Rent 2 Own in the US compared to RTO in Canada?
- Thread starter Joel
- Start date
In the US I trust they have what is called a Form 1041 (think that is the form), which allows an investor to defer income tax on profit from property sales (e.g. when you dispose of an RTO property to the tenant buyer). That is, as long as the profit is reinvested in another property, then not income tax is paid to the IRS.
To my knowledge, we do not have similar tax shelters in Canada for real estate sales, so any profit from RTO deals would have to be declared as capital gain. In effect, 50% of your profit gets taxed at your personal tax rate. Not sure if this can be avoided, and most of the Canadian rent to own books I have ever read (including the one promoted on the REIN site), do not discuss it in great detail. Rather briefly skim over it, if at all mentioned. I am interested to learn what Canadian RTO investors do to mitigate this tax burden. Certainly those investors who seem to make it their primary RE investment strategy, and who sometimes offer the RTO contracts in the JV section of this forum.
Don't think this answers your question, and not sure as a Canadian you would benefit from this Form 1041 process, but thought I'd throw it out there. Not sure who you pay your income tax to, as a Canadian investing in the US. Might be both IRS and CRA want a chunk of your flesh.
To my knowledge, we do not have similar tax shelters in Canada for real estate sales, so any profit from RTO deals would have to be declared as capital gain. In effect, 50% of your profit gets taxed at your personal tax rate. Not sure if this can be avoided, and most of the Canadian rent to own books I have ever read (including the one promoted on the REIN site), do not discuss it in great detail. Rather briefly skim over it, if at all mentioned. I am interested to learn what Canadian RTO investors do to mitigate this tax burden. Certainly those investors who seem to make it their primary RE investment strategy, and who sometimes offer the RTO contracts in the JV section of this forum.
Don't think this answers your question, and not sure as a Canadian you would benefit from this Form 1041 process, but thought I'd throw it out there. Not sure who you pay your income tax to, as a Canadian investing in the US. Might be both IRS and CRA want a chunk of your flesh.
[quote user=nubiwan]so any profit from RTO deals would have to be declared as capital gain.
Since the sale date is already known on day one it is NOT a capital gain but business income, a major drawback of RTO deals.
Don't worry too much about taxes, more about profits. If I make money I am happy to pay taxes. Making the profits is where the rubber hits the road.
Holding an asset long term, with rental income and tax free equity gain until sold (and then taxed only at 50%) is where true networth is built. You can use RTO as an income strategy i.e. another real estate related job. Nothing wrong with that, as RTO is more profitable, before tax, than a typical short-term buy-and-hold. It is just a different strategy.
Since the sale date is already known on day one it is NOT a capital gain but business income, a major drawback of RTO deals.
Don't worry too much about taxes, more about profits. If I make money I am happy to pay taxes. Making the profits is where the rubber hits the road.
Holding an asset long term, with rental income and tax free equity gain until sold (and then taxed only at 50%) is where true networth is built. You can use RTO as an income strategy i.e. another real estate related job. Nothing wrong with that, as RTO is more profitable, before tax, than a typical short-term buy-and-hold. It is just a different strategy.
Thomas is absolutely correct in that RTO is all income rather than capital gains, and that RTO is a strategy useful for creating cashflow and income but does not lend itself to long-term wealth creation.
As for your questions regarding specifics, the answers are very similar in both countries.
First, I will point out that one does not collect a security deposit, but rather "option payments" or "option consideration." The tenant is buying an option to purchase the property at an agreed price within a set time. The option payment buys him this right. The more the better, as this amount mitigates the risk for the RTO company.
In both countries, the RTO company should pay the closing costs because they are buying the house. When the tenant buys the house later, he will pay the closing costs.
Rental rate is whatever you can get. It must cover costs plus a healthy cushion. If a tenant is willing to pay $4000, then that's what I'll charge. I may then be able to give him a better deal on the final purchase price.
Monthly option credits depend on the initial option credit. If I have a 10% option payment up front, I won't collect anything monthly. When you collect monthly option payments, you limit the number of banks that the tenant can use when he buys the house as many banks won't deal with RTO's.
Contract structure is different for each province and will be different for the States as well. This is where a good lawyer comes in handy.
The bottom line is that you must be able to make a reasonable amount of money on these deals that will cover your costs (money, time, and effort) and will provide a reasonable ROI to both you and your investors. If a deal doesn't meet your minimums, don't do the deal. Either restructure it so that it works or just say "no."
As for your questions regarding specifics, the answers are very similar in both countries.
First, I will point out that one does not collect a security deposit, but rather "option payments" or "option consideration." The tenant is buying an option to purchase the property at an agreed price within a set time. The option payment buys him this right. The more the better, as this amount mitigates the risk for the RTO company.
In both countries, the RTO company should pay the closing costs because they are buying the house. When the tenant buys the house later, he will pay the closing costs.
Rental rate is whatever you can get. It must cover costs plus a healthy cushion. If a tenant is willing to pay $4000, then that's what I'll charge. I may then be able to give him a better deal on the final purchase price.
Monthly option credits depend on the initial option credit. If I have a 10% option payment up front, I won't collect anything monthly. When you collect monthly option payments, you limit the number of banks that the tenant can use when he buys the house as many banks won't deal with RTO's.
Contract structure is different for each province and will be different for the States as well. This is where a good lawyer comes in handy.
The bottom line is that you must be able to make a reasonable amount of money on these deals that will cover your costs (money, time, and effort) and will provide a reasonable ROI to both you and your investors. If a deal doesn't meet your minimums, don't do the deal. Either restructure it so that it works or just say "no."
Thanks for your detailed answer!
I came across recently a local mortgage broker who claims doing quit a few deals (24 in the last 7 months), he is taking minimum 15% option deposit, plus the tenant is paying all closing costs, consulting fee. I am wondering how I figure out its legitimacy, it sounds too good to be true.
I came across recently a local mortgage broker who claims doing quit a few deals (24 in the last 7 months), he is taking minimum 15% option deposit, plus the tenant is paying all closing costs, consulting fee. I am wondering how I figure out its legitimacy, it sounds too good to be true.
[quote user=Joel](24 in the last 7 months),
starting an RTO is one thing, seeing it to conclusion 2-3 years later is quite another as the tenant-buyer usually has personal issues that caused him/her to be in credit difficulty in the first place, otherwise they'd do a 5-10% down deal with CMHC and wouldn't need a RTO. Immigrants might be the exception here as they often have the cash and the job but no credit history yet in Canada, but again, there is risk they don't like the culture, or the neighborhood .. or the weather. So a well executed RTO deal (such as the one I just concluded) is very profitable, but comes with risk during the term or at the end on closing ( .. as ours was saved at the last minute with some creative strategies to get the tentant-buyer approved for the mortgage ).
starting an RTO is one thing, seeing it to conclusion 2-3 years later is quite another as the tenant-buyer usually has personal issues that caused him/her to be in credit difficulty in the first place, otherwise they'd do a 5-10% down deal with CMHC and wouldn't need a RTO. Immigrants might be the exception here as they often have the cash and the job but no credit history yet in Canada, but again, there is risk they don't like the culture, or the neighborhood .. or the weather. So a well executed RTO deal (such as the one I just concluded) is very profitable, but comes with risk during the term or at the end on closing ( .. as ours was saved at the last minute with some creative strategies to get the tentant-buyer approved for the mortgage ).
Agreed.
I could easily start 24 deals every single month if I wasn't concerned with how many deals ended successfully with the tenant buying the property.
Instead, we are incredibly picky as to which clients we approve. We may start a lot less deals than other RTO companies, but I am willing to bet that we have a higher success rate than most of those companies.
As for the closing costs, any time that you have a tenant paying expenses that are normally the responsibility of the purchaser of the property, you get a little bit closer to the tenant being considered a buyer with equity rather than a tenant with an option to purchase. This is a critical distinction and must be carefully spelled out in the contracts. Otherwise if the deal goes south, the tenant's option payment could be deemed a "purchase deposit" which could be deemed refundable if the sale doesn't close.
I could easily start 24 deals every single month if I wasn't concerned with how many deals ended successfully with the tenant buying the property.
Instead, we are incredibly picky as to which clients we approve. We may start a lot less deals than other RTO companies, but I am willing to bet that we have a higher success rate than most of those companies.
As for the closing costs, any time that you have a tenant paying expenses that are normally the responsibility of the purchaser of the property, you get a little bit closer to the tenant being considered a buyer with equity rather than a tenant with an option to purchase. This is a critical distinction and must be carefully spelled out in the contracts. Otherwise if the deal goes south, the tenant's option payment could be deemed a "purchase deposit" which could be deemed refundable if the sale doesn't close.
If they are tenants, then they can be evicted for non-payment or other substantial breach of the lease. If they are "buyers" then they cannot be evicted. If your "buyer" stops making payments, you could have a very complicated legal issue.
Plus, option payments are non-refundable if the lease is breached and option is deemed void. However, purchase deposits can be refundable if the sale does not close.
Plus, option payments are non-refundable if the lease is breached and option is deemed void. However, purchase deposits can be refundable if the sale does not close.