Re: This seems too easy … what am I missing? - Posted by Ronald * Starr(in No CA)
Posted by Ronald * Starr(in No CA) on August 26, 2003 at 05:20:48:
Since it seems to be working for other people in your area, it likely will work for you. At least until the housing market changes, if it does. Some people are reporting that is not working well in their areas these days because the low interest rates allow the renters with better financial situations to buy houses outright. Thus they are having to chose renter from the “bottom of the barrel” applicants. Result: higher default rate, more damage to properties, more expenses, less profit.
This approach is not new, it has been around for years. But it was rarely used until the past half-dozen years or so. Now it is very popular among newer real estate investors. But it has been popular only when we have had an “up” market–increasing house prices pretty much everywhere in the USA.
I predict that should your housing market experience declining prices that the selling or “exit” end of things will be a nightmare. Which potential homeowner is going to want to pay even the current market value for a property–let along a higher one–for a property when they expect it to decline in value over the next few years? And what is their motivation to pay more than market rents?
There are also some ethical issues, which Johnboy does not like to talk about. And most of the other practioners of this approach avoid discussing. I’m not going to tell you what your ethics should be. However, I do suggest that you read Jack Reed’s discussion about the topic on his www.johntreed.com website.
Understand that many practitioners of this lease/option selling approach do not like Jack Reed. But their arguments about the ethical issues are generally not well articulated, with the possible exception of Johnboy. I don’t know if his arguments are still around or not. But you might do an archive search here in the main board of this CREONLINE.COM website to see if you can find them. Unfortunately, some people have emotional, nonlogical reactions to what Jack Reed says, Johnboy included. It is impossible to communicate intelligently with them on the subject of Jack. I know, as I have tried.
Jack also has some concerns that the lease-option programs might be recharacterized by the IRS as being contract for deed sales (also known as contract of sale and other names in some states). Even he admits that he does not know that it happens. However, he suggests that a lease with option really is a contract for deed. Just study the major aspects of the two. I agree with him on this one.
If the IRS were to recharacterize the lease option as a contract for deed, the sale of the property for income tax purposes would be set at the time that the lease option was effective, at the initiation. So, the tax liability would be for the tax year that includes that date. So, if you have not declared it as a taxable sale on your income taxes, you would have to pay late fees, penalties, and so on.
Also, many people who hold for a couple of years and then sell who would claim that this is a long-term holding and thus eligible for capital gains treatment. They would lose this argument if their deal were recharacterized as a contract for deed. All of the gain would be taxable at ordinary income tax rates, not long-term capital gains rate.
I don’t know that the IRS will start massively recharacterizing lease-options as contract for sales. However, I think you should at least consider the possibility. As I said, the lease-option phenomenon has increased greatly in recent years. It may be that it has gotten big enough to interest the IRS. I have no evidence that this has occurred. Do you have any evidence it has not?
I am not planning on using this investment technique myself. So, I will not be hurt if the IRS cracks down. I hope you will not be hurt either.
Good InvestingRon Starr***