According to ESPN.com's Marc Stein, the Knicks have until 11:59 p.m. on Tuesday night to decide whether to match the Rockets' offer sheet to Lin.
The Felton trade is seen as mounting evidence that New York won't match Lin's contract. USA Today reported Felton received a three-year, $10 million deal.
The Knicks are currently deliberating the merits of paying Lin more than $25 million over three years, but two sources within the organization tell ESPNNewYork.com's Stephen A. Smith that the Knicks will not match the offer.
A team source tells ESPNNewYork.com the third year of the Rockets' offer -- worth $14.8 million -- makes it unlikely the Knicks would match. If the Knicks were to match the offer, they would also be subject to a luxury tax in the third year, potentially bringing their total out-of-pocket cost for Lin to about $43 million in 2014-15.
The Rockets' offer to Lin would pay him $5 million in the first year, $5.225 million in the second and $14.8 million in the third, according to sources.
A source close to Lin told ESPNNewYork.com that the Knicks' trade for Felton caught Lin off guard.
"He was very surprised," the source said. "He felt the whole time that the Knicks would just match the offer."
The Knicks acquired Felton and former Knick Kurt Thomas from the Trail Blazers in a deal that was first agreed to on Saturday night, according to sources.
In return, New York sent Jared Jeffries, via a sign-and-trade, and center Dan Gadzuric, whose deal is not guaranteed this season, to Portland. Also included in the deal was Kostas Papanikolaou, the Knicks' 2012 second-round draft pick, Giorgos Printezis and a protected future second-round draft pick.
Papanikolaou, a small forward from Greece, is expected to make his NBA debut in 2013-14.
Printezis was acquired in the Knicks' three-team sign-and-trade to obtain Tyson Chandler last season.
Clearly, the key acquisition for the Knicks was Felton, who averaged 17.1 points and 9.0 assists in 54 games for New York in 2010-11 before he was sent to Denver in the Knicks' trade for Carmelo Anthony.
Felton will start at point guard if, as expected, the Knicks don't match Houston's offer sheet to Lin.
Initial reports had the Rockets offering Lin a four-year deal for around $28 million. That deal included salaries of more than $9 million in each of the last two years, which would be a big hit on the Knicks' salary cap.
Still, the organization seemed intent on matching.
"They will match any offer on Lin up to $1 billion," a source told ESPN.com's Stein last week.
Knicks coach Mike Woodson said Wednesday that Lin would not only be back but would enter next season as the Knicks' starting point guard.
It's not clear, however, if the new deal has changed that thinking since it would increase the Knicks' luxury tax bill significantly in 2014-15.
If the Knicks re-sign Lin, they'll have $75 million tied up in four players -- Lin, Anthony, Amare Stoudemire, and Chandler -- in 2014-15.
Lin, a restricted free agent, made $788,000 last season. He averaged 14.6 points, 6.2 assists and 3.1 rebounds in 35 games with 25 starts before his season was cut short because of surgery to repair torn cartilage in his knee.
But in the 35 games he was healthy, Lin went from an end-of-the-bench afterthought to an international phenomenon.
The undrafted guard out of Harvard, who was cut twice in the preseason (once by the Rockets) and played in the D-League, set the league on fire in February, leading the Knicks to seven consecutive wins. He scored at least 20 points in nine of 10 games during that stretch.
Felton will be looking to bounce back in New York after a rough season with the Trail Blazers, in which he averaged 11.4 points per game on 40.7 percent shooting and briefly lost his starting job.
Felton's agent, Tony Dutt, told ESPN The Magazine's Chris Broussard that returning to New York had been Felton's first choice all along.
Thomas played for the Knicks from 1998-2005. The 17-year veteran was a key cog on the 1999 team that reached the NBA Finals. Thomas ranks 19th on the franchise's all-time scoring list, eighth in rebounds, fourth in blocked shots.
Ian Begley is a regular contributor to ESPNNewYork.com.