What is an option agreement?

Short answer: An option agreement gives the right, but not the obligation, to buy a property, and is typically used by developers who want to clarify the zoning (regulering) before committing to a purchase. The landowner ‘reserves’ the property against payment for an agreed period. Be aware: if the agreement in reality obliges a purchase, it can trigger a tax liability as with an ordinary sale.

Definition and legal basis

An option is a right or an opportunity to buy, for example, a property or shares. An option agreement is therefore an agreement that gives the right or opportunity to buy the contract object in question. The option agreement imposes no obligation to buy, and is consequently not a binding purchase agreement.

Option agreements are often used for the transfer of real property in development projects, and often serve as an alternative to a purchase contract. A purchase option on real property gives a right, but not an obligation, to buy a property at a later date. This means that the potential buyer ‘reserves’ a property against payment over a period. The parties have often agreed the sale price of the property before entering into the agreement.

How are option agreements used in property development?

Developers often want to clarify whether there are opportunities to rezone a site before going ahead with any property purchase. Option agreements are therefore a good solution for a developer to gain the opportunity to buy a property without taking on a large financial risk.

The landowner often has a site that is currently worthless, and that requires both knowledge and resources to develop. Developers often want to investigate whether an area zoned for commercial use can be rezoned for residential use, or to test whether an agricultural, nature and outdoor recreation area (LNF area) can be zoned for residential development before they go ahead with the purchase of a property. When a developer has the opportunity to carry out a zoning process ahead of a property purchase, the property’s potential and the financial risk are clarified before the final sale.

Read also: What is a zoning plan and what is its function? and Municipal master plan and zoning plan, what applies where?

Advantages and disadvantages for the developer

For developers, option agreements are usually financially advantageous. The main advantages are low risk, you clarify the zoning and potential before committing to a purchase, and you reserve the property without a full purchase obligation. The option premium is typically a fraction of the purchase price.

The downside is that the option premium is lost if the zoning does not go through or the project is shelved for other reasons. In addition, long option periods can tie up capital and resources in zoning processes that take longer than expected.

Advantages and disadvantages for the landowner

For the landowner, the obvious advantage is income from the option premium, a payment for reserving the property without it necessarily being sold. If the zoning goes through, the property can rise significantly in value. The downside is that the property is ‘locked’ during the option period; it cannot be sold to others as long as the option runs. And as we describe below, a tax pitfall can arise if the agreement is interpreted as a genuine sale.

Tax and option agreements, the most important pitfall

For developers, entering into an option agreement will usually be financially profitable, whereas for landowners it can be a tax pitfall. If the option agreement in reality means that the developer is obliged to buy the property, there is no option agreement in the true sense, but a final sale agreement. This means that entering into such an agreement can trigger a tax liability for the landowner on the property sale in the year the agreement is entered into. This is often a risk that landowners have not taken into account.

If there is a genuine option agreement and a sale agreement is signed during the option period, for example once the zoning situation has been clarified, tax is only payable on the option agreement in the year the agreement is entered into. The property sale is then not taxed until the property has been fully transferred to the developer.

Even if the seller receives the sale proceeds at a later date, they are liable for tax in the same year the agreement is entered into. This can cause liquidity challenges for the landowner, as they may well not have funds available at that point.

Typical contents of an option agreement

As a minimum, an option agreement should regulate the following points:

• The parties, landowner and developer/option holder, with full identification
• The property, cadastral numbers (gnr/bnr), address and any description of the area
• Option period, duration (typically 1–5 years) and any right to extension
• Option premium, amount, payment schedule and whether the premium is credited against the purchase price
• Purchase price on exercise, fixed price or calculation model
• Conditions for exercise, for example an approved zoning plan
• Right of rescission and consequences, what happens if the option is not exercised

Option agreement vs. purchase agreement, what is the difference?

The main difference is the obligation. A purchase agreement is binding on both parties; both buyer and seller are obliged to complete the transaction. An option agreement, by contrast, only gives the buyer a right, but not an obligation, to buy. The seller is obliged to sell if the buyer exercises the option, but the buyer is free to let the option expire. This difference is of decisive importance for the tax treatment, as described above.

Frequently asked questions about option agreements

What is an option agreement on property?

An option agreement on property gives a potential buyer (typically a developer) the right, but not the obligation, to buy a property within an agreed time period. The landowner receives an option premium as compensation for the property being reserved.

What is the difference between an option agreement and a purchase contract?

A purchase contract obliges both parties to complete the transaction. An option agreement only gives the buyer a right, not an obligation, to buy. If the buyer chooses not to exercise the option, they only lose the option premium.

Can an option agreement trigger a tax liability?

Yes. If the option agreement in reality means that the buyer is obliged to buy the property, the tax authorities may treat it as an ordinary property sale. A tax liability is then triggered in the year the agreement is entered into, even if the property has not been transferred.

How long is a typical option period?

The option period varies, but is typically 1–5 years. The length depends on the complexity of the zoning process and the parties’ negotiations. Many agreements include the possibility of extension.

How much does an option agreement cost?

The option premium is freely agreed between the parties. It is typically a one-off sum or periodic payment that compensates the landowner for the property being reserved. The premium can vary from a few tens of thousands to several million Norwegian kroner, depending on the property’s value and potential.

Option agreements in Placepoint

In Placepoint you can quickly identify properties with development potential, check the zoning plan and ownership, everything you need to assess whether an option agreement is the right strategy. With access to property data, property information and market analysis, you get a complete basis for decision-making.

Book a demo and see how Placepoint can help you with risk assessment in property transactions.