Alternatives to Selling: Becoming a Landlord
Before you sell residential property, consider the potential benefits of becoming a landlord.
Thinking about selling that extra piece of residential real property? Think again. There may be more value to holding onto the property and renting it out than you realize. It's worth evaluating such potential benefits as rental income, tax deductions, property appreciation, and being your own boss -- before you put out the "For Sale" sign.
Rental Income Cash Flow
Ideally, you want a rental to produce a positive annual cash flow. (Some people operate rental property at a loss with the idea of making money when they sell, but it's not ideal for beginning investors.) Here's how to determine the likelihood of achieving that.
Determine the likely rent you'll receive. To figure out whether positive cash flow is possible, start by determining how much your property would rent for. Check local listings for properties of a similar size and quality to yours, ideally within the same neighborhood. You may need to call some landlords or visit rentals for details.
Factor in "vacancy" time. Don't count on receiving rental income for 12 months of every year. Even if your property is in high demand, transition time between tenants can take a month or two. Nationwide, the vacancy rate runs around 10%, but this varies widely between urban and rural rentals, different regions of the country, and even by neighborhood or type of house. Ask your local reference librarian or real estate broker about your area's vacancy rates.
Subtract property expenses. Your rental income will not be pure profit. Factor in your projected property taxes, mortgage payments (if any), insurance, utilities, repair and maintenance costs, and if you don't wish to spend your own time dealing with tenants, property management fees (approximately 8% to 10% of the rental income).
Maintenance costs can be particularly high if your house is old or you've put off major repairs such as replacing the roof or furnace. As a landlord, you'll be responsible for keeping the property in habitable condition.
Calculate your projected profit. To get your projected profit, subtract expected vacancies and likely expenses from the annual projected rent.
If it looks like you'll come out $1,200 to $2,400 ahead each year ($100 to $200 each month), you're doing well by industry standards. If you'll only be breaking even, or will lose money by renting, it may still be worth it if you're likely to earn high profits by waiting to sell.
Here are some of the more significant tax deductions available to small residential landlords.
- Interest. Often a landlord's biggest deduction, this includes mortgage interest payments on loans to buy or improve rental property. It also includes interest on credit cards for goods or services related to the rental activity.
- Depreciation. You can deduct the value of your rental house (but not the land) over a number of years (27.5 years for residential rentals).
- Repairs. The cost of repairs to rental property (repainting, fixing leaks, plastering, fixing broken windows) is fully deductible in the year in which you pay for them.
- Local and long distance travel. Landlords can deduct travel expenses related to their rental activity. The IRS scrutinizes these deductions, however, so learn the rules and keep good records.
- Home office. Landlords can deduct their home office expenses, provided they meet certain requirements.
For many more deductions you'll be able to take as landlord, see Every Landlord's Tax Deduction Guide, by Stephen Fishman (Nolo).
"Net loss." Some landlords can claim so many deductions that it more than offsets all their rental income, resulting in what's known as a "net loss." This is especially common among landlords who don't own many properties -- particularly in their first year or two, when they tend to charge lower rents. Ending up with a net loss from your rental activities isn't a bad thing, though. Subject to certain restrictions known as the passive loss and at-risk rules, you may be able to deduct this loss from any nonrental income you have, such as a salary.
Despite recent (and past) drops, property values in the United States have been on an upward trend for the last several decades. Although nothing is guaranteed, U.S. population pressures suggest that this long-term trend will continue. To get a rough idea of how much your property has appreciated since you bought it, check out free websites such as Zillow and Homegain. The longer you wait, the more the property is likely to be worth.
Will the property rise in value at a greater rate than you could earn by selling it and investing the proceeds (minus capital gains tax) in the stock market? That's a tough prediction to make. However, many real estate investors feel that the safety of their investment compensates for the possibility of lower returns.
Being Your Own Boss
Some people make their living by buying, renting out, and ultimately selling real estate. If you only own one property other than your primary residence, you're not yet one of these big-time real estate investors -- but will get a taste of that lifestyle. Some people love the independence, and the chance to put in a little sweat and creativity in search of higher returns.
If, on the other hand, you've got your hands full with other projects, don't have the time or inclination to learn the landlord/tenant laws, and aren't ready for regular dealings with tenants, contractors, and local officials, being a landlord may not be for you.
To learn what it takes to be a landlord, see First-Time Landlord: Renting Out a Single-Family Home, by Ilona Bray, Janet Portman, and Marcia Stewart (Nolo).