Jane M. Young CFP, EA
It’s time to move but you hate to sell your house when the market is down. Maybe you should rent your house for a few years? Or, on second thought, maybe not.
There are many factors to consider before deciding to rent your home. Do you have the temperament and the time to be a landlord? Are you comfortable with the idea of having someone else living in your home? Do you want to manage the rental yourself or do you plan to hire a property manager? If you manage the property yourself do you have time to learn about fair housing laws, code requirements, lease agreements, escrow requirements and eviction procedures? Who will take care of repairs and maintenance and are you ready for tenant calls in the middle of the night? If this sounds a bit daunting, a property manager may be your best option. A property manager will cost you about 10% of the rent. Be sure to include this in your cash flow analysis.
Before renting your home do a realistic cash flow analysis. Add up your projected expenses and deduct them from your projected rental income to see if renting will result in a profit or a loss. If you project a loss, does your projected appreciation on the home while it’s rented compensate you for the time and money it will cost you? Do you have funds to cover a negative cash flow? Your expenses may include your mortgage payment, property taxes, insurance, home owner’s association dues, maintenance and repairs, legal and accounting fees and property management fees. A rule of thumb for maintenance and repairs is about 1 – 2% of the market value of your home, depending on the home’s condition. You may need to spend money up front to attract good quality tenants.
When calculating your rental income, you need to decrease your projected rental income by about 8% to allow for vacancies. In Colorado the average rental vacancy rate has been around 7-9 percent over the last five years, based on U.S. Census data. When a renter moves or is evicted it can take several months to get a new renter in place.
If you rent you can take a tax deduction for depreciation against your rental income. To calculate your annual depreciation, take the value of your home, on the date you begin renting, less the value of land and divide it by 27.5. Unfortunately, this is just a temporary gift from the IRS. When your home is sold you must recapture all of the depreciation at 25%.
Other potential drawbacks to renting your home include the possibility of major damage inflicted by a tenant, drawn out eviction processes, negligence or safety lawsuits and costly maintenance issues.
An additional consideration, if you have a capital gain on your home, is the loss of the capital gain exemption of $250,000 for individuals and $500,000 for a couple if you haven’t lived in your home for 2 or the last 5 years.