Rental business - Rent to own option

[retire to nature]

Hi All,

I got a lot of help from this website, I would like to appreciate and get some more help.

Many people advised me to sell my rental property.

I am in the process of selling one house (which my sister used to live) and have a lot of headache.

I got an offer from one of my tenant, that she is interested to do rent to own. She is section 8 tenant actually, so I am not sure how it would it works.

My original plan for 10 rental properties is to keep them until current tenants move out, I would sell. Because as far as I know it would give me better cap rate.

But I got wondered if it is good for the current tenant to convert to rent to own. I am pretty sure, some of them wants to buy it.

But I am not sure if appraisal is necessary? or how to make price and what kind contract needed?

Any pros and cons? by my research they need some money to start like down payment.

SO is it possible idea or better not think about at all.

Thank you in advance.

 

[HI Bill]

I've never done it, but would avoid rent to own for a few reasons:

1) You may still need to deal with repairs
2) You may still need to deal with the new owner's damage
3) If the new owner is Section 8, and the house needs a new roof or other major repair, they may not be able to pay for it. They may let the house fall into disrepair, then default on the 'rent to own'.
4) If the new owner brings drugs into the house, then the police can take the house...and you're left with exactly nothing.
5) If would be difficult to evict the new owner for default, without going through foreclosure.
6) The new owner hasn't put down a downpayment. If they decide to move, there's no real cost to them for defaulting on the agreement.
7) Selling outright relieves you of all burden, liability, and stress formerly associated with the property.

Added: The new owner may not pay for homeowner's insurance. This puts you and the property at risk.

 

[Dash man]

I once made an offer to a tenant to have them buy the home they were renting, which they chose to purchase. But a Rent to Own contract in real estate sounds iffy to my. You may want to speak with a real estate attorney about how a contract would work.

 

[retire to nature]

I've never done it, but would avoid rent to own for a few reasons:

1) You may still need to deal with repairs
2) You may still need to deal with the new owner's damage
3) If the new owner is Section 8, and the house needs a new roof or other major repair, they may not be able to pay for it. They may let the house fall into disrepair, then default on the 'rent to own'.
4) If the new owner brings drugs into the house, then the police can take the house...and you're left with exactly nothing.
5) If would be difficult to evict the new owner for default, without going through foreclosure.
6) The new owner hasn't put down a downpayment. If they decide to move, there's no real cost to them for defaulting on the agreement.
7) Selling outright relieves you of all burden, liability, and stress formerly associated with the property.

Thank you for the reply,

This answers what I wondered about. about whose responsibility something goes wrong. Thank you again.

 

[retire to nature]

I once made an offer to a tenant to have them buy the home they were renting, which they chose to purchase. But a Rent to Own contract in real estate sounds iffy to my. You may want to speak with a real estate attorney about how a contract would work.

I guess I can do this way too. I am wondering how post corona time would work in real estate market. is it good time to your option?

 

[OldShooter]

I have 25 years' experience renting small residential properties. I would not do this.

You will have to talk to a good real estate attorney who knows your states laws, which I obviously do not, but I would expect that in a rent-to-own contract you keep all the hassles of being a landlord but give up at least some of your rights to evict a problem "buyer." Said real estate attorney can also advise you on Section 8 rules, which are almost certainly going to be problematic, as she will have to pay significantly more to live there/to build equity than just the current rent amount -- which is what Section 8 is paying

 

[Dash man]

I guess I can do this way too. I am wondering how post corona time would work in real estate market. is it good time to your option?

Real estate markets are local. They can be different from one town to the next. Here in the Philly suburbs there isn’t much on the market. We did find a townhome to buy for our son and his family to live when they move here next month. We’d been looking since the beginning of the year. Everything is expensive, but the townhouse had been listed in May for a fair price by a family moving to Florida. Two offers, ours was cash, so they took it. We bought it before we could see the inside, but had a couple of inspection contingency clauses to protect us. We close next month. I hear in some parts it’s more difficult.

 

[RetiredAndLovingIt]

My son is currently in Escrow for the sale of one of his two rental houses and just got hit with news of a $40,000 Fed/State tax bill. He never consulted an attorney or tax man and is finding the only way to shield the sale from capital gains is to buy another property within 45 days after the sale(1031 exchange). He already bought a new home in February, we all told him it was a bad idea to buy before he sold but my son listens to no one. If he had this would not be a problem
His options are
Pay the tax bill, move on and expensive lesson learned.
Back out of the sale, pay the buyers expenses and hold onto the house as a second residence for two years after which time the tax bill goes away. House can't be rented in that time. Since he is currently carrying three mortgages that's really not an option.
Back out of the sale, keep renting it while he tries to figure out his next move but then he has no money to update the house he just bought on a lake.
He's always been a saver and took advantage in 2009 when real estate prices in California tanked. He was still in his 20's and bought his rentals for next to nothing and it's paid off handsomely but now if he's not careful he could potentially lose everything if the economy does not recover quickly or he lost his job. I honestly don't know how he can sleep right now, I'm not since I found about this mess.

 

[calmloki]

Yeah, the exit from rental property is painful. Good to be rewarded for hanging on and not flitting about with an investment, but if you don't 1031 or convert to personal dwelling your only exit is to continue renting till death, then pass at a stepped up basis to your heirs. We are trying really hard to remember the rental profits and increase in equity value as we divest, but it is a big owie writing the checks to the tax people. Don't remember them fixing any toilets..

 

[38Chevy454]

I can't see how a person that is on section 8, could possibly get a mortgage. Unless they are lying to govt and have a lot of cash income (likely the case), the whole reason being section 8 is because they need govt assistance for housing. A rent to own with such a tenant seems destined for failure, and high risk.

 

[Dash man]

My son is currently in Escrow for the sale of one of his two rental houses and just got hit with news of a $40,000 Fed/State tax bill. He never consulted an attorney or tax man and is finding the only way to shield the sale from capital gains is to buy another property within 45 days after the sale(1031 exchange). He already bought a new home in February, we all told him it was a bad idea to buy before he sold but my son listens to no one. If he had this would not be a problem
His options are
Pay the tax bill, move on and expensive lesson learned.
Back out of the sale, pay the buyers expenses and hold onto the house as a second residence for two years after which time the tax bill goes away. House can't be rented in that time. Since he is currently carrying three mortgages that's really not an option.
Back out of the sale, keep renting it while he tries to figure out his next move but then he has no money to update the house he just bought on a lake.
He's always been a saver and took advantage in 2009 when real estate prices in California tanked. He was still in his 20's and bought his rentals for next to nothing and it's paid off handsomely but now if he's not careful he could potentially lose everything if the economy does not recover quickly or he lost his job. I honestly don't know how he can sleep right now, I'm not since I found about this mess.

The recaptured depreciation tax bill never goes away unless you die. I believe for the capital gains avoidance, it has to be your primary residence that you’ve lived in for two of the past five years.

 

[Buckeye]

Thank you for the reply,

This answers what I wondered about. about whose responsibility something goes wrong. Thank you again.

You would want to be responsible for repairs to protect your investment.

You don't want the buyer to ignore a water leak, for example, and then walk away from the property some day and you are left with a huge mess.

 

[Finance Dave]

I have 5 rentals and have never done RTO but I've looked into it. THere are many "watch outs", based on my discussions with about 40 landlords that have done this. The two biggest being :

1) They then think of the property as theirs, so they won't take care of it the way you would...they will let things go, modify/alter things, and use cheap materials when making repairs

2) You should NEVER "rent to own", as this gives them equity in the property. Once you've given any equity, you can no longer evict...you must go through a difficult foreclosure process that can be costly. Instead of rent to own, develop a "Purchase Option" contract where they pay you a non-refundable fee that gives them an option to purchase the property within some time window.

Any way you do it, involve a lawyer.

 

[Onward]

My son is currently in Escrow for the sale of one of his two rental houses and just got hit with news of a $40,000 Fed/State tax bill. He never consulted an attorney or tax man and is finding the only way to shield the sale from capital gains is to buy another property within 45 days after the sale(1031 exchange).

For a 1031 exchange he has 180 days to buy the replacement property. He as 45 days to identify the property he's going to buy.

If he doesn't want another physical property, he should look into 1031-exchanging into a Delaware Statutory Trust. DST's offer full tax deferral, monthly income, and possible capital gains.

 

[CardsFan]

I can't see how a person that is on section 8, could possibly get a mortgage. Unless they are lying to govt and have a lot of cash income (likely the case), the whole reason being section 8 is because they need govt assistance for housing. A rent to own with such a tenant seems destined for failure, and high risk.

This one hit me as the obvious reason to be VERY wary.

 

[RetiredAndLovingIt]

The recaptured depreciation tax bill never goes away unless you die. I believe for the capital gains avoidance, it has to be your primary residence that you’ve lived in for two of the past five years.

The way it was explained to him that a married couple could legally each own a primary residence and as long as he used that address for mail and had utility bills that would qualify him.
I think he is aware of the recapture taxes but I will pass this along, thank you.

 

[RetiredAndLovingIt]

For a 1031 exchange he has 180 days to buy the replacement property. He as 45 days to identify the property he's going to buy.

If he doesn't want another physical property, he should look into 1031-exchanging into a Delaware Statutory Trust. DST's offer full tax deferral, monthly income, and possible capital gains.

I will pass that information along, thank you

 

[Dash man]

The way it was explained to him that a married couple could legally each own a primary residence and as long as he used that address for mail and had utility bills that would qualify him.
I think he is aware of the recapture taxes but I will pass this along, thank you.

Even if the IRS accepted that, it would depend on the amount of the capital gain to know if it would be sufficient to exclude the full amount of the sale from taxes.