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This plan came to me rather suddenly from DW and I started out writing the post as a hypothetical, but we actually went through a lawyer and did this.

Well, it's good you used a lawyer.

I thought it was potentially dangerous too, but there are some positive features. We got the remainder of the mortgage paid off (although this wasn't much anyway). We saved the property from going into foreclosure.

Okay, from your original post, it wasn't clear that the mortgage got paid off. Since you paid off the mortgage, sounds like there wasn't any fraud.

But I guess I'm confused. If the mortgage "wasn't much anyway" - couldn't you have just refinanced the remaining amount, plus maybe some cash out if you wanted additional cash? If you had refinanced into a longer term mortgage, you should have been able to lower the payments to something that you could afford, based on the rent that was being paid? Seems like that would have cost a lot less, and not brought the tax issues into play.

We appended a clause to the contract that gives us the option to buy the property back within six months. (DW has a plan -- as well as a back-up plan B -- to raise the money.) According to DW, this "option" talk entails that the buyer would be in violation of the contract if he were to sell the property without either (a) a release from the option, or (b) the passage of at least six months. (The word "option" doesn't sound that way to me, so she says she'll get the buyer to spell this out in writing to me.)

If you haven't already, you probably need to have the option recorded with your county clerk/recorder. If the option isn't recorded, the current owner could sell the property without your knowledge and get a clear title because the title company can't find an unrecorded option. Then you would have to sue to either get the property back, or get compensation from the parties involved in selling the property. Even after you get the option recorded, you should be pretty diligent about watching the MLS and FSBO listings, and checking the land transfer property records to be sure that the current owner doesn't attempt to ignore your option and sell the property. That said, if he has a buyer lined up to close at 6 months and 1 day, you are out of luck, so you need to get your financing in place sooner rather than later.

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