Should Buyers Allow Sellers to Rent Back?

Buyers that allow sellers to rent back and remain in a home after closing often enjoy a significant advantage over the competition. But few buyers (or agents) fully understand what’s involved should home buyers allow sellers to rent back. This is not a decision to be taken lightly; if/when things go wrong the ramifications can be serious, especially to the buyer/now landlord. There are a number of legal and tax concerns that most fail to think about when in the heat of competition. A few obvious things to consider if a buyer is allowing a seller post closing occupancy – and this list is far from comprehensive.

Are Rent Backs Allowed?
Is a rent back noted in the contract? Is a copy given to the lender or is this done with a wink-wink? What will the lender say? The loan is likely for a buyer’s primary residence, is a rent back allowed? Some lenders may permit a few days of layover but is there a limit? Does the income from the rent back meet underwriting approval? Is this now considered an income property? Is there max time before the owner must occupy the property? Best to work with the lender and get way ahead of this.

Hello Landlord
Once closed, a landlord-tenant relationship is formed. Agents are no longer involved, they are finished at closing. A rental contract is required; to not have one is foolhardy. Not one from Google; but one that is detailed, addresses the myriad of potential issues and is legally binding. Who, what, where, when, how….and what happens if/when terms are not met or conflict arises?

Owner Liability During a Rent Back
Does the buyer/landlord hold title personally? The smart landlords don’t, everything is individually owned under an LLC or similar entity. Experience reinforces that it's not if something goes wrong, it's when. Having that separation limits personal liability. Like the contract, done improperly and the buyer/landlord may face personal exposure if it hits the fan. So best to consult a lawyer, not Google.

Landlord Insurance Likely Required
Any post close occupancy must be reported to the homeowner’s insurance company. Is it allowed by them? Is an income/investment home policy required? Is additional personal liability required, something like an umbrella policy? Will the tenant be required to have renter’s insurance? If something happens and things are not in order, it’s over Johnny…it’s over.

Charging Rent or Free?
Is the seller/tenant remaining at no cost? At market rent? At a rate equal to the buyer/landlord’s carrying cost? Some buyers are so desperate to secure a home that they’re allowing sellers to remain in place at no cost. If there is a charge, how this income is collected will be of significant interest to the lender and the IRS.

Rental Terms for Post Closing Occupancy
Is there a security deposit? A walk through inspection and post occupancy walk through? How and when is the rent paid? What happens if it’s late or not paid? What happens if they fail to leave or damage the home on the way out? Who pays for home and site maintenance? Whose name are utilities held in?

Don't Forget Taxes on the Rent
How is income from this rent back period handled? An LLC will require a tax return; if none is formed this income needs to be personally declared. If it’s to be credited at closing, how will underwriting handle that? Is that allowed by the lender? This is likely CPA territory, no one welcomes a knock on the door a couple of years later from the IRS.

Repairs and Maintenance
Who’s responsible for something when it breaks or fails? Did something fail on its own or through misuse by the tenant? Some warranty companies will not honor agreements on rent backs; they consider them income properties and price them differently. If the tenant gets sideways with an HOA, how are fines or penalties addressed? Typically these are directed to and the responsibility of the owner. Does the owner have contractors on hand or will that takes weeks to arrange?

Owner Access During Post Closing Occupancy
Most new owners will do updates upon purchase, this now changes that dynamic. Tenants have rights; access to the property must go through them and be at their convenience. Getting times for inspection and estimates may be problematic especially when kids or work at home environments exist. The idea that someone can simply “pop over” should be dismissed.

Other factors may get into the mix in addition to the obvious ones noted above. Should buyers allow sellers to remain in the home after closing? That decision should be thoroughly researched and undertaken with significant caution. Like everything real estate related, everything is wonderful until it isn't; then it always seems to become an expensive, exhausting chit show.  

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• sellers (3)
• rent back (1)
• post closing occupancy (1)