Are Sales Taxes Due When You Rent to Own?
If you have trouble understanding how a rent to own real estate agreement should work, you are not alone. Rent to own deals can be written in a number of ways and are subject to local laws. In Texas, for instance, state law effectively converts a lease with an option to buy to a single contract for deed. Every element of a rent to buy agreement, from the purchase price to rent credits, if any, are open to negotiation, too. With so many factors to consider, it can be confusing for inexperienced buyers and may leave them wondering about taxes, fees and other expenses that could be due upon signing a lease or later, if they exercise their option to buy.
Sales Taxes on Leased Property
In most jurisdictions across the United States, sales tax is not due upon signing a lease, even If you include an option to buy agreement. Exceptions exist, most notably within the city of Phoenix, where sales tax is charged on rent paid to the owner of the property. This happens only if the landlord owns two or more properties in Arizona, and one of them happens to be in Phoenix. Arizona does not have a state property tax, however. Still, it can be complicated. Although the 2 percent sales tax on collected rents is charged to the landlord, the cost is commonly passed on to the renter. This would be true whether the tenant has an option to buy the property.
Upfront Expenses for Rent to Own
Because nothing is being sold, initially, when a tenant-buyer signs a lease with an option to buy, no sales tax is due, unless the property is in Phoenix or another obscure local municipality that taxes residential rents. In a rent to own situation, you are leasing the home and depending upon the lease agreement, you will normally pay a security deposit and the first month's rent. Tenants with pets may also have to post a pet deposit. The option to buy agreement could call for an option fee of 1 to 3 percent of the agreed upon purchase price of the house, which is typically non-refundable. Until you exercise your option to buy, your only other expense will be the monthly rent.
The Process of Exercising Your Option to Buy
When you exercise your option to purchase a house, a purchase contract is drafted using the details that are outlined in the option agreement, such as purchase price, seller concession from rent credits, if any, and possibly the closing date. You, as the tenant-buyer, will still have to qualify for financing, meaning that you will have to be credit worthy, meet the debt-to-income ratio set by the lender, have adequate income to qualify for a loan and have cash or a sufficient seller's concession to cover closing costs and your down payment. Taxes due and other fees you will pay will be calculated on a good faith estimate from your lender.
Taxes Due Upon Purchase of the House
Although sales tax is not commonly applied on the purchase of real estate, especially owner-occupied residential real estate, other taxes will be due. These taxes may serve the same function as a sales tax, but they are labeled such things as city, county or state property taxes, transfer taxes, doc stamp fees or excise tax. These taxes are detailed on the HUD 1 statement issued prior to closing on a property.
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