While it’s true that turning your primary residence into a rental property can quickly increase the amount of passive income you generate, there are pitfalls to be aware of in order to achieve the highest levels of success. The process requires time, planning, investment, and effort, but if you do it correctly, it can prove to be greatly beneficial.
Record levels of tenant demand for single-family rental properties across multiple markets continue to increase. And for some current homeowners, it makes solid financial sense to transform an existing residence into a rental property instead of selling it, particularly if the home was financed with a low-interest, long-term mortgage.
Continue reading now to learn about key considerations that are necessary if you’re considering becoming a landlord – including ensuring that you’re properly insured, understanding capital gains and depreciation taxation, finding quality tenants, and, if necessary, upgrading the structure to make it tenant-worthy.
Key Concerns When Transforming Your Residence into a Rental Property
Of course, when you are turning the home you currently live in into a rental home, the goal is to achieve a fluent transformation, secure responsible tenants with good credit ratings, and begin enjoying your new passive income stream without any hiccups or unpleasantness.
And that’s completely possible to do!
However, to ensure that there are no snags during the process, you’ll need to avoid some critical pitfalls that new landlords commonly fall prey to. With that in mind, here are some crucial factors to be aware of on your journey to becoming a landlord.
Take the Time to Develop & Work a Smart Plan
When converting your residence into a rental house, remember that you’re working on a long-term goal, and good planning, diligent effort, and patience are all particularly important. If you have the financial resources, you can pay a property management service to take care of most of what needs to be done for you.
However, for many homeowners at least, that expense cuts into net cash flow too much, leaving them to handle various tasks personally. You need a good plan, and to develop one, it’s smart to ask yourself questions like:
- How will you find quality tenants to rent to, and what steps do you need to pre-screen them?
- What improvements, if any, does the structure need to make it legally ready for tenants?
- Do you have state-specific rental and lease agreement forms ready for prospective renters?
You’re also going to have to plan out periodic preventive maintenance inspections, landscaping responsibilities, how you will collect your rent payments, how to handle emergency repairs, the best way to coordinate with your tenants during their move-in processes, and the capital expenses that you’ll incur throughout the course of this journey.
If you’re feeling overwhelmed, you’re not alone. Most new landlords face the same questions and insecurities. But it’s going to be OK! You can begin by writing down some notes on paper to guide your thoughts going forward.
Preplan Your Rental Property’s Annual Budget
There are a lot of different expenses that you will incur as you convert your current home into a rental property, including:
- General liability & dwelling insurance coverage
- Electricity, water, natural gas, & other utilities
- Attorney fees & other legal expenses
- Costs of repetitive maintenance
It’s smart to compile a list of all applicable expenses and develop a rough budget as soon as possible. This will give you a realistic expectation of what your monthly cash flow will look like, and allow you to project how much passive income you will generate in your first year as a new landlord.
Value-Add Property Upgrades
While it’s true that electrical, HVAC, plumbing, roofing, carpentry, painting, and other contractors can be expensive, you’ll also want to ensure that your rental property stays in solid and safe shape through the years. From a business perspective, investing today in quality renovations can help to ensure your long-term profit generation. And from a construction point of view, the sooner that subpar amenities are brought up to code or better, the less they cost cumulatively in the future. Fixing things today stops them from degrading further and costing more to fix tomorrow.
Rental Property Taxation Responsibilities
When a principal residence is changed into a rental property, the Internal Revenue Service looks at the sale of it differently than if it were just a primary residence. That means two things if you ever decide to sell the property:
- All profit on the sale is taxed as capital gains at a rate matching the seller’s federal income bracket
- Depreciation expenses are recaptured & taxed as common income, to a max rate of 25%
That’s why it’s good to develop a full understanding of the taxation you’ll incur as a landlord. And, if it’s in your budget, the advice and guidance of a real estate taxation lawyer can be invaluable, especially for new landlords.
Summary of Key Points
The advantages of transforming your primary residence into a rental property include significant tax deductions, reimbursement for depreciation expenses, taxation loss rollovers, and, of course, passive rental income.
Some of the drawbacks to turning your current home into a house for rent include the responsibility to pay capital gains tax if you decide to sell the property in the future, the repetitive and long-term need to secure quality tenants, and maintaining the structures and property at least to the quality levels set forth by county building codes.
Before you begin the transformation, make sure that your existing mortgage loan is appropriate for a rental property, or if it needs to be revised. And don’t forget to obtain dwelling insurance as well as landlord liability insurance. Plus, you’re going to have to take care of all the construction upgrades or enhancements needed to attract quality renters.
With a good plan, a lot of effort, and the financial investment necessary to ensure a quality transition, changing your primary residence into a rental property can be a smart and prosperous endeavor. Take your time on each step and with each action to ensure meticulous performance and excellent results. That way, you never have to look back at a step, waste time, and lose money by dealing with problems that should have never occurred.
