What is a rent-to-own home?
A rent-to-own home is exactly what it sounds like. Typically, the rental agreement for a rent-to-own home allows a renter the right to buy the property during or at the end of the agreement. A portion of the rent may go toward reducing the sale price if the renter chooses to buy.
The typical duration of a Rent-to-Own Agreement is one to five years. During that time, the renter makes monthly payments just like any other tenant would do under a standard Lease Agreement. If the tenant does not buy, the seller may continue to accept rent. The exact terms of the arrangement may be negotiated to suit both a seller and buyer's needs.
What options are there for rent-to-own sales?
There are two main types of rent-to-own arrangements that a seller can use: a lease option and a lease purchase. Most states have consumer protection laws that may apply to the total price or interest charges, so it may be a good idea to ask a lawyer about your state's laws.
In a lease option, or Lease with the Option to Purchase, the tenant has the option to buy the home. This agreement may specify a fixed price for the home or how the price of the home will be determined, such as via an independent appraisal at the time of the purchase. At any time during the agreement, the tenant can buy the home for that price, and the seller may not decline the purchase. If the tenant decides not to purchase the home for any reason, they are still liable for rent payments due according to the rental agreement.
In a lease purchase, the tenant commits to buying the property at the time of signing the Rent-to-Own Agreement. A lease purchase is effectively an alternative way to finance the sale that does not involve the buyer immediately taking out a mortgage and buying the property outright. If the buyer does not complete the purchase for any reason, including a change in their financial situation, the seller may be entitled to retake possession of the property and sue the buyer for damages. Just like a standard purchase contract, it is typical for the agreement to contain contingencies that may allow the buyer to get out of the deal without penalty.
What risks does rent-to-own pose to the seller?
The biggest risk as a seller is that the buyer may not complete the purchase. If the buyer has an option and home prices drop, the tenant might find a better deal somewhere else. While the seller can renegotiate their sale price, they might end up with less than they could have gotten initially. Even if the purchase agreement does not give the buyer the right to back out, there may still be a chance that they could fail to get financing or just refuse to close. This could result in the seller facing a costly legal battle if they want to recover damages from the buyer.
In addition, during the rent portion of the deal, the seller has all the typical risks of a landlord. If the tenant stops paying rent, the seller may have to send an Eviction Notice and go to court to get them out. And like a landlord, a seller in a rent-to-own agreement may be responsible for repairs, and must continue to pay taxes on the property. The rules for landlords and tenants vary from place to place, and some may allow a seller to make the buyer in a rent-to-own agreement responsible for more things than would be possible in a standard Lease Agreement.
Finally, keep in mind that a seller may not be able to back out of a rent-to-own agreement, which typically specifies that they will sell to the buyer as long as the buyer meets the terms of the agreement by the deadline in the agreement.
Why might a seller want to do rent-to-own?
Rent-to-own deals often make more sense in slower real estate markets. If a seller is having trouble finding a buyer at a price they are happy with, a rent-to-own arrangement can expand the pool of buyers to include people who may not be able to buy today. If the renter decides not to buy, the seller can still keep the rental income just like they could with a normal tenant. Additionally, someone who is at least thinking about buying your home is more likely to see it as theirs and may take better care of it than they would a temporary rental.
A property owner may also use a rent-to-own deal to help out a family member. They might want to help them buy a home without gifting them a property or co-signing on a mortgage. They can charge the market rent and treat the family member like any other tenant, or they can discount the rent. They can also set the purchase price as what they paid for the property plus closing costs, or set it at the current market value. When selling below market value, there may be legal implications as the difference between the market value and sales price may be considered a gift for tax purposes.
What are the rent-to-own tax implications for the seller?
With a rent-to-own deal, the seller typically gets the same tax advantages as any other landlord. For example, maintenance costs are generally deductible. Additionally, because the seller pays property taxes in a rent-to-own deal, they get the accompanying income tax deduction as well.
One big caveat, however, is that a seller may lose tax benefits if they go the rent-to-own route when selling their primary home. Many states give property tax exemptions and rate increase protections on a primary residence, but these could disappear if the homeowner converts their property into a rent-to-own home. Federal tax law also provides for reduced capital gains taxes on the sale of a home that was the seller's primary residence for at least two of the last five years.
If you are a landlord or property owner with questions about a rent-to-own deal, reach out to a Rocket Lawyer On Call® attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.