Reporting Option Consideration

[Charles Hill]

Okay, here’s the deal. I have been working with a tenant/buyer who has his eyes on a condo for him and his son. Father is in the midst of a divorce and needs to find a home for him and his teenaged son.

I have a seller I got through the For Rent By Owner on the internet. I called the owner, shared the story about our father/son situation and asked if he would consider selling the condo. I told him the dad, a lawyer, was adamant that he live in the same community where his son attends high school, and that he (dad) did not want to make a landlord rich with $1200/mo. rent. He will buy instead.

There was a moment of silence as the homeowner thought about the situation and said, "lets' talk about it". The home owner agreed to sell the 2 bedroom 1 bath condo for $252,500.00. After running comps on the condo's sold in his complex, his asking price was fair. He has a mortgage with PITI of $1000.00. Current tenant is paying $1300.00 per month. Current tenant will be leaving at end of April.

I will set the buy price for the tenant.buyer @ 4% above the FMV which will be $265,600 in 2 years, with a $10,000 option consideration. The rent will remain at $1,300.00 per month.

I know that the $10K is a non refundable fee that is credited to the purchase price or down payment. I am unclear as to how the $10K is credited to the T/B. What form do I complete that addresses this? Who gets copies of the form(s)? How is the $10K recorded so that at the end of 2 years, the money is credited to the T/B. Is the $10K held in escrow or in my bank account? Please tell me my bank account is the happy holder of this money. Is the money eventually. If the seller wants some of the option money how and when is that distributed?

I ask these questions so I can answer the seller and buyer about the option consideration from a position of integrity and professionalism. Walking me through this is greatly appreciated. I think there are some steps that may have been left out of this post, through my ignorance. Please fill in the gaps.

With respect,

[Bill Gulley]

Charles, what I would do here is to use two contracts, a lease agreement and a seperate option to purchase.

I'd set the lease payment at $1,100 (85% of what might be fair market rent should be fine at this rent level, IMO). I would make the lease between the buyer and the seller, there is no reason for me or you to be involved in the lease agreement.

The option would have an option price of $25,250.00 with the right to purchase the property for $252,500.00. The option would be made between the seller and myself or you, not with the end buyer initially.

The option would provide for the option price to be paid with $1,250 in cash and the balance of the option price of $24,000 be financed.

There would be a promissory note, unsecured made for $24,000.00.
This is where the calculator gets a work out.

24,000 is entered in a FI calculator as the present value or PV. Next there is a rent of 1,100 so to get the difference of what is to be paid subtract the 1,000 from 1,300 and you have 200 to apply to the option note. Enter -200 in as the payment or PMT. (entering the pmt as a negative number indicates an outflow of payments in the calculator to give you a positive interest rate figure, if you don't simply recognize the interest should be positive).

The next entry can be an interest rate desired to solve for the term of the note or enter the term and solve for the interest rate. I usually enter the term and solve for a positive interest rate that is minimal to meet any imputed tax amounts by the IRS.

I entered 144 months after a couple guesses and got an interest rate of 3.14%, that is sufficient for tax purposes, with required payments of $200 per month. So, my note would be made at $24,000 as the loan amount at 3.14% interest with a required monthly payment of $200 monthly. I would almost insist on a three year term with the note having a balloon payment required in three years to match the term of the option.

Another issue is that $25,000 is a high option price for a residential option over just a 2 year period as the basis of an option price is the value of the right to buy, which is another time value of money analysis and the property will not appreciate by 10% in two years.

10% as an option price is due to the financing requirements to ensure a significant down payment and is an accepted maximum amount for residential options. If, in this case the seller won't budge, the option price could be reduced to 20,700 while keeping the required payments the same as well as the lower interest rate and adjust the term of the note, but then making it with a two year balloon.

Why charge any interest? Because the option price is due at the signing of the option, that is being financed so the optionee or buyer does not pay that in cash at that time. The time value of money gives the reason to charge interest and if the buyer would rather avoid such a low rate, the can pay the full option price!

Even though your buyer is an attorney, disclose that the note is an obligation created for the right to purchase and the balance of the note would be due even if the option to purchase is not taken. (Most likely he knows that and should appreciate your honesty in disclosing that fact).

Now, you option agreement will be assignable, it was made in your name and on the signature page after the signature of the parties to the agreement, you will have an endorsement for you to assign your rights over to another party.

It can simply say: ASSIGNMENT, For and In Consideration of four percent of the Option Price hereinabove mentioned, the receipt of which is hereby acknowledged being paid in hand by the signatures below, the Optionee and Holder of this Option Agreement hereby grants, bargins, sells and sets over unto _____soandso, all of Optionee's rights, title and interests, at law or in equity, in and to this Option Agreemeent as of the day and year written below.

ENDORSEMENT: ___________(and the Optionee signs) Date___
You may have the buyer then sign as an acknowledgment.

I would not file for record the actual Option Agreement, but a Notice of Option that would not contain the option amount to buy or any other considerations paid, but it would include the term of the option.

Now, I'm sure that many investors have all sorts of assignment contracts for the sale of the option and disclosures but a simple endorsement with the assignment stated is all that is necessary to assign an instrument, much like endorsing a check over to another payee. The attorney buyer will enjoy the simplicity I'm sure than seeing a bunch of guru cover your tail documents in poor form, IMO.

Now, I suggest you hot foot it to an attorney there to draft the documents, the lease need not be special, but renewable or continue over the term of the option and there should be the requirement for the lease as well as the option agreement to be well kept and provide for the termination of both agreements in the event of default under either agreement.

You have no settlement requirement, other than receipts for the exchanges made, selling the option is not a real estate transaction but a business transaction. I have no idea of the requirements for such transactions in B.C.!!!!

When the buyer takes the option, the assignment recites the premium paid of 4% for the option and that expenses can be noted in his costs to acquire the property. It is not a reduction of the sale price as a premium paid to use that option agreement for the purcahse and here, on a HUD-1 would be shown as costs paid out of closing at settlement. It's of no concern to you. The deal is between the seller and your buyer/optionee.

Good luck! AND AGAIN, SEE AN ATTORNEY! :)