Tenant-buyer walks at month 30 of 36. Do I keep the option fee and all the rent credits?

Question

I have four small buildings and I've never done one of these, but a tenant in one of my duplex units asked whether she could buy the unit over time and I'm reading up before I answer.

The part I can't get straight is the ending where she doesn't buy. Say she paid a $5,000 option fee and we credited $200 a month for 30 months, so $6,000 of credit, and then her job moves and she never exercises. My understanding is I keep the $5,000 because that's what the fee bought, and the $6,000 of credit just evaporates because there's no purchase for it to apply to. Someone on another forum said the credit portion has to be refunded because it was really a deposit, which does not sound right to me but I can't explain why it's wrong. 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

My understanding is the same as yours, the credit only exists as a discount on a purchase price and if there's no purchase there's nothing to discount. But I'd want to see how the contract words it, because if it says the money is "held" anywhere it starts sounding 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

@juniper the tenant is buying optionality and optionality has a price. If prices had run up she could have bought at the old strike or sold the option. The cost of a right you don't use is the fee. Same as insurance you didn't claim 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

@arbor that's the question I'd put to thicket. If rent is $1,400 market and you credit $200 out of it, you're funding her down payment at $2,400 a year for the chance of a sale. If rent is $1,600 with $200 credited, she's 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 bit a neighbor of mine on a similar setup: the tenant-buyer stopped calling about repairs because she thought of the place as hers, and by the time she left there was $7,000 of stuff nobody had reported. Selling half the house's future doesn't change who owns the plumbing. I'd keep inspecting the unit annually and put that right in the lease.

Tenant-buyer walks at month 30 of 36. Do I keep the option fee and all the rent credits?

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