Tax Implications of Lease/Options:
As you have read from the previous information, lease/option strategy is a great way to leverage your real estate investments because it requires very little cash. The lease/option is more of a financing alternative than a financing strategy because you don’t own the property. The basic lease/option strategy involves two legal documents, a lease agreement and an option. A lease gives you the right to possess the property, or, as an investor, to have someone else occupy it. If you can obtain a lease on a property at below market rent, you can profit by subleasing it at market rent.
An option is the right to buy a property. It is a unilateral (one-way) agreement wherein the seller obligates himself to to sell you the property, but you are not obligated to buy. By obtaining the right to buy, you control the property. You can market the property and sell it for a profit. The longer you can control the property in an appreciating market, the more value you create for yourself. By combining a lease and an option, you create a lease/option.
The two primary objectives of the real estate investor are cash flow and appreciation. You don’t need to own a property to make cash flow or benefit from appreciation. A lease entitles you to possession, which allows you to make cash flow. An option gives you the right to buy at a set price, which allows you to benefit from future appreciation.
Lease-The Right to Possession:
Under a lease agreement, the lessor (landlord) gives the lessee (tenant) the right to possess and enjoy the property, which is one of the most important benefits of real estate ownership. The lessee is usually not responsible for property taxes and major repairs. Once you have the right to obtain possession of property, you can profit by subletting or assigning your right to possession.
Lease Option Pros:
- You don’t have to buy later-if the market drops or there is something wrong with the home. You can get out! If values go up, you can exercise the option and purchase the property.
- More sellers will do an option vs. giving up a deed-especially on “pretty” homes.
- A way to get nicer homes. It is more likely the seller that is not behind has taken better care of their home.
- Sellers with lots of equity are more likely to give you the option to buy the home than they are to give you the deed to their home.
- Have the potential to generate income in 3 different areas under an option (up front-monthly cashflow-backend on resale).
Lease Option Cons:
- Title is not in your name-seller could mess this up-must be careful to screen the seller.
- You will have short term capital gains vs. long term if you are not on title.
- Some sellers might feel like an “option” is not closer on their home.
- Sellers with lots of equity usually want to close and get their equity out.