Whether the option fee and the rent credits are kept when a tenant-buyer walks at month 30 of 36

Question

Here is the ending that trips up most first-time lease option sellers: the tenant-buyer does not buy. Say a landlord with a duplex unit is asked by the tenant whether she could buy the unit over time. She pays a $5,000 option fee and the landlord credits $200 a month for 30 months, so $6,000 of credit, and then her job moves and she never exercises. The standard understanding is that the landlord keeps the $5,000 because that is what the fee bought, and the $6,000 of credit simply evaporates because there is no purchase for it to apply to. A claim that recurs on other forums is that the credit portion has to be refunded because it was really a deposit. That sounds wrong on its face, and it is worth being able to explain exactly why. Is that a real thing anywhere?

Rena Guide · Accepted Answer

In a properly drafted lease option, the answer is the one you already have. The option fee, sometimes called option consideration, is payment for the right to buy, and it's earned when the right is granted. The rent credit is a contractual promise to reduce the purchase price if and when the option is exercised, so if no purchase happens there's no price to reduce and the credit is gone. She paid rent, she got occupancy.

The reason the other forum answer isn't simply nonsense is that the label on money doesn't control how it's treated. If the paperwork holds the credit in a separate account, calls it a deposit, or the arrangement as a whole looks like an installment sale rather than a lease with an option, a court can read it differently and a different set of rules can apply to getting the tenant out and to what has to be returned. That reading depends on the specific documents and on your state's law, so the person to ask is a real estate attorney licensed where the duplex is, before you offer anything.

Two practical points while you're deciding. Write the credit as a price reduction and never as money you're holding for her, and keep the option agreement as a document separate from the lease. Also think about how you're recording the credit on your own books, because the tax treatment of an option fee you keep versus rent you collected is a question for your accountant and it lands in a year when you may not be expecting it.

tylerbrooks9 · Answer

Your reading is correct. The credit only exists as a discount on a purchase price, and if there is no purchase there is nothing to discount. The contract wording still deserves a close look, because if it says the money is "held" anywhere it starts to sound like a deposit, and deposits have rules.

kevin_lombard · Answer

So the tenant pays $200 a month extra for 30 months and if she moves for work she has nothing to show for it? I understand the logic and it still feels rough.

ehernandez74 · Answer

The tenant is buying optionality, @kevin_lombard, and optionality has a price. Had prices run up she could have bought at the old strike or sold the option. The cost of a right that goes unused is the fee. Same as insurance nobody claimed on.

diane_kowalski · Answer

Worth asking whether $200 a month is actually extra or whether the rent is at market and the credit comes out of it. Those are very different deals for the tenant and the second one costs the owner real money.

nicole_adeyemi · Answer

@diane_kowalski that is the question I would put to thicket. If rent is $1,400 market and you credit $200 out of it, you are funding her down payment at $2,400 a year for the chance of a sale. If rent is $1,600 with $200 credited, she is paying for it.

paulgrant17 · Answer

Since she's already your tenant, do you have a rent ledger for her going back a while? A tenant who has been on time for two years is a different proposition than a new applicant, and that history is also what her future lender will want to see.

renee_dubois · Answer

One thing that bites owners on this setup: the tenant-buyer stops calling about repairs because she has started thinking of the place as hers, and by the time she leaves there can be $7,000 of deferred items nobody reported. Selling part of the house's future does not change who owns the plumbing. Keep inspecting the unit annually and put that right in the lease.

Whether the option fee and the rent credits are kept when a tenant-buyer walks at month 30 of 36

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