What Makes The Most Sense?

jspaeth profile photo

I have rental properties but I am new to the concept of lease with option. I would appreciate your suggestions – here is my situation:

We would like to move 30 miles south of where we are in order to be closer to where we work. Our primary residence is a nice 3br 2ba w/3 car attached garage and an additional 3 car detached garage on a one acre lot. The house is 7 years old. I owe $112K and have a line of credit of $100K of which has a $20K balance. The house should sell for $230K.

I am trying to decide if I should sell it or if I should offer it as a lease with option. I would say I could rent it for about $1200/month. My payments are high - $1100 month because it is a 15 year mortgage.

I am fairly certain that we could qualify for another mortgage even if we kept this house. And, even if it cost us a few hundred a month to keep it and have it rented, we could handle this…but I certainly would not want to do this unless it made financial sense in the long run.

Another consideration is the tax free gain (2 out of 5 year deal). If I sold it now, I could take advantage of this. If, however, I lease optioned this for 2 years (and the renter bought it) and we decided to sell our new house in two years…would I be able to take advantage of the tax free gain on both places in the same year? Is there a limit on this?

What would you guys do if you were in my shoes…What other information would be helpful in order to offer insight? Thanks.

Comments(4)

  • rajwarrior15th September, 2004

    I don't know your area, so you'll have to answer some of these questions yourself.

    In my area, this would be a high-end home. It may not be in yours. Regardless, are homes in that price range actually renting? It is usually harder to rent (or L/O) a higher dollar home. By harder, I mean that it will probably take longer to get a tenant.

    By my figures, your rent payments are off. If this was purchased with low credit score financing (typically 9%/30yrs) with only 3% down ($7), then monthly payments would be about $1800/month. This doesn't include taxes and insurance. On a L/O, this would be the number that I would be looking to get out of the property. Can it be rented for that amount?

    As far as the tax free gain, you need to check with your tax professional to verify, but as long as the home falls into the guidelines set, then you would get it, even if you had two houses that qualified. However, you need to consider a couple of things. First, keep in mind, that 75% of L/O's (average) don't actually exercise their options to purchase. Second, if that were to happen, what is the timeframe that most houses are selling for on the local MLS? Would this put you over the time limit of the tax free gain? If it did, could you accept that and pay the taxes and be happy?

    Roger

  • jspaeth16th September, 2004

    Hi rajwarrior:

    Thank you for your response. It is near the top of the rent scales although I did see a couple for 2000. I arrived at this rent amount by looking in the local newspapers and comparing it to other houses for rent with similar square footage. Now, it is likely that this house is much nicer than the others offered for rent.

    The average MLS time here is 30 days – and I am certain that I could sell it at this price in this amount of time. I am in the fastest growing city in the state.

    Are you saying that you generally set the rent amount by comparing it to what their payments would be as if they had gotten financing – this way if/when they do exercise their option, their mortgage payments would be in the same ballpark?

    I am thinking that it is worth a shot at offering it as a L/O and if I don’t get any takers, I can always sell it. While we would like to move…we are in no immediate hurry. Now, what would be an acceptable scenario/ deal using my numbers? In other words, how would you structure this so that it would be profitable?

    How much down (option)?
    Rent to ask? 1800?
    Rent credit?
    1 year or 2-year option?
    The house is worth 230K now…would this be their option price…or should this price be inflated by say 5% a year to allow for appreciation?

  • rajwarrior16th September, 2004

    The house is worth 230K now…would this be their option price…or should this price be inflated by say 5% a year to allow for appreciation?
    This is entirely up to you. Most would say bump the price by the 5% (if that is the ave appreciation). I tend to be more conservative. On a 1 year L/O, I usually won't do a price bump, instead offering that as an incentative of "equity." My market is a bit competitive, though, so you need selling points. You may not.

    1 year or 2-year option?
    Again, this is something that you'll have to decide what you're comfortable with. Personally, I would only do a 1 year here, as you might need the other year to try to sell conventionally, in order to still get the tax break.

    How much down (option)?

    I would shoot for $7-10K. This is roughly about 3-5%. On this price home, I don't think that I would take less than $5K, unless I felt VERY good about the tenants ability to make the payments AND get the refinance done.

    Rent to ask? 1800?
    Rent credit?
    The minimum rent that I would ask for is $1800, IF you can get it in your area. I'd probably shoot for $5K down and lease payments of $2K/month with a $200/month rent credit. However, you'll have to decide what will actually work for your area. I wouldn't go below $1500/month payments ($100/month rent credit). SIDE NOTE: On my L/O's the rent credit will only apply IF the payment is received on time. If it isn't, then it is up to you to decide to include it if the option is exercised. I always include IF they actually get the refinancing, but it works great as an incentitive to get the payments on time. Usually it only takes one "you understand that by paying this month late, that you don't get any rent credit" is enough that I don't get another late anytime soon.

    Hope that helps,

    Roger

  • jspaeth16th September, 2004

    Thanks for all your help Roger. This is exactly what I needed.

    I also read pub. 523 concerning the primary residence gain exclusion. The IRS only allows one exclusion every 2 years...even if you have two qualifing properties...so, I'll have to take this into account.

    It might be 3-4 months before I pursue the advertising of a L/O for my house (I am knee deep in a rennovation on my rental right now), but I will post back results - and more questions I am sure.

    Thanks again.

Add Comment

Login To Comment