L/O or Land Contract?

I’m asking this for a friend of mine.

She was offered a house on land contract. She would put down 10%, pay rent which would ALL be credited toward the price of the house, pay the taxes and insurance, and try to buy within 3 years.

The owner came back and said that he needs to do a L/O instead, due to tax reasons. I’m worried about her putting so much down (12k) and not having the deed, as in a land contract. All other specifics would stay the same (rent credit and all that). Should I advise her to insist on the land contract?

Why would you ever want a Lease Option as a tenant? Lease options are slanted towards the landlord – always. Don’t you want the benefits of home ownership? Do you get to share appreciation? NO. Your lease gives you an option to purchase at some future date at full price. You get no share of appreciation until AFTER you purchase.

Do you get to write off mortgage interest or property taxes? NO.

Do you benefit from mortgage reduction? NO. Only the owner does that.

Do you have pride of ownership? NO, you are a glorified renter.

Do you get to refinance at the end of the option period? NO. The only way you can is if the Landlord admits you have an equitable interest. Fat chance of that. The only benefits of a lease option are for the Landlord. Period. There are better ways to do this. By the way, as an additional piece of information, both the lease option and the land contract are Due on Sale Clause violations.

She would be getting 100% rent credit, which is nice.

I would disagree that a LO is always bad for the buyer and always slanted towards the seller. Sure if you let the seller write all of the terms and you don’t protect your interest then it probably is slanted. But, if you negotiate 100% rent credit as you suggest and you negotiate a future option price that you believe will provide instant equity when you exercise the option then that is a good deal. There is no way to determine what fmv is two or three years hence but that is the beauty of the option. You have the right to buy the property at a predetermined price but not the obligation. So if you negotiate a low enough price today and the property appreciates during the option period then you reap all of the benefits of appreciation if you exercise the option. Granted you don’t benefit from the typical tax deductions of home ownership during that interim period but if you are getting 100% rent credit then it’s living rent free during that period if you ultimately exercise the option. imo

According to the IRS, a “masked” land sales contract or “disguised sale” occurs when, “the Tenant is in possession of the property and makes the payments, which apply in part against the purchase price, but has not yet received the deed.” In other words, if it smells like a duck, walks like a duck… Notice they did not talk about whether the Lease Agreement was separate from the Option Agreement or, if they were dated at different times or, even that they were offered by different parties.

The IRS has determined that Lease Options are nothing but a “Delayed” or “Disguised” sale. "When a Lease Option is a masked land sales contract, the Tenant with a purchase Option becomes an owner of the property with equitable ownership in the property!" [McClellan v Lewis, (1917) 35 CA64] This determination, in my opinion has widespread and potentially disastrous tax consequences for any party involved in the Lease Option process.

Texas has banned lease options and Indiana, Maryland and Colorado are considering similar legislation. In Arizona, here is a list of five things that may violate the law and cause the judge to classify the transaction as a “disguised sale”, prepared by a Judge who actually co-authored Arizona’s landlord/tenant laws:

  1. Collection of more than 1.5 times the monthly rent as Option Deposit.
  2. Collection of an Option Deposit or Rent Credit to be credited to a Purchase, or to discount the Purchase as in a Down Payment.
  3. Predetermining a Purchase Price, as in delaying or disguising a sale.
  4. The Lessee also holding an option on the same property they are leasing regardless if it is one document or two separate documents. (sandwich lease).
  5. The Lessee being responsible for maintaining the property.

Be sure to check the state laws in your jurisdiction to be safe.