Making Money With Lease Options
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Transcript of Making Money With Lease Options
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Making Money With Lease Options, Rent To Own etc.....
Lets start with some basic definitions. What is a "lease option?" Basically
speaking, it is the ability to lease the subject property (real estate) for a monthly,
or annual payment amount, and have the option to purchase the subject property
for a set price at the endor anytime - during the lease period. Lease options go
by a lot of different names. "Rent to Own," "Lease with Option to Purchase," and
"Purchase Options" are the most common. The names may be different, but
essentially all these titles mean the same thing. As you become more educated in
different techniques, you find more and more ways to structure the offer, all of
which will have an impact on how much you can get paid. There are a lot of
reasons to buy property using a Lease Option, from an investors point of view.
One of the foremost reasons is that it allows you to control an asset with little, or
even none, of your own money. Talk about leverage! You mitigate your downside
risk further because you are not the one that has qualified on the loan yet, you can
control the asset. Before I get into some of the mechanics, lets look at some of the
benefits to you the investor, as well as direct benefits to the buyer and seller, using
this strategy. As I said before, as an investor you can earn maximum leverage withminimum cash outlay. You can put a property under contract to lease-purchase for
little to no money, and then find a buyer that would put up the option
consideration. You can usually control a property for a 1-2% down payment that
would normally require a 10-20% down payment if you were buying. There are
also at least 3 ways to get paid when doing lease options; we will get more into
that later.
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Advantages to You, The Investor
Maximum Leverage
Minimum Cash Outlay
No Property Maintenance
Cash Flow
You also dont have any maintenance on the property if you shift responsibility to
the new buyer; andany major problem would fall under the sellers homeowner
policy. The last benefit listed above is also the most important - cash flow. You are
not a charity. If structured correctly, lease option transactions can give you 3 and
sometimes even 4 or more paydays on the same property. With all these things
going for it, you can see why lease options are a great way for investors to go.
There are several types of options: a strait option, a sandwich lease option, or an
assignment on an option. We discuss all of these, and more in detail. Making you
money is great for you, but why would a seller ever go for it? Lets look at some
reasons for selling a property on a lease-purchase. When Sellers are more flexible
on their terms, they can usually demand a higher sale price. Buyers are more apt
to give them what they are asking without haggling, and you, the investor, can
still make money. When people are buying a property, they have pride of
ownership, and usually take better care of a property. I have actually had
thousands of dollars of improvements done to a property, and the Buyers didnt
purchase. You know what? It wasnt a problem. I then re-rented it, and got paid
option money all over again. You could actually go on forever. If you structure along-term lease up front, you can generate great cash flow. You can also typically
get higher rent, especially if part of the payment goes towards the purchase price
(more on that below). The Seller can also retain all the tax advantages associated
with offsetting income (Check with an accountant). Often times, a seller receives
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up front, a non-refundable option consideration, usually a lot more than a typical
rental deposit.
Sellers Advantages
Get a Top Sale Price
Better Quality Tenant
Higher Rent
Tax Advantages
Non-Refundable Option Consideration
No Management Headaches
Weve looked at benefits to you, the investor, as well as some for the seller, but
whats in it for the buyer? Lease-purchases are great for Buyers because they can
usually get into a house for only 3-5% down. It is oftentimes hard for Buyers to
come up with a big down payment. They also get their rent money working for
them. I like to structure lease-purchases so part of the Buyers monthly payment is
credited each month as part of their down payment. It, thereby, increases their
down payment each month. Buyers love this. Its a much better deal for them vs.
paying interest on a mortgage those first few years. I like to show them an
amortization table to show them the advantages.
To avoid problems down the road, it is good to lock the price today for what they
will pay tomorrow. This works well as the buyer is able to lock in appreciation
without actually owning the property. Those of you in California, and those of you
in some of the other hot markets know what I mean. I think one of the main
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benefits of doing a lease-purchase from a buyers perspective, especially if they
are moving across country, or into an area they know nothing about, is that it is a
great way to check out the neighborhood. Lets face it; some communities are
nicer to live in than others. Its hard to know where "the right side of the tracks" is
when you have never lived in the community. The Buyer may also want to "Check
out" the property. It can take a while to sell a property to if its not in the "Right"
neighborhood and in good condition. Nice Properties in Good Areas Only This is
also one of the reasons why you, the Investor, only wants to do lease-purchase
transactions in "Nice" areas and only with properties that are not in need of
repairs. You will find out that Sellers will practically give properties away in bad
areas, and there is a reason for this give away. You will end up a landlord with
problem tenants if you violate the Nice Property/Good Area rule. Stay outof the
lower and lower-middle class neighborhoods for lease options. They work best
with higher valued properties, for a multitude of reasons. Now that I have shown
you some of the reasons it makes sense to structure a lease-purchase transaction,
lets run through a few examples. As I do, I will explain how you can create
multiple paydays using this buying strategy.
Advantages to the Buyer The Key to Making it WorkBuyers Advantages
Low Down Payment
Rent Money Working for Him
Option Consideration is Credited
Price is Usually Locked In
Appreciation
Time to Evaluate House & Neighborhood
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Control
Example: House on Twin Loop:
How I found the property:
A seller responded to my yellow page ad that stated that I bought houses. I gave
him a FREE report which educated him on how I could help him. Motivation forSelling - Find Out "The Why" The husband had a job transfer 150 miles away, and
they had purchased another house. The realtor had been by, and told them that
they had to spend $5,000 to fix it up before they could sell it because the
basement was not 100% completed. It was a nice house in a good area. Solve the
Sellers Problem I told them I would be willing to lease the house for 1 year, for
$600 per month, as long as I had at least a one-year extension. Their under-lying
payment was $750 a month. I told them that in order for me to lease it, I would
need them to subsidize the payment at least $150/month, so I could make a profit.
You may ask why would they ever do that? Well, there are a lot of reasons.
1. They wanted to sell the house, not just rent it.
2. A Real Estate Agent wouldnt make the payments while it was listed.
3. $150 a month payment is a whole lot easier than $750/mo.
4. They couldnt do 2 house payments.
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Pay Day #1 "Monthly Payment Spread" An Example of
How it Works Your First Payday
I think it also important to say that they "bought" me. We developed instant
rapport, and they sensed that I knew what I was doing. They knew that I could
solve their problem. People will pay for specialized knowledge. I found out the
"Why", meaning: "Why they needed to sell". Then, I solved their problem. Within a
few weeks, I had rented it out to a new buyer, and created a monthly payment
spread of a few hundred bucks that equaled $2,400 a year.
Payday #2 " Front End" Option Consideration.
This is the difference between the amount of "Option Consideration" that you pay
the seller, and the Option Consideration you charge the buyer to get into the deal.
In the above example, I only had to make the property payments they owed. Since
they were moving, that was $600 due in about 2 weeks. I immediately began
marketing the property as a "Rent to Own." Within a few weeks, I had found my
buyer a mortgage broker with a few dings on his credit. He figured he would be
able to buy in about a year or so, and was willing to give me $5,000 as Option
Consideration, and rent of $800 a month. I had to take the option payments over
time. $2,000 to get in; $500 in 30 days; plus $2,500 in 6 months. I said, "Sure."
Lets get back to the Sellers for a moment. I had determined that the Sellers were
payment sensitive, and credit sensitive. That was why they were willing to subside
the payment. They were willing to basically give me their house for their payoffplus $5K. That equated to me, a purchase price of $85,000. This brings us to the
third form of cash flow.
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Payday #3 "Back-End Spread"
What I mean by "Back-End Spread" is the difference between the price that I had
the house under contract to purchase ($85,000), and the price that I had sold it to
my new buyer ($115,000) less the option consideration to be paid by the new
buyer. The reason I call this the back end is because, the money gets paid to you
when your new buyer exercises his offer to purchase. You basically earn the spread
between the two contracts. I will explain further in a moment. Before I recap this
deal, I want to talk about the Buyer. I had sold the property to them for the option
consideration of $5,000, paid over time, plus monthly payments of $800. You may
ask why would he pay so much to get into a house that he wasnt sure he wantedto buy. You see, most Buyers in his situation will do almost anything to buy. He
was a former homeowner. He knew his credit situation would not allow him to get
better then an 80% loan to value in the near future, which means he would have
to come up with at least $20,000. He didnt have it, and he had to wait at least a
year to get his credit scores up. Besides, when I explained that I would give him a
monthly credit of $250 towards the down payment, from his rent payment, it
made it a sure thing. What you are asking is a rent credit. Let me explain. His
payment was $800/month to rent. I gave back to him $250/month, deducted offthe purchase price in the form of a credit. Not bad, huh? Once the Buyer realized
that he was basically only paying $550/month in rent, and $250/month towards
the purchase price, it was a slam dunk. Structuring a lease-purchase for the Buyer
this way helps mitigate any concerns they may have about paying a little higher
rent payment. We all know that the bulk of the payment (99% +) during those first
few years of paying on a mortgage goes to interest, and only a very small % goes
to principle. I just show them an amortization chart vs. a rent credit for a lease
purchase where a 1/2 or a 1/3rd of the payment goes to principle reduction, and it
is easy. Finding the buyers, if you have the right properties, just isnt that hard.
NOW, LETS RECAP....
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PAY DAY #1
Monthly Payment Spread
Payment Out $600 To Seller
Payment In $800 From Buyer
Monthly Cash Flow: $200 x 12 months = $2400
PAY DAY #2
Front End Option Consideration
Option $ Paid to Seller $600
Option $ Collected from Buyer $800
Option Money Collected = $5000
PAY DAY #3Back-End Spread
Purchase Price to Seller $85,000
Sale Price from Buyer $110,000
Rent Credit to Buyer ($200 x 12 mo.) $2,400
Back End Profit = $22,600
GRAND TOTAL
$30,000.00 Profit
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In the beginning of this Section, I mentioned 3 or more pay days. There are
actually a few more. Create "Paper" with Lease-Purchases You can use this
technique a few ways. One way is you can take back part of your back-end profits
from your new buyer is in the form of a note. In the before example, I could have
carried a note for $10 or $15,000. If the Buyer was still going to have a hard time
qualifying for the new loan. I would have actually increased my return, and
monthly cash flow by earning additional interest. The second way to earn paper
on a lease purchase once you get good at creating the deal, is to assign the whole
agreement to another investor for a flat fee, and/or take back a promissory note.
This gets you out of the deal entirely, but earns you some monthly cash flow.
Certain situations may make this an attractive way to go.
Lease Purchases for Cash Flow
Done correctly, lease purchase transactions are on auto pilot. It is a good idea to
use an escrow company to collect the payment from the Buyer. Use an escrow
company to pay the underlying payment on the Sellers mortgage directly, so you
know it gets paid. I feel a little stupid saying this, but the one time that I allowed
the Seller to pay it, it didn't get paid. Its a story for another day. All I can tell you
is, that you must have control in the transaction, or dont do the deal. One of the
reasons I like a third party escrow company to service the payments is that, when
the buyer goes to get their financing, there is an undisputable payment history.
Sometimes you can get that rated as a mortgage, and put it on a credit report to
help with your Buyers FICO credit scores.
Bottom line....Lease options are an excellent way to go. You can control staggering
amounts of property, and not have your name on one single mortgage. Its funny.
If I look back at all my deals over the last 14 years, its the ones I owned with bank
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financing that have caused me the most grief. Lease options are by far less
stressful when things dont go your way, and market conditions change
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JR'S KEYS FOR LEASE OPTION
Find A Property That You Would Like To Purchase On Lease Option. Here Are The
List Of Steps And Documents That I Use:
Check List Buying Real Estate With Lease Options.
1. Optioned Property Information Worksheet,
2. Optionor/Seller's Property Disclosure Statement,
3. Standard Real Estate Lease Agreement,
4. Option To Purchase Real Estate Agreement,
5. Real Estate Optionor/Seller's Affidavit,
6. Notice Of Real Estate Option Agreement,
.
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Checklist Selling Real Estate With Lease Option
Use When You Are Optioning To Sell And You Are The
Seller
1. Have Each Applicant Complete "Application For Lease/Option" To Be
Submitted With Reservation Check And Photo Copies Of Identification, Social
Security Card, Pay Check Stub And Last Years W-2 Form.
2. Complete "Application Receipt Agreement",
3. Confirm Information On Application And Pull Credit Report.
4. Verify Funds In Account And Deposit Reservation Money Check.
5. Prepare And Execute "Standard Real Estate Rental Agreement"
6. "Move-In/Move-Out Inspection Report"
7. Prepare And Execute "Real Estate Option Agreement"
8. Mark Your Calendar For A Date Before Which The Option Must Be ExercisedAnd Write A Letter Or Call To Remind Optionee/Buyer Of The Timing In Order To
Insure That The Date Does Not Pass Unnoticed.
9. Upon The Receipt Of Buyer's "Notice Of Intent To Exercise Real Estate
Option" Within The Time And In The Manner Allowed Under The "Real Estate
Option Agreement", Then; Prepare And Execute Standard Real Estate Purchase
And Sale Agreement"
10. Follow Standard Procedures For Closing The Sale.
11. If Extending Option Term, Prepare And Execute "Extension Of Option To
Purchase Real Estate Agreement"
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Now those are some of the documents and steps that I would use. Depending on
the deal would determine the paperwork
Never focus on just one; sellers or buyers. Focus on getting BOTH buyers and
sellers at the same time.. if you had to choose, however, get educated on finding
sellers FIRST! You'll be able to practice negotiating and become an expert at
talking with sellers... Once you've got that down, the buyers will come... buyers
will and always have been an easy thing to find... there out there...
So focus on BOTH buyers and sellers, but sellers first if you had to choose one (to
prevent you from getting overwhelmed)..
You can take an option in your name then assign it to a tenant buyer and step outof the way. This does not require a closing at your transaction, contract
assignments are not real estate transfers, but can be filed for record if needed. :)
I invest in real estate that has been on the market a long time or more is owedthan the current value so I am dealing with sellers who are more motivated to sell
so I only pay $10.00 option fee.
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in order to avoid a large option fee to a seller it important to take the right
approach, have the right presentation and it has to benefit the seller enough for it
to have value to them
Selling lease options is actually the focus of my business. To begin with, I just tell
them if they are looking for any money, it will need to be on top of my 5%
assignment fee. So if they are selling a 100k house, then I get 5k so if they need 3k
then we gotta find someone with 8k. Then I ask them If I should ignore a good
buyer for the property that does not have at least 8k. They usually quickly come
around and tell me just to get someone good.
I personally use an attorney to draw up all of my papers and close the deal at his
office. I charge the buyer for this service. All checks are written to the escrow
account, and checks are cut accordingly for first month rent and assignment fees.
You work with the owner to set the numbers, including the option price, rent and
rent credit.
When I send preliminary figures to the owner, I know that those are very likely the
figures we are going with. I include in there my assignment fee, and I normally
give the owner $1k of that, since there is no deposit with a LO, or at least you
really don't want one.
Then, you sign the docs with the owner, giving him $5 or $10 or whatever for
option consideration, and you now need to bust it to find a tenant/buyer to assign
it to.
You aren't assigning it to an investor, you are assigning it to the end buyer.
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The rent credits should reflect on your docs as a seller concession, and I don't even
use the term rent credit or show a monthly rent credit on the option to purchase,
just the total concession.
The payments go from the T/B to the seller, but you can use an escrow service for
this, but there is a fee of course.
I don't use an escrow service. No need for it for how we structure everything, but
that's up to you.
You don't need an agent to market the property, but that's up to you, and about
how you structure your model etc.
You can't necessarily charge a much higher lease amount either. We normally set
it at the going rent rate, or about what the payments will be at finance.
All Real Estate, like politices (LOL) is local.
It doesn't matter what strategy you want to get into, before you begin you really
need to talk to a local RE attorney. IMO, you should never use a contract from
some other area (state) or any site without running it past a local attorney.
As to title folks, they are in the phone book, you need to talk to these folks and see
what they will do, ask, they will be a good source of information for local
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requirements. Not all are investor friendly, so shop around and don't take the
word of one closing agent as gospil. If you hei a dead end on any issue run it by
the attorney as he or she may convince the closing agent that all will be well in
some cases. Good luck
Title companies are insurance agencies basically, providing title insurance. These
agencies are often owned by attorneys, but an agent does not need to be an
attorney. If a title company is owned by a non-attorney agent, they will have some
relationship with a local attorney to cover the bases of the business.
An escrow closing is usually done by an insured closing agent or an attorney.
Lenders may also close thier own loan transactions involving sales and usually
have an insured closing letter, a gurantee by a title insurance company to cover
any errors or ommisssions in such closings. I use to close my own loans and
obtained title coverage.
An escrow is simply money held in trust, Real Estate Brokers may have escrowaccounts and may close transactions but that is rare today due to compliance
issues, liability assumed and the fact that the services are affordable.
Attorneys may also close transactions and they will also have escrow accounts to
hold money in trust to facilitate a closing. Title insurance will generally be afforded
for an attorney closing as they are also insured and bonded as attorneys and meet
such requirements.
You should look to an attorney or title insurance company in your area to provide
closing services for you. You could have a situation where an attorney is willing to
close a transaction yet a title insurance company will not insure the closing but
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will provide title insurance. In such a case, it is the attorney's professional
coverage that may cover the attorney services. This is probably rare now but could
be arranged if allowed under state law.
So, as an investor, you should have choices, however, when you sell and the buyer
obtains a loan, that lender may require how, where and when such loan is to be
closed.
Talk to TI folks and RE attorneys in your area to see what best fits your needs.
Call the local Board of Realtors and ask them who thier attorney is for the Board,
they might give other names, maybe thier past attorney if they'd rather not say.
Call title companies and ask them. Call the Bar, they will give you a list of RE types.
You can also ask RE Brokers.
Some attorneys may say they can't help, that probably means that if they are on
retainer with a broker or Board, they may feel that any matter that comes up with
you may result in a conflict of interest.
Interview with several, it should be free, you'll get thier sales pitch but figure out
who you click with best and assess thier experience in the area.
You can live in fear or you can step up. Talking to a RE attorney is a good idea. The
best idea is call your state Real Estate Commission and meet with a compliance
officer and tell/show them what you want to do regarding lease options. Then you
can determine from the get go if you are in compliance or not
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Originally posted by Robert Burns:
I've was recently sent a complaint by my state real estate commission board
regarding my lease option work. I met with them and reviewd my lease option
agreement and explained to them that I was simply "assigning my rights in mylease option agreement" and receiving an assignment fee for such. It is LEGAL to
assign your rights in a contract. It's done all the time in all types of businesses.
Robert I love this soooo much. Face the fear. Do the right thing. This is a valuable
business if you do your due diligence, and that includes investigating the local
Realtor board.
This is my explanation to real estate agents and brokers.
"I have looked into this matter with my attorney. I am entering into agreements as
a principal and I do not act as an agent for a fee or commission.
Anyone can assign an interest in a lease, an option, or a bill of sale for a fee,acting as a principal."
Then ask them,
"If you have a listing about to expire, for whatever reason, please call me, I may be
able to help."
Lastly, I place this on my Letter Of Intent to Lease and To Option:
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"Please be advised that the undersigned is interested into entering into a Rental
Agreement and Option to Purchase Agreement. Please be advised that I am a real
estate investor that intends to enter into the agreements contemplated for the
purpose of investing in real estate as a going business concern. I now provide you
with this Letter of Intent. "
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There are two major problems with lease options the way they are being taught in
seminars:
The percentage of tenants who fail to buy the home is scandalously high
There are numerous other serious, potential ethical and legal problems
High failure rate
Claude Diamond runs his lease-option business in a way that I object to, althoughit's pretty typical. He says about 50% of his lease-option tenants are unable to
exercise their options. That means that about half the people who do business
with him as lease-option tenants end up thousands of dollars poorer as a result
when they walk away from their large front-end payments and year or two of
above-market monthly rent payments. These are people who entered into the deal
in the hope of becoming homeowners and leave less able to become homeowners
than they were when they first met Diamond.
That reminds me of the trade schools whose students pay thousands of dollars
tuition, then a high percentage of the "graduates" of the school cannot find a job
in the field for which they were trained. When I voiced my objections about the
high rate of his lease-option tenants being unable to exercise their options,
Diamond asked, "Whose responsibility is that?"
In other words, if a lease-option tenant pays Diamond thousands of dollars for the
lease option, then loses it all because they are unable to exercise the option before
it expires, that's the tenant's problem, not Diamond's, even when it occurs half the
time. I disagree with that attitude toward such a high failure rate. And I give the
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general advice that whenever you deal with anybody in any field of endeavor, you
should make the working assumption that the person will treat you the same way
he treats other people.
Other lease-option practitioners have failure rates as high as 95%. That's not right.
The lease-option tenants are typically young couples who cannot afford their
dream of home ownership and are convinced that a lease option is a back door to
owning a home. In fact, the vast majority lose the thousands or tens of thousands
of extra dollars they shell out, above and beyond what a lease would have cost.
When the lease option is over, they are far less able to afford a home than when
they started. I suspect many permanently lose their ability to buy a home because
they fell for the false promise of the lease option.
There is no question a lot of real estate investors are making a lot of money from
lease options. But most of it is dirty money earned by scamming young couples,
not by finding a need and filling it, the age-old legitimate path to profits. Rather,
this is the predators' way: a fool and his money are soon parted, so devote your
life to finding fools and taking their money.
The tenants do not exercise the options for two reasons:
The option is not in the money
The tenant's financial difficulties that prevented him from buying a home to begin
with were never fixed
'In the money'
An option is in the money when the option price is less than the current market
walue of the property. You would not exercise unless that were the case. In
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probably the vast majority of cases, the landlord sets the option prices in the lease
option so high that the option price is never likely to be less than current market
value. Furthermore, on the rare occasion when the option price turns out to be less
than market value, the landlord just reneges. In the stock market, they have
procedures to prevent that. No such procedures exist in real estate.
Can't qualify
Lease options are targeted at people who want to own a home but who lack the
cash down payment, credit, and/or income to qualify for the mortgage. In virtually
all cases, there is little reason to believe that will change during the two or three
years the option lasts.
So by making a lease option that is never likely to be in the money to a person or
couple who is not likely to qualify for a mortgage so they can exercise the option,
the lease-option scammer does a deal that he is pretty certain will result in his
pocketing $10,000 to $20,000 of the tenants money and leave the tenant out in
the street with nothingno benefit from having paid all that extra front money
and rent.
Legal problems
Lease options are explicitly named in numerous laws and legal documents as
triggering events. They trigger almost all mortgage due-on-sale clauses. They
trigger reassessment for property-tax purposes in California, thereby wiping out
the protection California homeowners normally get from Proposition 13.
Another problem is the legal doctrine of substance over form. It is possible to do a
lease option that is clean. But the various gurus advocate doing lease options in a
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way that arguably triggers the federal income tax doctrine of substance over
form.
That doctrine says that what you call something does not necessarily determine
what the law will regard it to be. Calling a lease option a lease option does not
mean the court will treat it as a lease option. In fact, I believe they will treat most
guru-designed lease options as land-contract sales in substance. The legal
implications of such a determination are amazing in their number and seriousness.
You could have a tax-free exchange invalidated. You may find that you are unable
to evict the tenant. IRS may say that all your lease options were installment sales
and that you must pay overdue tax and penalties on them, tax that will be inflated
by the typically inflated option prices
Here are some issues that will get you in trouble, give you a bad reputation,
maybe jailed as some "investors" here have been;
The SAFE Act
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Tenant/landlord law
Consideration given for a valid contract
Preditory lending/financing and transactions
Fraud, puffing the deal
So far, while I know you want to make as much as you can, you're headed down
the road of scammers, step back, get away from guru strategies and give yourself
time to study the basics. RE is an area where you can easily get bad advice, wrong
answers and be lied to by others, especially when they have a vested interest
selling you crap.