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Some pretty good dialogue with a new member

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This topic contains 1 reply, has 0 voices, and was last updated by Avatar of bill_gatten bill_gatten 10 years, 12 months ago.

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    Thanks for a great workshop last weekend at Newport Beach. Merrie and I really enjoyed it.

    My pleasure!

    Could you help me understand how I would discuss the following lease/option ideas under the equity holding trust scenario:

    We take these same parameters that you’ve set out here and build them into an addendum to the Beneficiary Agreement, spelling out what you and the tenant want to happen, and what is required. My suggestion might be to have him sign and date a copy of a current Comparative Market Analysis so that he can’t come back at the end and claim that you took advantage of his naivete (especially in view of your legal background)..

    We bought the property for $244,600. Balance on the mortgage is $182,000. Our monthly payment is $1,245. A CMA at the time of purchase said the property was worth about $295,000. The appraisal obtained for the lender said the value was $265,000. We are talking to prospective tenant-buyers about a variable monthly payment of $1,750, $1,650, $1,450, or $1,350 based on an initial option payment of $3,000, $5,000, $7,000 or $10,000 respectively. We also are offering a monthly “rent credit” for timely monthly payments, i.e.: $50.00 per-month based on an initial $3,000 option payment, $100.00 per-month based on an initial option payment of $5,000, etc. Finally, the home is a two story rambler with a partially finished basement. A bedrooms exists in the basement, but there is no bathroom. Many prospective tenant-buyers want to finish a bathroom in the basement and get some kind of credit against the ultimate purchase of the property.

    The documents we use provides that the lease is a one-year lease with a possible one-year extension. We, of course, could extend the lease, but want to encourage the tenant-buyer to buy us out within two years.

    This would be accomplished by setting up the trust and the lease for a year with the right to extend for one year at a time for up to __ additional years. You might also state than each extension need be accompanied by, say, a $5,000 contribution to the trust’s contingency fund…or paid outside the trust as a mutually agreed Extension Fee.

    One of the more difficult parts of our discussions with tenant-buyers has been telling them that the ultimate purchase price will be based on a CMA at time of option exercise, but that there is a minimum purchase price which we have so far fixed at $282,000. Our proposed lease-option documents state that we, as landlords, choose who does the CMA.

    I might suggest that you both agree to provide CMA’s to be averaged.

    One of the tenant/buyers we spoke to simply wanted to know what he would need to come up with in 2 years. He didn’t like the idea of a floating purchase value.

    Nor would I. The EHT can be set up so that the purchase price is Fair Market Value at the time of purchase in 1, 2 or 3 years, less of course any equity having accrued by then that is over and above the MAV at inception, and also minus any refunds due relative to the Contingency Fund. In order that the Contingency Fund needn’t be refunded, merely add its amount to the property’s Mutually Agreed Value at the inception of the EHT.

    Ultimately we told him we would be willing to give him a two-year lease and fix the option purchase price at $282,000 if he would put $10,000 toward the option (see above), we would accumulate an option credit of $100.00 per-month from his $1,350 monthly rent, and we would give an option credit of $4,000 toward installation of a bathroom in the basement. We figured that would allow him to buy the property at $265,600 by exercising his option in two years ($282,000 less option credits of $10,000, $2400, and $4000 = $265,600).

    You decide exactly what you want him to pay you, irrespective of credits, when he buys the property. Then the credits and option fee can be worked into the price without there being an Option per se, and without there being any interest consideration (would trigger characterization as a disguised security agreement or equitable mortgage), due on sale violation, a predetermined purchase price…or Equity claims (which could foil eviction efforts and force judicial foreclosure, ejectment and quiet-title actions) until the purchase of the property. Also, the tenant will be wholly able to access the full income tax write-off for the term of the agreement (thereby justifying higher payments to you over the term of the agreement).

    Here are some questions I have when I begin to talk to tenant-buyers as resident beneficiaries:

    1. Do you think it makes sense to have a minimum purchase price?

    No. Just allow the purchase price at term to be Fair Market Value, minus any moneys owed to the resident beneficiary (which amount owed might even include a few thousand additional Contingency Fund dollars…over and above what was actually posted by him).

    2. Is the MAV basically the same idea as our $282,000 minimum?

    It could be. The MAV is only used to determine what your equity is at inception. If you owe $262,000 and your Mutually Agreed Value at inception is $282,000, that means your refundable contribution at termination is $20,000 (your starting equity) prior to any othr distribution of proceeds. If you owed more than $282,000 then your equity is obviously zero as is your refundable contribution.

    3. Would the $282,000 (or whatever figure we use) be used to determine the respective beneficial interests we have as settlor (co-beneficiary) and the RB?

    The respective beneficiary interests really have nothing to do with your profit potential unless you’re planning to do an equity share with the acquiring party. If a lease option model is what you’re looking for, logic would dictate that you give him only enough beneficiary interest to allow for income tax deductions until he buys you out. However, I find that giving them 50% to 90% is more salable and really doesn’t make any difference to you, or have any impact on profit or purchase price or taxes–unless you are planning to share in net sale proceeds at termination. The contract provides for you and the RB to share proceeds relative to the percentage of beneficiary interest held, unless there is a prearranged forfeiture by either party of such interest.

    4. Does the RB acquire his relative beneficial interest based on MAV ($282,000) less contributions he makes, e.g., $282,000-$10,000 (contingency fund?)-$4,000 (bathroom credit?)–$2,400 (monthly purchase credit?)? If that’s right based on the figures I’m using here, the respective beneficial interests would be: Settlor 94% and RB 6%.

    First off, the RB always needs at least 10% to be able to access the benefit of income tax deduction (for interest and prop. tax). However, as mentioned above, the percentages of beneficiary interest don’t necessarily have anything to do with the percentages of profit, the percentages of tax deductions taken, insurance benefits, property tax increases, conveyance tax, voting rights within the trust, etc., unless so stipulated in the contract.

    5. Can the RB’s beneficial interest increase based on accumulated credits against purchase price the same way a portion of the rental payment can accumulate as a credit against an option purchase price? If so, does the RB’s beneficial interest change each month?

    Sure, although it’s usually not done when the Lease Option model is the objective. With equity sharing or other full purchase models (land contract, wrap-around, etc.), you could start off at say 10% to the RB then increase the beneficiary interest by 10% per-year for 10 years (until they’ve accumulated 100% ownership upon refinancing). Or, perhaps 10% per-year for five years in a 50:50 equity share scenario. In your case, you might start of with 33.3% and increase it by anothr 33% in the following year, assuming prompt payments and strict adherence to the terms of the agreement.

    6. Does the RB’s beneficial interest in the trust translate to the value of his equity if he ultimately purchases the property?

    Yes. Unless he has agreed to relinquish it at the end.

    Bill, if all of this seems very confused to you, I’m sure it is. I’ll appreciate any advice or explanation you can give to help me think of all of this more clearly.

    No problem. I don’t confuse easily.


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