If you’re reading this, chances are you may be planning a move.
Maybe you’ve been planning to purchase a new home, or you’ve had a second property for a while which you haven’t used as much.
So, you’ve been planning a sale.
But through a variety of potential circumstances– such as an increase in demand for rentals– you might now be considering it’s time to become a real estate investor.
Specifically, by converting your primary residence to a rental property.
Converting your primary residence to a rental property comes with several great benefits, but there are also some things that are important to know in making that shift.
- The pros and cons
- How to actually make the conversion
- Tax tips and laws that are important to keep in mind
- And some other frequently asked questions like fair market value
We’ll cover each of those points below, but let’s start with why you’d want (or not want) to convert your primary residence into a rental property in the first place.
Why convert a primary residence to a rental property?
When you think of converting your primary residence into a rental, the first thing that likely comes to mind is cash flow.
After all, whether you’ve already invested in rental properties before or not, that’s an additional property bringing in additional cash each month.
That’s certainly the biggest pro of converting, but there’s more to it than just that.
In addition, there are also some cons you should consider before making the leap.
So, let’s talk about those now before we get into the how:
Pro: Tax deductions
If you’ve ever owned a business before, owning property is a lot like that.
There are different types of rental properties, but we’ll assume you’re talking about a single-family property used as a primary residence.
There is an assortment of deductions you can claim on your taxes to reduce your tax liability on that property.
- Maintenance and repairs
- Property management fees
- Legal fees
Income for a rental property needs to be reported on IRS Form 1040 Schedule E, as well as any deductions you’re taking.
Just make sure you’re crossing your T’s, as you don’t want to get in trouble with Uncle Sam.
If you’re uncertain, consider working with a real estate attorney to make sure you’re doing things right.
If you’re not accustomed to how this works, think of it this way:
If you make $50,000 in annual rental income, but you can deduct $15,000 in expenses, your actual taxable rental income would be just $35,000.
Pro: Claim depreciation expense
Similarly, there are other tax benefits you can take advantage of by converting a primary residence to a rental, such as the ability to claim depreciation expenses.
How does it work? Let’s break it down:
According to the IRS, you can claim depreciation on a property for up to 27.5 years.
That means every year you divide the value of the property (minus the value of the land, as that doesn’t count) by 27.5 to get the deductible amount.
Let’s look at an example:
Your property is valued at $350,000. This needs to be the value at the time of the conversion of the property, keep in mind.
The value of the land is $50,000 (a bit high but makes doing the math a little easier for example's sake).
That means that $300,000 of the property’s value is depreciable.
You then divide $300,000 by 27.5 to get your depreciable amount, which equals $10,909.
Why is this great?
If the income on your rental property for that year after deductions was $35,000, you could then further deduct that $10,909 in depreciation expense.
That would then further reduce your tax burden down to roughly $24,000.
Pro: Diversify your cash flow and supplement your income
We touched on this earlier, but this is by the far the first benefit most mention when they think of owning a rental property.
It’s no surprise why.
The ability to have one or more properties generating rental income each month which just require some regular upkeep and maintenance is attractive.
Not only that, for most, rental income diversifies their income and investment portfolio as well, affording a healthier overall financial situation.
And rental property investing has proven itself over the decades as reliable in virtually any market, so it’s not just a solid source of additional income but a sound one as well.
Con: Managing a rental takes work
While hugely beneficial, something that can’t be overlooked is the fact that managing a rental takes time and effort.
- Looking for tenants
- Setting up and doing showings
- Signing the lease
- Moving in your new tenants
- Regular inspections to maintain the condition of your property
- And unexpected events such as repairs
Fortunately, much of this work can be semi-automated– or at least made much easier– by using property management software.
DoorLoop, for example, gives you access to features such as:
- Automated listings to make looking for tenants easier
- eLeasing tools to make the leasing process a breeze
- Maintenance management tools that streamline work orders between you, your contractors, and tenants
- And more
Managing a property still takes work, but with software, you can greatly minimize the work involved in managing your property.
Con: You’ll need to budget for property-related expenses
While highly profitable if done right, managing a property requires you to set aside for property-related expenses.
That can include:
- Maintenance and repairs
- Legal fees
While the rent you bring in from the property should more than cover all of these expenses, you can end up in a tricky spot if you don’t prepare in advance for handling these fees.
That’s especially true in the case of maintenance, which is often unexpected.
How to convert your primary residence to a rental property
Now, let’s talk about tips for actually converting your property into a rental.
Assuming you’ve carefully weighed the pros and cons and are ready to start renting out your property, there are a few steps to converting that property to a rental.
However, there is a lot of potential detail depending on your situation.
So, it may be best to speak with a real estate attorney to make sure you’re taking any necessary steps beyond this to convert it properly.
1. Check with your lender to see if you can use your mortgage for a rental property
This first step is key and it’s here because while some lenders offer provisions allowing the said mortgage to be used for either a primary residence or rental, some don’t.
It all depends on the mortgage you have and your lender. So, you’ll need to check with your lender to confirm either way.
If your mortgage doesn’t allow it, you’ll need to look into options for investment property loans to refinance the property as a rental.
2. Add landlord liability insurance
You’ll need to obtain landlord liability insurance if you’re converting the property to a rental.
However, the good news is this is typically an easy step that simply requires a quick call to your property insurance provider.
3. Apply for licenses and permits
Similar to the steps above, this one is unique to your situation. Specifically, your local state and city laws.
Each area is different, some requiring you as the landlord to collect the rental tax or another similar policy.
Make sure to check with your local chamber of commerce or state office to be absolutely sure you’re following your local laws and not general information you read online.
4. Prep the property
It’s easy to overlook, but we can’t forget to mention this step.
You’ll want to start thinking about what an attractive rental property looks like and what you need to fix up around the property to get it into the condition it needs to be in before renting.
This could mean minor fixes around the house or more significant changes.
In either case, you’ll want to focus on making the property:
- Full-functioning (nothing broken/needs fixing)
- And visually attractive
Beyond this, you’ll need to calculate and decide on a fair market rent rate as well as set up a process for screening tenants and completing the lease.
To that end…
5. Get property management software
One last but vital step is to get software to help you manage your property.
The reason this is so important is because of how many moving parts there are to property management.
Property management involves no less than:
- Maintenance and repairs
- And legal related tasks
That’s a lot, but it becomes way more manageable with a good property management tool on your side.
For example, with DoorLoop you can:
- Marketing: Automatic listings make it easier to keep your properties and units filled the moment they become vacant.
- Accounting: A full chart of accounts, automatic rent payments, a convenient portal where tenants can pay rent and more, QuickBooks Online integration, and more.
- Leasing: A complete suite of screening and eLeasing tools.
- Maintenance: Maintenance management tools that make the entire process simpler.
- Communication: Tenant portal, streamlined communication tools, and more.
And this is just a taste of what you can take advantage of.
The result is a streamlined, simplified, and more stress-free property management experience from beginning to end.
To see what DoorLoop can do for you, schedule a free demo. See how DoorLoop can simplify your property management efforts.
Frequently asked questions
Now, let’s finish by touching on a few frequently asked questions we either didn’t get to above or are important enough to highlight in their own question.
How long do you have to live in a house before you can rent it?
How long you need to live in a property before renting it out depends mostly on your lender.
Typically, it’s suggested you live in the property for 12 months before converting it. However, it’s best to check with both your lender and in some cases local laws to make sure you’re following in accordance with everything.
Does your mortgage change if you rent?
You may not have to change your mortgage if it already allows you to convert it to a rental property.
Whether your mortgage allows this is entirely dependent upon your lender. So, check with them to find out what your mortgage allows.
If it’s not allowed under the specifics of your mortgage, ask your lender about refinancing to an investment property loan or look elsewhere.