Rent-Back Agreements: What are they?
What is a rent back agreement? Background and overview of a rent back agreement.
A rent-back agreement is a short-term agreement or addendum to a real estate purchase contract wherein the seller stays in the property for a period of time after the close of escrow while continuing to pay some—if not all—of the sellers monthly living expenses. The purpose of the agreement is to allow the seller to stay in their home for an agreed upon period of time and avoid the need to move twice. In certain circumstances, it can save the buyer from having to carry two mortgages, or where the buyer is obtaining financing with restrictions, it can allow the buyer to utilize the proceeds from the sale of their prior home to help purchase the new home while allowing the seller time to find their next home .
The term of a rent-back is typically serially numbered days such as 1 day, 2 days, etc. to discourage the seller from treating the rent-back as if it was a lease. And while the agreement may certainly function like a residential lease for a short period of time, calling it a lease can create problems. Most real estate practitioners understand that the residential landlord/tenant laws impose significant security deposit requirements for lease agreements and further that some Landlord-Tenant statutes might interfere with the ability to cancel a rent-back agreement if it were called a lease. Prudence dictates that you avoid the confusion and limitations these statutes impose and call it what it is—a rent-back agreement.
Components of a Rent-Back Agreement
When utilizing a rent-back agreement template or drafting a new agreement, consider these five key terms for the contract:
- Terms of Occupancy. Without exception, the terms of the occupancy should be agreed upon when the seller is allowed to retain possession of the home. There can be a wide range of flexibility in this area including a short-term stay of one to three months, a long-term lease, or the ability for the seller to stay indefinitely. Generally, these decisions depend on the wishes of the buyer and seller, as well as their perceived needs. The type of agreement, however, should always be discussed early in the process to avoid any misunderstanding later.
- Rent Payment Details. There are a number of elements pertaining to rent which should be considered. For example, who will receive the check and how payments will be made? In this situation, also consider whether interest should be paid to the landlord/seller on the security deposit. Some buyers do prefer to put the deposit in an escrow account as opposed to giving a check directly to the seller.
- Duration of the Agreement. Duration is closely related to the terms of occupancy but also includes other considerations such as how the process will be handled if the buyer sells the home prior to the expiration of the agreement. By a lien, may be made and a deed may be placed in escrow with instructions that if the buyer sells the property and notifies the attorney to close, the attorney closes the transaction and gives the buyer the proceeds with the condition that the seller must vacate per the terms of the rent-back agreement.
- Contingencies. It should be mutually determined how the buyer will handle certain contingencies that could affect the duration of ownership. For example, the buyer may have the right to move into the property immediately, should a full appraisal or the approval from the HOA be denied. Access to the home for repair work should also be discussed. In both of the aforementioned situations, the buyer will want to inform the seller in writing of his or her plans to terminate the agreement. Of course, issues may arise that are not expected. These should also be addressed in advance so that there is a clear path to follow if an unexpected situation should occur.
- Responsibilities of Parties. As a general rule, the seller is responsible for utilities, condominium fees, property maintenance, etc., during the term of the rent-back agreement while the buyer is the responsible party for the insurance. If there is an outdoor area, the seller would also be expected to maintain the yard and other exterior areas of the property. The buyer would be responsible for maintaining the interior of the home.
The role of a real estate attorney is invaluable in helping clients navigate their way through the entire real estate transaction. Especially during the contract and closing process, qualified counsel can provide the expertise to help their clients get through what can be an extremely fast-paced time. An experienced lawyer practicing in this area will have many of these templates on hand and can be sufficiently flexible to help their clients maneuver through the details of a rent-back agreement.
Pros and Cons
While there are clear benefits to rent-back agreement templates for buyers and sellers alike, there can also be some downside. For example, if you’re a buyer, consider that the agreement could easily become subject to negotiations and discussion between lawyers as neither party wants to be taken advantage of or extend the length of the rent-back. You may find it difficult to budget for the cost of rent-back each month as prices and rent-back length varies greatly.
Being forced to act quickly can also be a disadvantage to a buyer as it may leave you feeling cornered into accepting an agreement that doesn’t work for you. You will also need to consider the costs yourself; if you can afford the cost of rent-back, how will you manage with the additional expense on top of your mortgage and bills?
Sellers must keep in mind that they are allowing the buyer into their property temporarily so they could potentially cause damage to the home that could lead to disputes over the security deposit. If the agreement is broken by the buyer early, the seller may be forced to move out and move back into the property.
Legal Considerations
When buying or selling a home, it is common for the parties to agree to allow the sellers to remain in their homes for a short period of time after the closing, such as a few days, weeks, or even up to a month. This period of time is called the "rent-back period" and the agreement between the parties regarding the rent-back is called a "rent-back agreement." These rent-back agreements can be short and simple, or they can get more complex when they involve large amounts of money changing hands, financing issues, and/or the need for repairs to the property.
There are lots of "off-the-shelf" rent-back agreement templates available on the Internet. However, there are many pitfalls associated with using a template. A do-it-yourselfer may not be aware of how local laws or specific state requirements impact a rent-back agreement. Problems from using an online rent-back agreement template can result in unfavorable tax consequences, making the agreement unenforceable, or severe financial costs.
Lease Agreements Have to Be Carefully Drafted to Be Enforceable. If the rent-back agreement is not written correctly, it won’t be enforceable. Each State has its own laws regarding residential rental leases, and these laws have to be followed. Some states require that residential leases be in a particular form, and that they also contain certain language or "conspicuous disclosures." If the rent-back agreement is supposed to be a residential lease – because the seller is going to continue actually "renting" the property for a predetermined period of time – then you cannot use a generic template for a commercial lease or one in which the landlord takes possession of the premises back at the end of the term.
State Laws Impact How and When to Handle Monetizing a Deposit. Most States do require that residential landlords return deposits to tenants, but the law places restrictions on when and how to return the deposit and charges a fee if those requirements are not properly followed. Because most rent-back agreements start out as a residential tenancy (even if it’s only for a few days), State laws relating to tenant deposits will also apply. However, if the parties enter a rent-back agreement before the sale closes, and the deposit is not handled properly, the deposit cannot be fully monetized until after the closing takes place.
In addition, if the parties do not comply with State laws regarding how and when deposits are handled, they can lose the right to collect the deposit later. (This means that the landlord has to turn over the full deposit to the tenant even if the landlord has suffered losses as a result of damage done to the property by the tenant). It can also mean that the parties have actually created a landlord-tenant relationship that has to be terminated prior to the sale of the property. And that may impact the closing or even result in litigation between the parties .
It Is Important to Use the Correct Lease Agreement for the Jurisdiction. Even if the parties do not intend to create a lease, if the rent-back agreement is not drafted correctly, you can end up creating a lease that has to be terminated before the transaction can close. In addition to all of the other financial complications that come with attaching a lease to the property, you have to go through multiple steps to terminate the lease before the property can be conveyed to the purchaser.
Renting Prior to Closing Can Have a Dramatic Tax Impact. When parties enter into a rent-back agreement, they have to consider whether there’s an actual business purpose behind the transaction. For example, if the buyer is paying significant sums of interest on the primary mortgage, the buyer can often offset this interest against any income generated from leasing the property after the closing. If the rent-back agreement is just an excuse to avoid taking occupancy of the residence, the State may view the rent-back agreement as a mere lease and you (or your estate) loses the ability to deduct the mortgage interest on your personal residence.
Timing is Critical for Tax Planning Purposes. The key to structuring a rent-back agreement is timing, mostly in relationship to when it’s entered into and the anticipated closing date. But there are also other critical timing issues that have to be considered. For example, it is oftentimes not advisable to sell a residence and take back a property before a portion has been depreciated. In addition, if a transaction spans two taxable years, you may face unfavorable State tax consequences for the second year. And while both parties may want to minimize their exposure to State taxes, the upside can be costly if the timing is done the wrong way. So it’s important to consult your tax advisor on how a rent-back agreement can assist with tax planning and revenue.
Timing Matters to Tax Filing Deadlines. It’s also not uncommon for a rent-back agreement to impact tax filing deadlines. It is possible that your taxes are due before the transaction closes. Alternatively, if the parties entered into a rent agreement that impacts the allocation of sales proceeds, both the buyer’s and seller’s taxes could be due at the same time. Finding a solution that satisfies both parties will help you avoid penalties that can arise if the parties miss their tax filing deadlines.
Specific Language is Important to Properly Monetize Rent. It’s also not uncommon for the parties to forget to include specific language in the rent-back agreement referring to the timing and process of monetizing the deposits. Even if the timing and process language is included, the language must be clear if the parties expect the funds to be available for the next closing. Otherwise, the parties may need to rewrite the rent-back agreement and go through the entire process again.
Customizing a Rent-Back Agreement Template
When adjusting a rent-back agreement template for a unique situation, it’s important to be conscious of the specific needs of both the buyer and seller. To start, the parties should remain focused on the underlying goal of the rent-back – making it possible for the buyer to close on their new home while providing the seller with time to continue the search for their next home. Remember to clearly address and explain the duration of the rent-back, including specific move out dates and contingencies (for instance, if additional time is needed to close a sale of the seller’s house). Make sure that all other move-related obligations, such as utilities, cleaning and yard work, are clearly delineated and addressed.
Addressing potential risks and liabilities is another key component of customizing a rent-back agreement. This may include allotting for any damages that occur during the rent-back period or accounting for responsibilities related to insurance and liability. It’s also useful to clearly communicate responsibility for any household issues that are present when the rent-back begins, such as broken doors or windows or plumbing problems, to reduce the likelihood of conflict before or after closing.
It’s critical to include disbursement details that address the return of any deposits that could potentially be at risk of forfeiture. Many templates state that the parties must contact each other in case of damages, but lack clear timelines – be sure to provide a timeframe for this notification so that the process can run smoothly and disputes can remain at bay. It’s also suggested that the rental amount not be the same as the buyer’s current mortgage payment to avoid the possibility of false security regarding the continued ability to pay.
While transitioning from one home to another can be a complicated process, rent-back agreements offer a valuable resource to make the process easier and reduce incidences of conflict.
Utilizing a rent-back agreement template – and personalizing it for the specific situation of the buyer and seller – can make the transaction process more straightforward, while protecting everyone involved.
Common Rent-Back Agreement FAQs
*What happens if I do not abide by the rent-back agreement or if I fail to pay my rent?
The rental agreement is a legally binding contract, and closing or transferring title will not dismiss your responsibility to abide by its terms. If you do not pay your rent (or abide by the other contract terms), the landlord can sue you for breach of contract, can evict you, or can sue you for specific performance to force you to abide by the rent-back. If you are late on your rent, an eviction action is not the remedy for the landlord in North Carolina. The landlord can sue you for breach of the contract and seek damages. In most cases, though, the landlord wants you to vacate as quickly as possible, so it is in your best interest to make sure you are current on your rent.
*Am I required to pay my rent to the closing attorney?
No. Since you are not yet the owner of the property (and perhaps might not want to be depending on what you find during your tenancy) , fees are paid to the closing attorney only once the deed is recorded. Therefore, you may simply pay the rental amount to the landlord directly, at least until closing occurs.
*If I have questions about what home maintenance or repairs are required during my rent-back, whom do I ask?
If you have questions about these obligations, you should refer to the terms of the rent-back agreement to see whether there are any restrictions on what you can and cannot do. If in doubt, contact the person who was responsible for drafting the agreement.
*Can I sublet or even sell one of the properties I am living in?
You must obtain written consent from the landlord prior to subletting or selling the property because the agreement between you and the landlord is a legally binding contract.
