For lots of reasons, you may be thinking of becoming a part-time landlord, an enterprise filled with promise and peril. Financially, there’s a lot you have to get right, and you could pay a high price if you get it wrong. Up ahead: some common traps new landlords fall into—and how to steer clear of them.
3 Tips for Renting Your Home
Avoid spending more than you bring in
Sounds obvious, right? You want to collect enough in rent to cover your costs, if not more—this is what the pros call being “cash-flow positive.” Carrying costs will include property taxes, insurance, maintenance, repairs, mortgage payments, and possibly a property manager. Breaking even will be much easier, of course, if you no longer have a loan on the home. But even then, getting the math right can be a challenge. “What can quickly trip up new landlords is not regularly allocating money for maintenance and repairs,” says Gillian McCarthy, a certified financial planner(CFP) in Pottstown, PA. McCarthy suggests setting aside 10 percent of the rent you collect for upkeep, more if it’s an old home. And cut your estimate of how much rent you’ll collect by 5 percent to cover potential vacancies. In the case of a vacation home or an apartment on your property, turning a profit may be less important to you. “Even if the rent just helps offset some of the out-of-pocket costs, it’s a win as long as you’re comfortable renting out your home,” says Shawn Gallagher, a CFP in Melville, NY. If you’re holding on to the home for a few years before you sell, breaking even may be a sufficient goal.
Don’t put the rest of your finances at risk
Homeowners insurance protects your, property against disasters and minor mishaps, but strangers staying at your home pose even bigger risks. If a tenant has an accident, for instance, you could end up being personally on the hook for the resulting damages. With a short-term rental, your homeowners insurance may be sufficient, though your insurer may want you to enhance your coverage. For a longer-term rental, you’ll probably need a landlord or rental policy; it’ll cost about 25 percent more than a standard homeowners policy, but it adds other features, such as income replacement while a damaged home sits empty. An umbrella policy gives you substantially more liability coverage in case of a catastrophic accident. To best protect your finances, experts recommend putting a rental home into a limited liability corporation (LLC), especially if you have substantial assets. “When something happens at a home you own, tenants can come after you personally,” Gallagher says. “Putting the property in an LLC can help protect you.” Creating one online cost a few hundred dollars, including state filing fees, but better to hire a lawyer, he adds. That could cost $3,000 or more, depending on how complex your situation is.
Make sure to master the tricky tax rules
As soon as you rent out a home for 15 days or more, you trigger an income-tax bill (14 days of rentals each year are tax-free). You’re entitled to lots of write-offs that can reduce that bill: Mortgage payments, property taxes, insurance, repairs, and professional fees are all deductible. You’ll also be able to deduct depreciation—essentially the value of the house less the land, spread over 271/2 years. But you’ll need to take care with some deductions; deductible repairs versus nondeductible improvements can be a gray area, for example. “It’s the difference between patching your roof and replacing it,” says Tom Gibson, a CPA and senior tax strategist in Vero Beach, FL. What raises the level of difficulty is when you use the house part of the year and rent it out at other times. If you rent out a property more than 14 days annually and also live in it during part of the year, you have to prorate deductions based on the number of days the property is rented over the combined total days it is used. While direct costs like advertising for tenants are fully deductible, maintenance and insurance must be prorated. “The key to success is to keep really good records,” says Henry Grzes of the American Institute of Certified Public Accountants. You probably won’t be able to deduct rental losses against ordinary income. Rental income is considered passive and is deductible only against other passive income. Professional real estate investors can deduct losses, but you need to spend more than 750 hours a year actively managing the property to qualify, or about 15 hours a week. “Ideally, you don’t want to spend fifteen hours a week on your rental,” Grzes says. “Better to have great tenants and less work.”
Should You Hire Help?
This is possibly the biggest decision landlords have to make. “As a landlord, you have to ask yourself if you’re ready to deal with some major headaches,” says Catherine Valega, a CFP in Winchester, MA. “Are you ready for the hassle? If not, it may make sense to pay a property manager.” By hiring someone to manage the property, you can off-load the work of screening tenants, drawing up a lease, collecting rent, and handling maintenance requests, among mother things. But you could pay about 10 percent of your rental income for that help, maybe more. If you go it alone, you’ll need to research local rules for rentals (more towns are adding restrictions to discourage short-term rentals), run background checks on prospective tenants, draw up a lease, and deal with repairs. “If you’re going to be your own property manager, choose properties close enough so you can get there in 20 minutes,” says Valega. Since every state has different tenant-protection laws, you may want to use an attorney to draft a lease. For screening, you can pay an online service about $50 to run a report covering financial problems, criminal history, and any previous evictions. The key, McCarthy adds, is to determine your process for screening tenants and stick to it, even if the people seem really nice. “The purpose of screening is to avoid potential eviction, which is a terrible experience on both sides,” she says. “Where you get into trouble is when you have a process but you ad-lib.”
