Written byAn option to purchase is a contractual right, not an obligation, to buy an asset such as land or a leased vehicle at an agreed price.
Also known as: purchase option, option deed, option agreement, call option
Key points
- The holder may exercise the option or let it lapse; the seller is bound to sell if the option is validly exercised.
- The option period, exercise mechanism and price or pricing formula are fixed in the deed, and an option premium is often paid.
- Once exercised, the holder pays any deposit and the parties proceed to settlement on the agreed date.
- On an equipment or vehicle lease, the option price is usually the residual value set at the start.
- Stamp duty treatment varies by state and GST may apply to the premium, so duty and tax clauses belong in the deed.
How an option to purchase works
The parties sign an option deed and the holder pays any option premium, which starts the option period. During that period the holder completes due diligence, such as title searches and planning inquiries, and satisfies any conditions precedent like development approval or finance approval. To exercise the option, the holder serves a signed notice in the manner and by the deadline the deed prescribes; a late or defective notice can mean the option lapses and the premium is forfeited.
Once exercised, any deposit is paid, the sale contract or transfer documents are exchanged and the parties proceed to settlement on the agreed date. The holder may also be allowed to assign the option or nominate another purchaser, usually with the seller's consent. Some Land Titles registries accept option deeds for lodgement or allow a caveat to protect the holder's interest.
Types of option, and options in a lease
A call option is the usual form: the holder has the right to buy. A put option is rarer and gives one party the right to compel the other to buy. Options can also be conditional, so they can only be exercised once development approval, finance or rezoning is settled, and many include nomination or assignment rights so the holder can pass the benefit to a related purchaser.
In equipment and vehicle finance the option sits inside the lease rather than in a separate deed. The lessee can pay the residual at the end of the term and take ownership, or hand the asset back. A lease of premises can work the same way, with the tenant paying an option fee or higher rent for the right to buy. Whatever the structure, the document should cover the option period and any extension rights, the price or pricing method, whether the premium is refundable or offsets the purchase price, the conditions precedent, and what happens on default.
Benefits, risks and tax treatment
For the buyer, an option secures price and terms without an immediate obligation to buy, and allows time for approvals, finance and due diligence. The downside is usually limited to the premium, which can be forfeited if the option is not exercised correctly. For the seller, the option earns premium income and locks in a potential buyer, but the property is effectively off the market for the option period.
Duty treatment is state-specific: some jurisdictions treat the premium as dutiable at grant, others assess duty on exercise, and an assignment may itself attract duty. GST may apply to the premium if the grant is a taxable supply by a GST-registered supplier. Premiums are often assessable income for the seller and can form part of the buyer's cost base for capital gains tax, so check with your accountant and the relevant revenue office.
Example
A developer takes a 90-day option over a block of land, paying an option premium on 1 March. The option expires at 5pm on 29 May. The developer uses the period for title searches and planning inquiries, then serves the signed exercise notice on 20 May. The deposit is paid within two business days of exercise and settlement follows 60 days later. Had the developer decided not to proceed, the option would simply have lapsed and the premium would have been forfeited.
Not to be confused with
- Conditional sale
- a conditional sale binds both parties to the sale from the start; an option binds only the seller until it is exercised
- Lease purchase
- a lease purchase is the whole lease contract with the buy-out already built in at the residual; an option to purchase is the standalone right to buy, which can sit inside a lease or in its own deed
Frequently asked questions
How does an option to purchase work?
The parties sign an option deed and the holder often pays a premium. During the option period the holder does due diligence and can exercise the option by serving a signed notice in the way the deed prescribes. If exercised, a deposit is paid and the sale proceeds to settlement; if not, the option lapses.
Is an option to purchase a binding contract of sale?
No. The option itself is a right, not a transfer. The seller is bound to sell if the holder validly exercises the option, but the holder is never obliged to exercise it. A binding sale only arises once a valid exercise notice is served and the sale contract or transfer documents follow.
Do you pay stamp duty on an option to purchase?
It depends on the state or territory. Some jurisdictions treat the option premium as dutiable when the option is granted, others assess duty on exercise as part of the transfer value, and assigning an option can attract duty in its own right. Check the revenue office for the relevant state before signing.
What happens if the option is not exercised in time?
The option normally lapses and the holder loses the premium, unless the deed contains extension or waiver provisions. Because the exercise deadline often specifies a time of day and a method of service, holders need to check the exact cut-off and serve the notice well before it.
What is the purchase option on a lease?
On an equipment or vehicle lease it is the right to buy the asset at the end of the term, usually for the residual value set when the lease started. Exercise it and you own the asset; decline and you hand it back, subject to the return conditions in the contract.
Related terms
Lease
A lease is a contract giving the lessee the right to use an asset owned by the lessor for a set term in return for payments.
Read definitionLease purchase
A lease purchase is a lease over a vehicle or equipment with a contractual option to buy it at the end for a pre-agreed residual value.
Read definitionResidual value
Residual value is the amount a leased car or asset is expected to be worth when the lease ends, set at the start and used to calculate the rentals.
Read definitionConditional sale
A conditional sale is a contract where the buyer takes possession of goods but the seller keeps legal title until a stated condition, usually full payment, is met.
Read definitionSettlement
Settlement is the final stage of a finance deal, where the lender releases funds, security is registered and you take delivery of the asset.
Read definitionDeposit
A deposit is the upfront amount a buyer or borrower pays towards a purchase, either as part-payment on a sale contract or as cash contributed to asset finance.
Read definitionGo deeper
Sources
This article is general information only and is not financial advice.