When it’s time to move you might think about renting your home. Because we sell so many homes that were turned into rental properties, we’ve gathered insight into some of the things homeowners don’t think about before converting an owner occupied home into a rental property. Here are 5 things you should think when deciding between renting or selling your home.
Do You Want To Be A Landlord
I’m always willing to help anyone look at the rent vs sell figures so you can make the best decision for yourself. But before we get that far I will ask you if you really want to be a landlord and if you didn’t own the home would you buy it as an investment property.
I will also ask if you like working with people? What will you do when the rent is late? Would you be willing to evict someone? How will you feel when you see your home has been damaged by a tenant?” These are all important questions because the landlords who do well treat it like a business and don’t let their emotions get involved.
Will Renting Your Home Be Profitable?
This is a much more complicated calculation than simply multiplying the expected monthly rent by 12 and subtracting your mortgage payment. Here are some of the expenses when renting your home:
Mortgage – Calculate both the principal and interest into the equation.
Property Tax – In most areas property taxes don’t go down. You will also lose your Homestead Exemption and the 10% cap. Be sure to do your calculations without those reductions to your property taxes. Your property taxes will likely increase substantially as a rental property.
Repairs – Repairs are almost a certainty…Remember Murphy’s Law.
Vacancy – Don’t expect full occupancy all the time. In some areas it may take 45 days to rent a home. Make sure you do a thorough market analysis before doing your calculations.
Insurance – You will want to call your insurance agent to see if you have coverage as a rental property. It's likely you don't and the new property will be more expensive.
HOA Fees – In most cases the owner pays the HOA fee.
Management Fees – If you decide not to manage the property you will pay a property management fee.
Losing The 2 in 5 Capital Gains Tax Exclusion And Other Tax Considerations
One of the best rules in the tax code is the 2 in 5 Capital Gains Tax Exclusion. If you have lived in the home for 2 of the previous 5 years you can sell the home and not pay capital gains taxes on the first $250,000 of gain ($500,000 for a couple). With the capital gains tax being up to 20% this is a substantial tax break. If you rent the home for 3+ years you will lose this exclusion. Depending on your income you may also be subject to the 3.8% investment tax.
I also often find many landlords don’t understand how depreciation works and think it’s free. Depreciation isn’t free money, it’s just deferred. When you sell a home whether or not you have taken depreciation on your taxes you will be subject to a depreciation recapture tax. Be sure to include that in your calculations.
Before renting a home you should check with your own tax advisor or the IRS to determine the tax implications of renting or selling. It’s always best to consult with a financial advisor who can look at your unique situation.
Deferred Maintenance And Capital Expenditures
Is your AC nearing the end of its life? What about the roof? Those could be significant expenses you would have to pay. Even if they don’t need to be replaced soon you should include a budget for capital expenditures when doing your calculations. If you need to replace the carpet and paint before renting you may need to that again when the tenant moves out.
What Else Can You Do With Your Money?
Homeowners often call me and ask if their home will be worth more in 10 years. It is likely your home will be worth more in 10 years, but that is not the question you should be asking. A savvy investor will be comparing investments and pick the one that is most profitable. Even if your home is worth more in 10 years that may be a poor overall investment compared to other investment opportunities. Homeowners with large amounts of equity built up and who do want to be investors may be better off selling that home and buying 2 smaller homes with more leverage to juice up the return.
Whenever you are making a complicated financial decision such as deciding to rent or sell a home it is important to understand all the numbers. Hopefully this information will help you make the best choice for your situation. Kopa Real Estate sells homes as well as leasing and property management. Whenever you would like to look at realistic figures for the total costs to rent or sell your home contact me directly at 512-791-7473 or email eric@koparealestate.com.
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