Selling your residential property might be a way to generate income. But it’s not the only way. You might also consider converting that primary residence into a rental property.
There is more to making this switch than putting your house on the market as a rental. You should also understand the pros and cons of making the switch.
There can be upsides to rental conversions, including the following.
Passive Income. Rental properties can provide passive income, though rental yields may vary based on market conditions, maintenance costs, and occupancy rates. This could be helpful for wealth accumulation and retirement planning.
Portfolio diversification. A rental property could protect your investment portfolio from market volatility while also offering appreciation potential.
Tax benefits. You could use various deductions to lower your taxable income, including insurance premiums and maintenance costs. Furthermore, you can also use property depreciation, which allows you to allocate the cost of the property over its useful life (27.5 years for residential real estate), reducing taxable income. Additionally, some investors may qualify for a Passive Activity Loss deduction, which can help you deduct passive losses against passive income, depending on your modified adjusted gross income (MAGI).
Converting your primary residence into an income-generating property has various advantages. However, rental conversions also have pitfalls, including:
It involves effort. In addition to handling the property’s operations and management, you need to spend some time and effort finding the right tenant and executing a lease agreement.
It can be expensive. Managing a rental property costs money. Tenant searches, marketing, repairs, maintenance, utility bills, and professional fees add up.
Potential tax liabilities. If you plan to sell your rental property, you could be subject to tax liabilities. Capital gains occur if you sell your property at a value above its current basis; those gains are taxed. Meanwhile, depreciation recapture happens when you take advantage of depreciation tax breaks and sell the property.
Check the HOA Rules
Some homeowners associations (HOAs) might not allow you to convert your residence into a rental property. Be sure to check the by-laws and determine if your plan is allowable. If not, you may need to explore alternative strategies or reconsider your plan.
Apply for Permits
Your local government may require you to fill out and submit permits before you start renting the property. The most common is the rental license, which helps ensure your property follows zoning regulations for such property types. Some jurisdictions also require a Certificate of Occupancy (CO) to confirm the home meets building and safety codes for rental use.
Tell Your Insurance Company
Your insurance policy might have clauses concerning coverage validity if your property is used for anything other than personal use. Talk to your insurance agent or company about necessary changes in coverage.
Design an Income and Expense System
It’s a best practice to create a way to track income and expenses. You need accurate records to assess your rental property’s profitability (or lack thereof) and to help when filing your taxes.
Determine the Rental Rate
Research rental rates charged by comparable properties in your neighborhood. This can help you determine a reasonable rate that can also provide a steady passive income stream.
Turning your primary residence into a rental property can provide various benefits, making it an attractive option for homeowners and investors. From the potential passive income to the available tax deductions, a rental conversion could offer advantages versus a home sale.
However, before taking this route, it’s important to understand the pros and cons of this practice and the tax rules for converting a primary residence into a rental property.
If you have plans to sell your property while taking advantage of tax-deferral strategies, contact the experts at Realized 1031 for assistance. For a no-obligation meeting, visit the website at realized1031.com.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.