My wife and I are considering making an offer on a house with an illegal in-law unit, a little cottage (or maybe more like a shed) in the back yard. The extra space would be perfect for housing our frequent out-of-town visitors, and maybe even offering up as a short-term rental on one of these "sharing" sites.
I am a little concerned, however, that it's listed in the seller's materials as “illegal.” What does this mean? Should we go forward with our offer?
You are right to be hesitant about buying this property. A unit listed as “illegal” or unlawful was likely constructed without the required construction permits. Attempting to use such a property in the way you wish could lead to headaches.
The good news is that you were informed of the issue prior to purchasing the property. This gives you the chance to carefully consider your options.
Here are some of the issues that commonly arise with illegal construction:
- Inferior and/or unsafe construction. A permit is required to ensure safe and quality construction. Without a permit, there's no guarantee that the in-law unit was constructed well.
- Expense and hassle of bringing property up to code. If the city (or governing municipality) finds out about the illegal unit, it will require you, as the new owner, to bring it up to current code and obtain the required permits. The city does not care that you weren’t responsible for the original construction. Obtaining a permit after construction has been completed can be a lengthy and costly process, and may require tearing up some existing walls and so forth. See Discovering Unpermitted Construction When Selling Your Home for more information.
- Financing challenges. Your financial institution may not be willing to extend financing on a house that includes unpermitted construction.
- Insurance limits. If there is a fire or other incident in the in-law unit for which you may pursue an insurance claim, your insurance company may deny coverage. You likely will not have trouble initially obtaining the policy, but beware of the small print that excludes coverage for construction not built to code standards or built with inferior construction. And if you decide to rent the space out, be sure to read Insurance Questions When Renting Out Your Home Short Term; your homeowner's coverage may not be as extensive as you'd expect if you're running a "business" in your home, leaving you potentially liable if a guest is injured.
- Retroactive tax obligations. If your local taxing authority has not been assessing real estate tax on your in-law unit because it wasn't a recognized part of the property, you may become responsible for paying back taxes.
- Obligation to disclose issues to future home buyers. When you eventually sell the property, you will be required, by law, to disclose the unpermitted construction (assuming you haven't since brought it up to code) to any potential buyers. This will make it harder for you to sell the property for the price it would otherwise be worth.
If you decide that purchasing a house with unpermitted construction is not worth the risk, you can walk away, assuming you're not too deep into the closing process by now.
Another option is to negotiate to have the seller obtain required permits prior to sale. This may be a good solution if you are willing to be flexible with the closing date (the permitting process can be lengthy and unpredictable).
If you do choose to go forward with the purchase, consider the terms of your offer carefully. The property may well be worth less than its list price. For example, the market value of a two-bedroom house with an illegal in-law unit is actually closer to that of a two-bedroom house without the extra unit.
Also see Nolo's articles on Airbnb and Other Short-Term Rentals of Your Home.