Lease Purchase in Canada

[Christine Thygesen]

Hello, we have been unsuccessfully trying to sell our house and have recently been contacted by a couple wishing to rent to own our home.  She is recently out of a three year college program and her husband is less than a year into his own business. The banks won't mortgage them without 2 more years of income.  She has already told me that they have $30k to use towards their purchase credit.  I have been reading the forums and trying to learn what I can about Lease purchases but would love more direction.  This may be a silly question, but I am such a newbie that I have to ask:  would I be able to use the $30k as a down payment for my new home or does it need to remain in trust until the end of the lease term?  Thank you in advance for any advice!  

[Roy N.]

@Account Closed is selling her home in Canada, so there will be a few subtle differences ... in some ways it will be easier.

Christine:  You could start by reading Mark Loeffler's "Investing in Rent-To-Own Property: A complete guide for Canadian Real Estate Investors".   His bits about qualifying the tenets/buyers should be helpful to you.  I would also advise you find a CPA who is familiar with real estate and with the CRAs Interpretive Bulletins (IBs) on lease options vs instalment sale and an attorney who practices real estate law as her/his primary talent.

Where this is your primary residence, you also have the consideration of structuring the deal such that you retain the capital gains exemption on sale - normally when you turn a property from your primary residence into a rental, there is a deemed sale at FMV which establishes the new cost basis for the property. When you later sell it, you will pay capital gains on any appreciation realised since you converted it to a rental. If your purchase option with the tenant/buyer sets the purchase price (2-3 years out) to be the same value, you should mitigate any capital gains. This is a conversation you need to have with your CPA and real estate attorney.

When setting up any resulting rent-to-own deal (if these folks qualify), you will want to take great care not to wander across that line CRA uses to determine an instalment sale.

Essentially, you will have two agreements: a) a regular lease for the rental of your house {this could be a 2-3yr lease or an annual lease with automatic renewal pending on the tenancy law in BC} as you would if renting to any tenant and b) an option to purchase the house for price X at time Y in the future.   The purchase option agreement will stipulate a fee the tenant/buyers will pay for the right to purchase and will require a deposit be remitted.    The rent they pay while living in the house prior to purchase will be rent (not refundable, no credited towards the purchase).  

Where you start getting into a hazy area (in the U.S.A. they have recently added clarity around this matter) is if you collect above market rent and credit a portion of that rent towards the purchase ... this is where your CPA will be necessary, but I would recommend you not go this route.   

The purchase option agreement can have a deposit (5%-20% of purchase price) to be made by the tenant/buyers, a portion of which will not be refunded in the event they do not exercise their option.   You will probably need to/should hold these monies in escrow until the tenant/buyer exercises the option as the funds are technically a deposit and not yet yours .... your attorney and CPA will provide the guidance here.

At this point I would find your team (attorney, CPA) and do your diligence on this couple before spending the money required to draw-up the agreement.

... oh, and welcome to BP!