First, letâ€™s start with the lease option, which is really two things, a lease and a purchase option. A lease is a contract for the use and possession of land, creating a landlord/tenant (or â€œlessor/lesseeâ€) relationship.
A purchase option is a unilateral agreement wherein the optionor (â€œsellerâ€) agrees to give the optionee (â€œbuyerâ€) the exclusive right to the purchase the leased premises. The option price is generally set at a fixed price at the inception of the lease, although it does not have to be. At any time during the option period (which generally corresponds to the lease period), the tenant can exercise his option to purchase.
An option is not the same as a regular purchase contract, which is a bilateral agreement. A bilateral contract legally binds both parties to the agreement, whereas an option only binds the seller. An optionee is not bound to buy; it is his option do so (or not to do so).
A lease with option arrangement is not a sale, but rather a landlordâ€“tenant relationship. In rare cases, a court may reâ€“characterize the transaction as a sale if it looks like a sale. Furthermore, the IRS does not classify a lease option as a sale until the option is exercised (see, Tax Court Memorandum 1999â€“11).
Contract for Deed~
A contract for deed (aka â€œinstallment land contractâ€) is an agreement wherein the buyer makes installment payments on an arrangement similar to an automobile financing. The seller holds legal title to the property as security for payment, while the buyer has â€œequitableâ€ title. When the buyer pays the full amount due under the contract, the seller delivers legal title to the buyer.
Equitable title gives the buyer the right to live in the property, improve it, rent it and otherwise enjoy all of the benefits of ownership. However, since the buyer does not have legal title, he cannot use it as collateral for a home equity loan (although in some states, banks will lend against an equitable interest in a contract for deed).
The IRS generally treats a contract for deed as a sale, which means the buyer has the tax benefits of ownership. Thus, the payments of interest that are made by the buyer in possession are deductible as â€œmortgage interest,â€ even though the buyer does not have legal title to the property. A contract for deed seller must report the transaction as an installment sale on form IRS Form 6252. Once sold, the seller cannot claim depreciation or any other tax benefits of the property. If the buyer defaults on the contract and the seller exercises his legal option to reclaim the property, the tax code treats the transaction as a foreclosure.
The legal process for repossession of the property is not entirely clear in every state. Some state statutes (e.g., IL, TX & PA) clearly spell out the process, which is somewhat more involved than an eviction, but clearly less burdensome than a fullâ€“blown foreclosure. In most states, the process is not clearly defined, so courts deal with a buyerâ€™s default on a caseâ€“byâ€“case basis.
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Happy House Hunting,
Sheri Mapes the Cincy House Expert
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Okay, more words...
The previous responses are outstanding (I cut and pasted those, TYVM).
One other item to consider (and I do not know your Ohio Laws) - be very careful not to trigger a "Due on Sale" clause in the Seller's existing Mortgage.
In many states, if that Seller's current Mortgage Holder deems such a transaction (Contract for Deed, etc.)
to be a Transfer of Title (New Ownership),
they may enforce the Acceleration Clause in the Mortgage and demand Full Payment of the Loan Balance immediately.
Again, find a good Real Estate Attorney who can advise you accordingly.
Best wishes to you,
The only things I would add would be to (as a buyer) try and get the longest possible lease term you can while trying to get the max Rent Credits you could towards the purchase price.
Have your Option recorded at the county courthouse. This way, you are protected from having the seller try to sell it out from under you or some other wacky things that sellers try to pull. If he/she tries to sell the house without your knowledge, the title search will come up with your Option to Purchase (which means that you have purchased the right to buy the property in the future.)
You may want to involve an escrow company (attorney's and title companies can set it up for you) so that you know the lease payments YOU'RE making are not just being pocketed by the seller while he/she lets the house go into foreclosure. They (the escrow account) can have emails sent to each participant in the deal showing the flow of money during the whole process. It makes for a great paper trail. And this helps when you go to get traditional financing at the end of the lease. (Lenders like to see that you've been making payments over a period of time)
I wish you the best of luck and Viva La Lease Purchase!
As with any kind of financial contract, lease-purchase deals can be structured in such a way that all the benefits flow to one of the parties and none to the other. Buyers especially need to be careful. But lease-purchase plans have a solid economic rationale, which means that they can be structured so that both parties benefit.