Have you ever rented your primary residence to somebody?

[Peaceful_Warrior]

My wife and I are still looking to move to the Pacific Northwest, and we are looking at the possibility of renting our condo to somebody we know and trust and then renting a similar condo to live in.

This would at least get us moved to the area we want to be in, even though the market around here won't yet support selling our place. Then, when the market improves, we could sell our place here, and then purchase a home instead of continuing to rent.

Has anybody done something like this, and do they have any recommendations for how to go about it?

... Particularly helpful would be descriptions of the process you went about doing this and any documents/contracts you found most important.

 

[Nords]

Has anybody done something like this, and do they have any recommendations for how to go about it?

Remove or sell all possessions, furniture, and emotional attachment. Be ready for a frustrating long-distance relationship in which stuff that you'd fix in a heartbeat will cost $75 for a service call and maybe even management fees.

It's no longer your home, it's a piece of underperforming investment property!

Hopefully this won't damage the friendship either. If there's accidents on your property, natural disasters, infrastructure problems, medical issues, hospital bills, unemployment, marital discord/divorce, or anything else standing in the way of your rent payment then it will surely test the strength of your relationship.

But maybe you'll have better luck with your friends than we've had with our previous tenants. We have very low expectations of tenants, and different expectations of friends.

 

[Fireup2020]

I have learned this in my 36 years...Do NOT rent to your friends! I have watched problems with this scenario repeatedly - can think of 4 situations. One thing to rent out a room to a friend - but the whole place while you are gone? Find yourself unknow tenants, run credit reports, interview them for at least an hour. Sign a solid lease. Good luck 8)

 

[WM]

We are currently renting what used to be our primary residence, but through a property manager, since we expect it to be long-term. We'd never owned a place to rent before, so it was a big decision.

If I were renting to friends, I'd be very careful to spell out expectations just like renting to strangers - who's responsible for what upkeep, what happens if they want to move sooner than you wanted to sell, etc.

In deciding to rent out our house, even though we may eventually move back there, we stopped thinking of it as our primary residence - now it's just our rental house. I am assuming that when we get back to it, it will not have been maintained the way we'd ideally want, carpets will need replaced, some of the older cabinetry will be further deteriorated, landscaping will be so-so, etc. - I wouldn't have rented it out if we couldn't let go of our attachment to keeping it just the way we liked it.

 

[jdw_fire]

This would at least get us moved to the area we want to be in, even though the market around here won't yet support selling our place. Then, when the market improves, we could sell our place here, and then purchase a home instead of continuing to rent.

If you have a large gain in the property remember you have to sell within 3 years (I think the rule is you have to have lived in the property 2 of the last 5 years) to get the favorable tax treatment.

 

[hellbender]

In 1980, my wife and I moved 1200 miles away. We rented out residence out for a period of about 5.5 years. (not to friends however). We had just purchased the place for $40K. The owner carried 100% of the selling price for 20 years at 9%. We took possession back upon our return. We sold the place for $95K after having made only a handful of mortgage payments, soon after our return.

I remember thinking how incredible it was that I could buy an appreciating asset with little of my own money, have someone else effectively make the notes via the rent payments and then sell it for a large capital gain. I was hooked. This was only the first of several successful real estate investments to come over the next 20 years.

You might want to consider the additional complication of renting to friends. You may not be friends when this is all done.

 

[Peaceful_Warrior]

Good tips so far, and I think so far we're ok in those regards. This person is somebody we know and would trust to take care of the place (he is particular, well-kept, keeps his things tidy, etc), but not somebody I would call a friend. We also do plan on selling within the next 3 years (ideally 1-2 years) so the IRS tax issue won't be a problem.

I can detach myself emotionally from the place, especially since we don't plan to move back here. I'm going to talk to the person about a Lease-to-Own option and see if he's interested, as this would help mitigate several potential issues. I would love to rent it permanently as a cash-flow property, but being in CA it's a negative proposition.

When I get into rental real estate more seriously, I intend to have a property manager handle things. I'd rather give somebody a cut and have me be completely hands-off, than to increase profit but still have a j*b.

Another thing I've read about is offering a discount (say $50/month) and the renter agrees to handle all minor maintenance (i.e. they handle everything short of washer/dryer/fridge replacement and things of that degree). At the end of the lease, any maintenance that should have been covered and wasn't fixed by the renter, is then removed from the deposit (so this makes them accountable, but typically also costs them less and me less since I don't have to pay somebody labor to fix it).

Also, I was considering a 'sale clause' that says upon sale of the home, I give some bonus/concession money to the renter for the inconvenience of having to show the place. This helps ensure that it becomes in their best interests for the property to sell when it becomes time... so that they'd be more likely to keep the place nice and tidy, etc. I think this is better than a rent-discount which actually discourages the individual from helping to sell the place (because as long as it doesn't sell, they keep the discounted rent)

 

[Deetso]

I still dont own my first house. Prices have gone up in the town in the area I live in- my home buying plans have been put off for a while.

Not meant as a hijack- but as a lifetime resident of the great pacific northwest I would like to put my two cents in.

CALIFORNIANS KEEP OUT!

Of course nothing personal you understand...

just be ready for more of this- I know several people who are SURE that californians are whats wrong with everything that is wrong in this state. Including rising costs of homes!

 

[Mwsinron]

I still dont own my first house. Prices have gone up in the town in the area I live in- my home buying plans have been put off for a while.

Not meant as a hijack- but as a lifetime resident of the great pacific northwest I would like to put my two cents in.

CALIFORNIANS KEEP OUT!

Of course nothing personal you understand...

just be ready for more of this- I know several people who are SURE that californians are whats wrong with everything that is wrong in this state. Including rising costs of homes!

Plan on selling my property in Lake Tahoe just to come piss you off. Which state do you live in again?

 

[Ed_The_Gypsy]

We have done this twice.

We went on assignment for several years once. Put all of our stuff in storage and used a property manager we found by reputation and let them take care of everything. We were the only people on the project who used a professional property manager and we were the only ones who had no troubles. We never moved back in and eventually sold the place.

We moved from Houston to the PNW for work and rented out the Houston house because we never thought we could sell it in that market. The renters loved it and bought it later. Again, we used a professional we found by reputation and were so happy we did.

God bless professional property managers! I would never do this on my own.

We are again considering doing this with our house in Bellingham, Washington, while we go galivanting around the world but we are intending to return to it one day.

We have heard of an organization for people who swap houses which seems to work OK. They leave everything there and leave any special instructions. Anyone have experience with this?

 

[chinaco]

Run the numbers. Do an NPV (Net Present Value) calculation from all of the cashflows.

You will need to factor in time. Since you do not know when the market will improve, you will need to develop a time range. (low, mid, high).

Calculate the PV net proceeds numbers from the sell of the condo under a number of scenarios. Pick the mid-point between worst case and best case. Call that your potential net from the sale.


Factor in your additional rental expenses for when you rent. additional insurance, property taxes, repair and maint, the cost to prep your condo for the eventual sale. (once you tell the tenant you are intending to sell... they will move and leave it vacant unless you make it worth their while).

You will pay taxes on the rent money you gain... but you will get some tax benefit, by depreciating the condo... You may have a capital gain at the end.

Unless you find your net gain (NPV) in today's $ is fairly high... it is probably not worth the headache.

 

[simple girl]

We have done this twice.

We went on assignment for several years once. Put all of our stuff in storage and used a property manager we found by reputation and let them take care of everything. We were the only people on the project who used a professional property manager and we were the only ones who had no troubles. We never moved back in and eventually sold the place.

We moved from Houston to the PNW for work and rented out the Houston house because we never thought we could sell it in that market. The renters loved it and bought it later. Again, we used a professional we found by reputation and were so happy we did.

God bless professional property managers! I would never do this on my own.

This is exactly what we are doing. On assignment for about the last year. We hired a lawyer to look over the property management agreements. She helped us turn one down that had terms that weren't favorable to us.

Our current firm is "ok". They found a renter for us but initially we weren't happy with their screening process. They wanted us to accept one client whose credit score was lower than we were comfortable with. So make a list of what your own criteria are and assure that your PM follows your guidelines. Also, we do have to stay on top of them to some degree. For example, we need a yearly termite inspection done to maintain our bond. I call the PM company, give them the info. They are to call the tenant and set up a time for the inspection. I call the termite bond company and find out it hasn't been scheduled (about 1 month later). So I've gotta call and pester the PM to follow up on this again. So, it's not without it's headaches, but I believe it is better than being a long-distance landlord.

BTW, we called multiple PM's and only got a few call backs. Seems like most weren't all that interested in managing a SFH. Good luck in finding a good PM. Or at least a decent one!

Would we do it again? Definitely. For us, it makes sense. Our mortage is being paid by the renter while we are on the road earning per diem. We know the house will likely need repairs, carpet replaced, etc. when we return. Just hoping we will come through this without any major damage...but we know that is a risk.

 

[kcowan]

We have heard of an organization for people who swap houses which seems to work OK. They leave everything there and leave any special instructions. Anyone have experience with this?

Yes we have done home swaps with 3 different families, and 2 of them have now become regulars. Everyone has different personalities and quirks but generally it has been good. We keep our housekeeper coming during our absence and we pay for her. All maintenance is also handled by a manager. These two decisions have made it much easier. We also swap cars.

There are several organizations that facilitate swaps and the choice depends on where you want to swap.

 

[Enuff2Eat]

do u like headaches ?? how about lose a friend?? i did it once and unless u're so lucky or rent it way below market. i would suggest clipping coupons for tylenol caused u will need it.

enuff

 

[playaman]

When my wife and I moved to Washington, D.C., a number of years ago, we rented out our primary residence in Texas to friends of friends, persons we knew casually. It was a disaster, and I would never do it again. In retrospect, it was probably as much my fault for thinking they would care for "my" home as if it were theirs. Nonetheless, I would never do it again.

 

[Peaceful_Warrior]

UPDATE:
I've decided to hire a property management company to handle this, even if I do rent to this acquaintance. Although after researching rents, my property may be more than he's willing to pay.

FOLLOWUP:
For those of you who have done this, I am curious about some of the tax complications.

Did anybody deduct the depreciation from their personal income taxes?

 

[WM]

Did anybody deduct the depreciation from their personal income taxes?

You may as well take the depreciation - when you sell, the IRS assumes that you did take it, whether you did or not. At least, that's my understanding.

 

[Peaceful_Warrior]

I guess my question was a little too simple. Did anybody use a property management company and still qualify as an 'Active Participant,' who also took the depreciation which resulted in a paper loss?

Then, because they owned the home in 2 of the last 5 years, sold the home with tax-free gains?

You may as well take the depreciation - when you sell, the IRS assumes that you did take it, whether you did or not. At least, that's my understanding.

 

[Nords]

I guess my question was a little too simple. Did anybody use a property management company and still qualify as an 'Active Participant,' who also took the depreciation which resulted in a paper loss?
Then, because they owned the home in 2 of the last 5 years, sold the home with tax-free gains?

You're abusing the vocabulary a little, too.

The IRS assumes that whenever you rent a home that you're depreciating the home. (Don't try to depreciate the land!) This depreciation is "recaptured" as personal income when you sell the home. You'll be punished taxed whether you depreciate or not. So yes, every landlord should take depreciation.

The definitions of "active", "passive", and "material" make my head hurt. Essentially you can always deduct expenses up to the limits of your rental income. In addition, if you or spouse actively participate (not necessarily materially!) then you can deduct up to $25K in passive rental losses (in excess of the passive rental income) from your other income. Page 3 of IRS Pub 925 says that examples of active participation include approving new tenants, approving rental terms, and approving expenses. You'll probably have that sort of relationship with your manager so you'll probably be an active participant and you'll probably be able to deduct rental losses in excess of income. Perfectly clear, no? Read the pub (and Pub 527 as well) or seek professional advice before proceeding blissfully down this road.

Owning the home for at least two of the last five years allows you to escape cap gains taxes up to a $500K limit (even longer if you're in the military) but you'll still have to pay the depreciation recapture. Again read the rules, seek professional advice, blah blah blah.

 

[Buckeye]

Go the the Q&A section of the website www.mrlandlord.com. Read it for a week or two and then make your decision. Property manager or not, it's going to be very difficult. Virtually no small time property owner has a property manager they can brag about. Be prepared for the worst and hope for the best. It's not for the faint of heart, especially if it is a long distance situation. Very, very stressful. Make sure you have a large safety fund for those unexpected repairs and evictions and vacancies. Having been a long distance landlord (sometimes with a property manager) for 13 years, I wouldn't wish the experience on my worst enemy.

 

[Peaceful_Warrior]

Your response is more along the lines of what I was trying to get at. I understood what you said about 'Active' since I read that IRS pub, but wasn't sure how that fit into the grand scheme of things.

Thanks for pointing out the depreciation recapture... that's something I didn't understand and will look into. From what I've just now read, it sounds like in my case, it means that I would get a tax-free gain on everything I *should* have gotten, but if I depreciated anything then I have to pay taxes on whatever gains I have as a result of the depreciation.

Overly simplistic example here:
- Cost basis is $350k
- Depreciated $25k over 2 years
- Sell as a homeowner for $450k

Result: I get $100k tax free, and I pay tax on $25k at capital gains rate (assuming I can't attribute some of the depreciation to the land). Is that correct?

In reading, it looks like the recaptured depreciation is at 25%, so it's more advantageous to take the depreciation during the rental years. My problem is: I have to qualify as 'Active Participant' in order to qualify to take the depreciation since I'll *already* be renting at a 'Loss' of about $150/month based just on expenses/income.

Since the plan is to move to a lower cost of living area, even renting at a loss and not getting any tax relief is financially advantageous as our total housing costs will go down considerably.

You're abusing the vocabulary a little, too.

The IRS assumes that whenever you rent a home that you're depreciating the home. (Don't try to depreciate the land!) This depreciation is "recaptured" as personal income when you sell the home. You'll be punished taxed whether you depreciate or not. So yes, every landlord should take depreciation.

The definitions of "active", "passive", and "material" make my head hurt. Essentially you can always deduct expenses up to the limits of your rental income. In addition, if you or spouse actively participate (not necessarily materially!) then you can deduct up to $25K in passive rental losses (in excess of the passive rental income) from your other income. Page 3 of IRS Pub 925 says that examples of active participation include approving new tenants, approving rental terms, and approving expenses. You'll probably have that sort of relationship with your manager so you'll probably be an active participant and you'll probably be able to deduct rental losses in excess of income. Perfectly clear, no? Read the pub (and Pub 527 as well) or seek professional advice before proceeding blissfully down this road.

Owning the home for at least two of the last five years allows you to escape cap gains taxes up to a $500K limit (even longer if you're in the military) but you'll still have to pay the depreciation recapture. Again read the rules, seek professional advice, blah blah blah.

 

[Nords]

PW, you're confusing the heck out of us when you mix the word "depreciation" with the word "deduction".

Lemme start over and make it a little plainer.

When you sell your rental property, the IRS requires you to pay depreciation recapture. You don't have a choice. The IRS assumes that you are depreciating the property according to the depreciation rules. You have to pay taxes on the depreciation of the house (or whatever property you're depreciating) and the IRS will calculate it for you if you don't provide the numbers.

So, IMO, there is no choice whether or not to depreciate your property. You will depreciate it. You'll also depreciate it according to the rules in Pub 527 for buildings, carpets, appliances, furniture, etc. There's no "active" or "passive" or "material" when it comes to depreciation. Just follow the rules, the tables, and the formulae. The IRS will use it all against you later so you might as well use it on yourself now.

The deductions are for your expenses. You can just about always deduct rental expenses to the extent of rental income (but I'm sure someone will point out an exception to that glittering generality). If you have passive activity losses in excess of your rental's passive income, then you can generally deduct those passive activity losses against other passive income (for example, rental home #2). But if you actively participate in those passive activity losses then you can start deducting those passive losses against other (non-passive) income.

I can see why this could be confusing.

Your math is correct-- $50K cap gains free of taxes and another $50K depreciation recapture taxed at 25%.

But now I have to go back and look at our own rental property. If you don't make the two-years-out-of-five rule I believe that the cap gains are taxed as income (in whatever bracket that puts you, ouch) and the depreciation recapture is still 25%.

Martha, how 'bout an assist here?

 

[Peaceful_Warrior]

PW, you're confusing the heck out of us when you mix the word "depreciation" with the word "deduction".

I was under the impression that when you pay taxes annually, the depreciation WAS a deduction. If this is not correct, then I'm turned all around. If it is correct, then I've got concerns.

So the issue I'm concerned with is this:
- If I'm already taking a loss on the property that I can't deduct from my personal income taxes, then this would mean I also cannot deduct that depreciation.

When I go to sell the property... what happens?

 

[Buckeye]

I think the rules for active participation are pretty loose for rental property. Hiring a property manager doesn't make you passive since you still make decisions about tenants (at least I would stay in that loop), rental rates, upgrades, major repairs, etc. I wouldn't worry about not being able to take the deductions (including the depreciation).

Look at your property tax bill to see how the assessor has your home value divided between land and dwelling. Land does not depreciate so you will subtract the value of the land from your purchase price and only depreciate the value of the dwelling. You don't necessarily have to use the land value stated by the assessor but sometimes it's hard to know a reasonable value for the lot. If you have another way of knowing the value of the lot, use that. You will also use the lesser of the value at purchase or at the time the property went into service. Usually the lesser value is at purchase but you never know nowadays.

 

[Peaceful_Warrior]

Thanks for the tips, Buckeye. So now to make sure I understand this -- let's assume I take $150/month loss and also depreciate about $8,000 annually. This brings me to a total loss of about $9,800 that I then deduct from my personal income taxes (assuming I'm 'Active').

Then when I go to sell the place as a homeowner (lived in 2 of 5 years), I will pay capital gains taxes on all of the depreciation that I took. So, if I were to take 2 years for $16,000 then I am going to pay taxes on that at capital gains rate.

In the end, the benefit of the depreciation is that I deduct it from my ordinary tax annually and then pay it at capital gains upon sale.

Is my understanding now correct?

And because of that scenario is why the laws were implemented regarding active/passive to ensure that people aren't using real estate losses as only a tax shelter?

I think the rules for active participation are pretty loose for rental property. Hiring a property manager doesn't make you passive since you still make decisions about tenants (at least I would stay in that loop), rental rates, upgrades, major repairs, etc. I wouldn't worry about not being able to take the deductions (including the depreciation).

Look at your property tax bill to see how the assessor has your home value divided between land and dwelling. Land does not depreciate so you will subtract the value of the land from your purchase price and only depreciate the value of the dwelling. You don't necessarily have to use the land value stated by the assessor but sometimes it's hard to know a reasonable value for the lot. If you have another way of knowing the value of the lot, use that. You will also use the lesser of the value at purchase or at the time the property went into service. Usually the lesser value is at purchase but you never know nowadays.