Should you sell your primary residence or turn it into a rental property?
If you’ve been paying attention to the news, you know that inflation is high and the cost of living is increasing almost everywhere. At the same time, home values are increasing, and property taxes are rising with them. If you want to make a wise real estate decision in this environment, what should you do?
There are two main ways for homeowners to get value out of their current properties. First, you can sell the home and get your equity out of it. However, a less conventional strategy is becoming more popular in our area: converting your primary residence into a rental.
So how do you go about converting your primary residence into a rental? First, you need to speak with your lender if you bought the home in the past couple of years and haven’t paid off your mortgage yet. If you try to rent a house without telling your lender, you could potentially be breaking the law. Student loan programs and lenders have varying rules about if and when you can rent your house after purchasing it as your primary residence.
In most cases, if you finance the home as a primary home, you’ll need to live there for at least 12 months before you turn it into an investment property. However, be sure to check with your lender. As we’ve seen, lenders make exceptions to their occupancy requirements and actually allow owners to rent their homes sooner. Next, you’ll also want to check local laws and regulations to make sure it’s legal for you to convert the home into a rental. Local jurisdictions have restrictions in place and specific processes that you’ll want to know and follow.
There are some fantastic pros to converting your primary residence into a rental. For example, you’ll have a steady stream of passive income you can use to invest in other areas. Rents have been rising all over the country, so you might be able to make more money from your rental than you think. To calculate your passive income potential, you’ll need to account for your monthly mortgage payment, the landlord insurance, the property taxes, and maintenance and upkeep.
“There are many tax benefits to rentals.”
There are also many tax benefits to rentals. The most important one is the depreciation expense. This is an exemption for general tear and it could make all of your rental income tax free. If you’d like to learn more about how this exemption works, or if you’d like help calculating the cost in return from your rental, please reach out to our team.
Unfortunately, there are some cons to turning your primary residence into a rental. You’re likely dreaming of a tenant paying your mortgage, but managing a rental takes more time and energy than just making sure direct payments hit your bank account each month. Being an owner of a rental property comes with financial risks, and those include unexpected repair costs, tenants who may not pay rent, or maybe even a slowdown in the rental market and decreasing rental rates.
Maintaining a rental can be a full-time job. So we usually recommend hiring a property manager to help manage the investment for you. Typically, you can expect to pay about 1% of your property’s total value a year in maintenance costs. Through our 20 years in real estate, we have built relationships with amazing property managers locally and actually around the whole country. If you’d like an introduction to one of them, please reach out to us and we’d love to share their information with you.
Another potential downside is you could also potentially forfeit the ability to exempt yourself from capital gains taxes when you eventually sell. This is because the law states that you do not have to pay cap gains on a property that you’ve lived in for two of the past five years. You can get around this using a 1031 exchange, but you’d have to use the funds to purchase another investment property, so your options are limited.
If you have questions about the tax implications of selling or renting or if you’re considering renting your property, please reach out to us so we can set you up with our CPA and get your questions answered.
