Q: We are trying to sell our house, and have had some difficulty finding qualified 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?
A: A lease with an option to purchase is a legitimate real estate transaction. Basically, under the arrangement you have discussed, your purchasers will move into your property, and sometime within the next two years will buy your house.
First, you must recognize that 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 Washington 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.
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 they will have an opportunity to select the best time to go to settlement. 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 consider the taxable consequence 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 18 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 18 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. This must be carefully reviewed with your tax advisor before you sign the lease-option contract with your purchaser.
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 talk away from the deal within the next two years, the deposit should be forfeited in your favor.
Draw up a careful 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 taxes. If your tenants pay the taxes, what guarantee do you have that the payments are made, and made timely?
The contract must reflect that, when settlement will actually take place, 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 actually 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. The appropriate landlord-tenant laws of your jurisdiction should be explored, and appropriate safeguards spelled out in the basic arrangement.
Don't forget that if your purchasers decide to back away from the deal, there may be significant damage in your house that will affect the market value of your property.
A lease with an option to purchase clearly favors a potential buyer. It should not be taken lightly by seller, because of the many problems which it can create. If you are inclined to hang on to the property for a couple of years, enter into a straight landlord-tenant arrangement, and give your tenant the right of first refusal to purchase the property.