Lease Option Agreements: Great for Investors and Tenants

When I first started investing, I read everything. I wanted to be a great investor. I read Donald Trumps “The Art of the deal“. I read Robert Kiyosaki’s “Rich Dad Poor Dad“. In an effort to be a great investor, I even read the Beardstown Ladies’ Common Sense Investment Guide. I subscribed to almost every possible investing magazine. I learned to use Value Line investment tools and played on Bloomberg systems well before he was mayor of new york. I even worked for a CFA and investment company. I gathered all my information and at the ripe old age of 23, I sought out to be the next over night millionaire.

Well, thing do not always go according to plan. Through my trials and tribulations, I still love the concept of investing. One big thing I learned is that real estate is the best investment vehicle. One of the greatest tools I’ve seen for investors is the lease option agreement. As a Tenant, the lease option agreement is great as well. One key thing I’ve learned about most people that were wealthy is that they held most of their assets in real estate. And the Great investor structure the deal in a way that they win at the beginning. The lease option agreement is a Great tool for new investors to enter into the investment world and win at the beginning.

How do Lease Option agreements work Great for Investors

Lease option agreements are a lot like stock options. In both cases the investor owns and asset. They sell the option to buy that asset at a set price on or before a future date. In the case of a stock, I own the stock which sell for $10 a share today. I sell the option to buy they stock at $15 for 6 month to you for $2. You pay me the $2 up front. If within the next 6 months you chose to execute your option, you pay me $15 and the stock is now yours. If you choose not to buy the stock over the next 6 months, your option expires. I get to keep both the stock and the option premium of $2 if and when the the option expires.

Lease option agreements work quite the same way. You the investor own the house. You sell the option to buy a house at $150,000 to Joe for $3,000 up front over the next 2 years. The fact is Joe has can choose to buy the house or not buy the house within that option period. If Joe buys the house, you keep your $3,000 option fee. Joe will let you know he plans to execute his purchase option and pays you the extra agreed upon some. Here is the fun part for Great investors. With lease option agreements, Joe is also your tenant. So while Joe may or may not buy your house in two years, you have Joe as a tenant paying you to live in the property. So regardless of Joe executing the option, Joe give you rental income over that 2 year period as your tenant.

How do Lease Option agreements work Great for Tenants

In the above case, Joe is the tenant. The real benefits for Joe are simple. Joe gets the ability to:

  1. Build his credit while renting a property he may buy he may to qualify to own today
  2. Structure a deal on a home that may increase in value by the time he purchase (thereby giving him equity in the home immediately after his purchase under the right market conditions)
  3. The ability to walk away from the home in a market where they deal is no longer of interest to him
  4. Ability to get control of an asset that he may not qualify to purchase at the time of the initial lease

Many, investors that are really hungry to move lease option agreements. Some investors might offer perks like free lawn service for a year. I once offered free maid service for a year (2 times a month). Some people will offer Flat screen TV’s to tenants if they come with the earnest money deposit quickly. There are many deals for a tenant that wants to do a lease option agreement. Some luxury home sellers are structuring lease option agreements to move high dollar properties quickly. I have even seen cases where a car is offered with a lease option agreement.

Some of the Great Tax benefits of Lease Option agreements

The old saying is “it takes money to make money” is not always true. I know of a case where an investor bought a house from a seller using an assingable option agreement. He made his lease option agreement assignable because he had very little money. In fact, this motivated seller paid him to buy the house. Again, he got an assignable contract on a home he never lived in or owned. He then found another investor whom paid him an assignment fee to buy his contract on the house. He literally got paid buy both sides without putting up his own money on the deal. You can make your lease option agreement assignable, and sell it to other investors if you choose to move the deal quicker than they option period. You should get a coach before trying any of the more fancy option agreements. I would consult your local tax adviser to get into the details of assignment fee as taxable income. However, I’d rather have income and need to address a tax issue than no income at all.

I’m all for paying my fair share of taxes. Especially now with the new posting of tax cheats on Maryland’s comptroller home page. Not to mention, I support the concept of paying for public services. I do believe in limiting my taxable business exposure legally. I am not aware of a way around the 6 – 7% state tax in Maryland that you must pay when you sell real estate.

In your best case scenarios You can reduce your taxable income if you.

  1. May limit certain gain on the sale of residence if they obtained the property through a like-kind exchange
  2. $250,000 can be excluded if you are a single individual owner has owned and used it as a principal residence for two out of the five years before the sale
  3. $500,000 can be excluded if you are a couple and both owners have owned and used it as a principal residence for two out of the five years before the sale

So after living in a property for two years, it makes the most tax sense to start a lease option agreement on the property and shelter the at least $250,000 in taxable gains.

As a whole, lease option agreements are great for both investors and tenant. You should consult with your local specialist on details. You should also do your research to get a better understanding. I wish every God’s Grace as they learn more about lease option agreements.

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