Can you discuss this kind of transaction?
ANSWER: With home sales lagging in today’s marketplace, we are seeing a revival of the so-called “creative financing” techniques that were so popular in the early 1980s, when real estate sales were also slow.
Sellers are willing to experiment with any legal avenue to give them an opportunity to sell their house.
One such creative method is a lease with an option to purchase. This is a legitimate real estate transaction. Basically, under the arrangement you have discussed, your purchasers will move into your property, will be tenants for a period of time, and some time within the next two years may buy your house.
First, you must recognize that if your purchasers buy, you may be selling your house as late as two years from now, but at today’s prices. Although I am not a fortune teller, and am troubled about the future of mortgage-interest rates, I remain confident that the price of real estate in the metropolitan area will continue to increase.
Thus, even before considering some of the legal protections needed in an option to purchase, you should consider the economic potential of this transaction. You might want to provide an escalation clause, so that the price will go up periodically depending on when the sale takes place.
A second consideration goes to the status of your existing mortgage. I suspect that your purchaser is attempting to gamble that rates will go down within the next two years, and your purchaser will have an opportunity to select the best time to go into escrow. However, you should analyze your own mortgage document (the deed of trust on your present house).
The standard form instrument specifically states that if such a lease contains an option to purchase, the lender reserves the right to call the entire mortgage due and payable. This may trigger the so-called “due on sale” clause, which has been the subject of much litigation and comment throughout the country.
Before signing the contract with your prospective purchaser, discuss this matter with your present lender to assure yourself that the lender will not accelerate the payments and create difficulties for you during the lease option period.
Finally, you should explore the taxable consequences of such a transaction. If you are selling the house in which you live (for tax purposes called the principal residence) the Internal Revenue Service will permit you to defer the profit you will make on the sale of your house if within 24 months of the sale, you purchase another principal residence equal to or greater than the selling price of your present home.
If you plan to purchase another house within the next 24 months, and if your purchaser does not exercise the option to purchase until after that time, you may be hit with a substantial tax on the profit on the sale of your house. You must carefully review this situation with your tax adviser before you sign the lease-option contract.
If, after giving consideration to these matters, you still want to go through with the lease-option arrangement, here are some suggestions to protect your interest:
--The purchaser should be required to give a substantial deposit now. If the purchaser decides to walk away from the deal within the next two years, the deposit should be forfeited in your favor.
--Draw up a document that will look like a standard landlord-tenant lease. Work out the details of the transaction now, before your purchasers move into the property. For example, who will pay the utilities and the real estate taxes? If your tenants pay the taxes, what guarantee do you have that the payments are made--and made timely?
--The contract must also reflect that at the actual settlement, the purchasers will take the property in an “as is” condition.
In other words, you do not want to guarantee the plumbing, structure or any other condition of the house when the settlement takes place--which can be as late as two years from now. After all, your purchasers will be occupying the property, and you do not want to guarantee against their own living style.
What happens if your purchasers decide not to go through with the transaction? This is a very delicate area for discussion, but must be spelled out, in writing, before you allow your purchasers to move in. After all, an option to purchase is not a guarantee that the purchasers will in fact buy. It is not a binding purchase and sale contract.
The appropriate landlord-tenant laws of your jurisdiction should be explored, and appropriate safeguards spelled out in the basic arrangements.
Kass is a Washington lawyer and newspaper columnist specializing in real estate and tax matters. While questions cannot be answered individually, those of general interest will be addressed in this column. Questions and comments may be sent to Kass at 1050 17th St. N.W., Suite 1100, Washington, D.C. 20036.