Selling rental property to tenants over time

[ArkTinkerer]

Considering sale of rental property to tenants. Goal, for me, is to spread the purchase cost over time with the least risk.

I am considering setting it up as a lease with option to buy, perhaps with some funds going toward the purchase price. If I could spread the purchase over 5 years I think I would be in much better shape tax wise. I don't want to be in a position to have to do a foreclosure rather than simple eviction. If I did the lease with option, I would want a COLA adjustment to the payments, and, to be fair, would increase the amount dedicated to the purchase to have the same adjustment. Adjusting the purchase price the same way sounds good but I don't know if that will fly. Also either have to have a fund for insurance and taxes or proof those are paid. Then there is the issue of making sure the property is maintained. Lots of items that need to be covered in ways I have not done before.

Could really use some practical advice from those who have done this before.

 

[JDARNELL]

I have a lease option on a property. In addition to paying me the rent they pay an additional 55% that goes to principal reduction. Is they can’t by they lose
The money

 

[ArkTinkerer]

Not a bad deal.

 

[ArkTinkerer]

How do you treat that extra money as far as taxes are concerned?

 

[calmloki]

We were pretty low key when we sold a little old house to our tenants. Only self protective thing we did was to do a land sales contract vs trust deed. Allegedly easier to foreclose if need be. We are also using an escrow service for PITI collection. The taxes stung. One of us paid all taxes as if we had been paid in full, which resulted in reaching into the pocket to pay them as we did a low down payment. The other is paying taxes based on principal received.

 

[Lienlord]

I've sold a couple of rental properties to tenants using owner financing. My attorney drew up a Contract for Deed (15 yr amortization @ 8% with 10% down). The property stays in my name until loan is paid in full, refinanced or property sold. The tenants are happy because their monthly payment is lower than rent and each payment goes toward ownership.
I'm happy because I'm no longer responsible for the maintenance on the property, and I'm netting about the same as renting. Plus the cashflow is level for 15 years. As far as taxes, my CPA only counts the % of the payment that is profit after recovery of my purchase price.

 

[JDARNELL]

How do you treat that extra money as far as taxes are concerned?

So the money is treated like a deposit until either they execute the contract which will then be treated as part of the selling price and I will then have capital gains tax and depreciation recapture. If they do not execute the purchase and defaulted on the funds then I will have to claim the funds as income during that tax year.

Each month the tenant has more and more funds at risk and has more incentive to execute the contract. The reason they wanted to do this was they were concerned about their ability to finance 2 yrs ago. They had already been renting for 3 yrs at that point. The term to execute is 4 yrs so a couple more to go. When time comes they will have a lot of "equity in the house" at closing and I have had the luxury of using the funds before the time of sale. I have used the funds to pay down principle which has reduced my borrowing costs. I did recently use a HELOC on that property to purchase another property that I am going to use for a housing cost hack. I will disclose what I did to the board once I have a track record on how it is going. The price we set has an adjustment in it if we decide to extend. They have asked me to extend a little longer. We set a price that I was comfortable with and they were comfortable with. I lost some potential appreciation but it could have gone the other way. At the time I did the contract I had a lot of risk. For me the house is too much risk to keep as a rental when I leave the area next year and I wanted to get rid of it on my timeline. In my area I like my townhouses for rentals instead of this McMansion which was a primary residence at one point. I do get a nice IRR on the capital I have tied up in the house.

I may do a 1031 exchange to a property that I might want to occupy at some point. I have nothing in mind and may decide to just bite the bullet on the taxes at time of sale. I say that but honestly the thought of paying the taxes might push me into the 1031 exchange near an area where I eventually will inherit 6 more homes. Needless to say my strategy to avoid the tax payment longterm is to pass it through an estate. Of course I am putting that off as long as I can.