 |
|
|
|
|
|
Should You Rent Your Home or Sell
It?
employment, according to a survey by
the career web site Monster.com.
It is usually necessary to sell one's home in order to afford a new home. Most people do so when relocating. However, some people choose to rent out their homes instead especially if they plan to return. In some cases, people know that they'll be back in a year or two - possibly when they complete a graduate degree or finish a specific project at work. There are also times when a would-be seller wants to hang on until the market picks up in order to sell at a price deemed acceptable. A more likely scenario lately, however, is that the owner wants to maximize his or her gains and is inclined to hang on while property values continue to soar. Others, like Miller, don't feel confident in changing jobs and want to keep their old home until they're certain they won't be coming back.
Whatever the reason, there are important financial issues at play when weighing this decision and it's helpful to have a clear idea what issues come into play. Below are a few things to consider:
It's a taxing issue
As you probably know, if you have lived in your home for a least two of the past five years you qualify for a generous tax break from Uncle Sam. The unmarried can earn up to $250,000 in tax-free gains while married couples who file jointly can enjoy up to $500,000 in capital gains tax-free.
Here's the good news: Those who plan to rent out their home for a year or two will still qualify for these breaks (provided they've lived in their home for at least two of the past five years). Be careful though, should a person sell more than three years later, they will forfeit the tax exemption, meaning their gain would be taxed as a capital gain. Once you move out of you home, the clock starts ticking on these two out of five years.
Thus, for those whose renting plans would turn a tax-free gain into a taxable one, consider selling. The guideline is, if you have a large gain on your personal residence, you don't want to rent it out and risk losing your tax-free gain. That's a very bad idea.
Don't take a house that you're not going to have to pay tax on and convert it into rental property if you know you'll never live in the home again. It's like taking money and throwing it in the fireplace. One solution to this problem: Move back into the house and live there for two years before you sell, you'll requalify for the exemption.
The tax benefits of renting
On the other side of the fence, becoming a landlord also offers some attractive tax perks. While rental income is taxed as ordinary income, the numerous deductions on expenses and depreciation could easily be eliminate your tax bill. But there is always a catch. If you eventually sell the house and qualify for the capital-gains tax exemption discussed earlier, you'll be taxed on the amount you depreciate. This little exemption could make renting out your home considerably less attractive.
Let's talk about deducting expenses first. Nearly every out-of-pocket expense relation to owning and managing the property can be deducted. For example, you can deduct your mortgage interest payment and property taxes just like you deduct them on your primary residence. You can also deduct any advertising or broker fees, cost of repairs to the property, utilities and management company fees, maintenance expenses such as cleaning services, the cost of fire and liability insurance, and even travel or transportation expenses incurred for the maintenance of the property and collection of rent.
Then factor in the "phantom deduction," better known as depreciation. To find your depreciation, divide the fair market value of the property at the time you start renting it out (minus any land around the property) by its recovery period - which is 27.5 years for residential rental property. Voila! You now have your annual depreciation. For example, if the home is worth $300,000, you divide that by 27.5 and get a $10,909 annual deduction. Deducting depreciation will cover a lot of the income you're receiving from renting your home, so it's a nice tax shelter. If you have another $15,000 in out-of-pocket expenses, which are also deductible, you can get over $25,000 in rent tax-free.
While you cannot deduct improvements, you will recover their cost by depreciation. You may also want to look into deducting the depreciation on the cost of any appliances, carpeting, furniture or plumbing. You can do this over five years. So if you purchased a new $1,000 refrigerator for your rental, you can deduct $200 a year from your rental income for five years.
Renting Out Pros Cons · Property can continue to
appreciate · Property may be
damaged · Rent may be tax free due to
tax-breaks · May lose tax-free capital
gains if you
sell · Mortgage, taxes and insurance
payments are covered in rent · Troubles with tenants may lead
to potential legal or financial problems
Selling Pros Cons · May qualify for tax-free
capital gain · Risk being priced out of market
if you return · Frees up equity to purchase a
new home · Lose any future property
appreciation · Only one house to maintain and
no need to find renters · May have to sell at an
unattractive time for real-estate market in your
area
Can you afford to rent out your home?
Do you need to sell you home in order to afford you next home? For many homeowners this is the case. Renting is simply not a viable option because they need to raise the capital necessary to buy their next home. Owning two homes requires deep cash reserves in case the home goes vacant for a period. What kind of discretionary income will you need to pay for expenses when you don't have a renter for a while? What if a tenant is late or unable to pay for one or two months of rent - will you be able to carry the mortgage payments anyway? These uncertainties could be risky for a moderate-income family.
There's also the risk that a tenant could damage or destroy your property, lowering the overall value. A tenant may also cause problems that lead to an expensive eviction process. Frighteningly, if you have to evict a tenant, it could cost you anywhere from $2,000 to $5,000 and is a drawn out process. Evictions can last as long as 18 months, during which time the tenant is likely to refuse to pay rent. Are you financially prepared for the worst?
Is you house appreciating quickly?
You may decide to rent your home out if you expect prices in your area to soar markedly over a three-year time span. But consider, historically speaking, real estate appreciation tends to keep pace with the rate of inflation, so even if property values have risen in your neighborhood during the past few years, that doesn't mean they'll continue to do so.
Look at the house as part of your overall portfolio and consider it an investment you need to protect. Ask yourself: Are you diversified in your overall investments? What if something were to cause a set back in the real estate market? If the majority of your net worth would be tied up in your two houses, you should consider more diversification, and it would be a good idea for you to sell the house and invest the profit.
Is the rental market hot?
Sometimes it's a sellers market. Sometimes it's a landlord's market. Call your local board of realtors or a real-estate agent and have them appraise the house and ask for a rental appraisal. Compare the numbers for the rental and the number for the sale. By and large, if the market is stable, it will make sense to rent the house out because the income from rent will cover your mortgage and other related expenses.
Do you ever plan to live in the home again?
If you know you will return to the same town or area years from now, you risk being priced out of the market if you sell your house. If you think you would want to move back into the same home, it would make sense to rent it out.
Renters in your home
Do you feel uncomfortable about tenants in your home? One of the most important issues is how you feel about the home. If you're very attached to it, then you might feel like the renters are strangers in your space. It's difficult to rent out a home that you love and come back to it to find out someone has trashed it. This may be especially true if you leave your furniture, appliances and decor behind. Are you able to separate yourself emotionally? It will be necessary for you to take off the personal hat and remember you now own a business.
Do you want to be a landlord?
Becoming a landlord isn't for everyone. Will you be able to manage the property from afar? What happens if a pipe breaks out and you're out of state? While it's expensive, it may be necessary to appoint someone to manage the property. Being an absentee landlord is difficult unless you have someone to administer the property. Be prepared to part with 10% of the monthly rent if you hire a property-management company to oversee your rent house. Depending on your agreement, the management company could look after everything related to the property - from putting it on the market and screening your tenants to collecting rent, maintaining the property and even taking care of your mortgage. It may be worth the 10% to be rid of the hassle.