WRONG!!! - Posted by JohnBoy
Posted by JohnBoy on March 26, 2002 at 06:49:51:
There is NO state that I know of that says you MUST offer rent credits to make it a valid lease option! Absolutely false and ridiculous! You have that all backwards! Actually, by offering any rent credits you can run the risk of having the lease option reclassified as a sale!
But since you claim some states say otherwise, then list the name of ONE state and provide the statue that says this. I’m betting none exists!
“”“As far as the rent credits go< i have done it at the request of my title companies, to establish an interest in the title beyond the deposit.”“”
This is WHY you DON’T want to do that! You don’t want to establish any interest in title to your tenant/buyer! That’s what can cause your L/O to be reclassified as a sale! That can cause your eviction to be thrown out and a Judge forcing you to go through a judicial forclosure! These are the things you want to AVOID at all costs!
In your other post you stated:
“”“Each month they pay 1200.00 the payment is 900=$300.00 positive right? Wrong $200.00 month goes to the down they are building up, and $100.00 goes to taxes and insurance. Net cash flow to me $0.00"”"
If the PITI payments are $900 and they pay you $1200 then your cash flow IS $300 per month.
Now if you are saying your agreement states $200 of their rent is credited towards the “down payment” NO MATTER WHAT…then you are playing a dangerous game!
ANY rent credits offered should ONLY be applied towards the purchase price IF, AND ONLY IF, the optionee exercises the option. That means rent credits don’t get applied until they FIRST EXERCISE THE OPTION! They are not applied each month up until they decide to exercise the option or not. FIRST they MUST exercise the option BEFORE ANY credits are ever applied. THEN, and ONLY THEN, at that time rent credits based on X amount of rent paid each month previously shall apply towards the “Purchase Price”. NOT the down payment!
The other problem where you say:
“”“Wrong $200.00 month goes to the down they are building up”“”
This is WRONG! You should NEVER state anything about monies going towards their down payment. They are only leasing with an option to buy. They aren’t BUYING until after they exercise the option. So there is NO down payment in a lease option, only on a sale when you actually are buying something. Any rent credits should only be applied towards the PURCHASE PRICE! Not towards a down payment. If you apply it towards a down payment and they decide NOT to buy then you may end up having to refund them all the monies you applied towards their down payment. If they don’t actually BUY the property in the end then there would be no down payment and if your contract is stating they have been paying towards a down payment you may have to give it back since they are not going to buy in the end, even though your contract may say its non-refundable. It’s not something I would care to have to try and defend in court, so why even risk it when you can use proper wording to avoid it all together???
So the problem with your method of claiming the $200 isn’t true income until after the property sells is seriously flawed. If everything goes smoothly then you can get away with it. But if a tenant ever wants to take you to court over this you could end up having to refund them that $200 per month because of the way you’re structuring this and claiming it isn’t income recieved until after the property sells. If it ain’t income according to your contract with the way it’s written, then it’s just a deposit being held until they buy, even though you may spend it, but you may end up having to give it back!
You are trying to create hoops to jump through for tax purposes to defer claiming the income and have your cake and eat it to by trying to say it’s non-refundable money being applied towards the down. Somewhere alomg the line you are going to get caught up in this where it’s going to come back to haunt you.
So if the payments are $900 PITI, and the income from rent is $1200, then your income IS $300 per month whether you give any rent credits or not!
The lease should be separate and the rent listed in the lease should state the rent is $1200.
The option agreement is separate any rent credits should be stated in the option agreement. That’s two separate contracts and two separate transactions. So you can’t claim the rent credit given in the option agreement to offset the actual rent amount stated in the lease. Two separate contracts that have NOTHING to do with each other, IF properly structured.
If the OPTION agreement states $200 for rent credits then it should state rent credits shall be applied IF, and ONLY IF, the option is exercised. Otherwise NO credits are ever applied otherwise!
Also, all the rent credits won’t be applied by the lender. The lender will only allow any amounts that EXCEED the fair market rents for the area to be applied towards the buyer’s down payment. NOTE: That is the LENDER that allows any rent credits and any option money paid to be applied towards their down payment. That is between the lender and the buyer as to how they will allow anything to be credited and applied, NOT ME! My contract states NOTHING about any down payment, period! The words “down payment” are not even mentioned in my contracts. They are NOT buying. They are only leasing with a separate option to buy. So any money paid up front is listed as non-refundable option consideration and any rent credits are applied towards the “purchase price”, IF and ONLY IF, the option is exercised, period!
Also, to avoid the risk of having the option consideration called a security deposit, you should get at least $100 as a security deposit that is stated in the lease agreement. The option money is stated in the separate option agreement so there is no confusion as to what that money was for!
Also, the more you allow as rent credits the more risk you run of having the L/O reclassified as a sale. So if you give rent credits you should keep them to a minimum to avoid more risk of having the L/O classified as a sale should you end up in court with a tenant that decides to get an attorney to protect their interest.
So lets say my pay off was going to be $100k in 2 years. I L/O the property for $124k. My total payments are $900 per month which includes taxes and insurance. I charge my tenant $1200 RENT in the lease agreement. My cash flow is $300 per month period! If I offer $200 in rent credits in the option agreement IF they exercise the option, my cash flow is STILL $300 per month! The rent credits are only OFFERED to be given IF the exercise the option. So in order to get the credits they must first exercise the option before they are even applied towards the purchase price. If they don’t exercise the option then no rent credits are forfeited because none were ever given in the first place. They must first exercise the option before they even apply!
The only reason the rent credits are even OFFERED to be applied based on X amount of rent paid each month ON TIME, is for an extra incentive to get them to pay the rent on time each month.
So basically the way the rent credits work is, $200 of the monthly rent shall be applied towards the purchase price, IF you paid that months rent on time, AND, IF you exercise the option, THEN and ONLY THEN shall the rent credits be applied towards the purchase price.
So since my tenants are NOT getting any rent credits applied until AFTER they exercise the option, then there is no way I could get away with claiming the $200 per month as not being income until the propery is sold or the option expires, which ever comes first.
The way you are saying you are doing this has the risk of having your L/O reclassified as a sale and could have potential tax problems. Not to mention the risk of having to refund the TENANT all their money you claimed was already given to them as a credit before ever exercising the option!
You may have done 50 deals this way, but how many have you had go bad where the tenant hired an attorney and tried to fight this in court?
Based on the way you explained it here and if I were your tenant knowing what I know now, and if I had a problem where I couldn’t pay and you went to evict me…guess what? I’d be in court claiming equitable interest because of all the option money I paid and all the rent credits I had coming according to my contract (compliments of YOUR title company because they told you to do it that way, LOL) and I’d be claiming this bogus L/O of yours was nothing but a covered up sale taking place because you just wanted to avoid paying taxes on the income you were making off my payments! Oh what a messy court battle it could turn into for you in the end! You may end up having to foreclose instead of a simple eviction. Or you may at least be require to refund me all my money paid as option money and rent credits since I’m not going to be BUYING the property now. Or you could end up in a bigger mess with the IRS because of the way you structured this! Or a combination of everything. Who knows how the Judge will rule. But there is case law established on having L/O’s reclassified as sales and that could be used against you to prove a case regardless of which state you live in!
Structure the deals properly and allow yourself the best possible protections to limit all your risks! Try to get cute by cutting corners, using wrong language in your contracts, and trying to avoid taxes by deferring them for a year or two is going to add more risk on your part. Sooner or later it will catch up to you. It’s not a question of WILL it ever happen…if you keep doing it then it’s just a question of WHEN!