For many military families, summertime means moving time. With the approach of a PCS, you may find yourself faced with decisions about what to do with the home you have purchased at your current duty station. Should you sell or should you keep the home as a rental property? What if you are under water on your mortgage or cannot sell the home? Items to consider when making your decision:
Do you want to be a Landlord? Some people really like owning rental property and may have several at prior duty stations. While others hate the idea of someone else living in their house or do not like the stress of dealing with tenants. Think about which category you fall into and factor that into your decision.
What are the terms of your Mortgage? Does your mortgage allow you to use the home as a long term rental unit or does it specify that the owner must occupy the dwelling? Contact your mortgage company, or read your loan papers, to determine what is required in order to rent the home out.
Don’t forget about Insurance. You will need to notify your insurance company regarding the change in status of the home and make sure your policy covers you adequately, not only for damage to the home but also gives you liability coverage in case of an accident or injury to future tenants.
Do you have an Emergency Fund? If an appliance needs to be replaced or something needs to be fixed, the tenant will contact the landlord (you) or the property management company. This will be your responsibility and you will need to have funds set aside to meet these needs. Your renter rightly expects to have everything functioning as intended and as spelled out in the lease.
How will you Manage the Property? You can manage the property yourself or use a property management company. If you decide to manage the property yourself you will need to track all income and expenses, screen potential renters and be familiar with the Landlord rights and responsibilities in the state where the rental unit is located. When deciding to use a property management company get referrals and references. Ask what sort of statements and services the management company provides and look them up on the local Better Business Bureau website for any potential complaints.
A good Contract is key. Whether you manage the rental or use a company, make sure everything is spelled out in the lease agreement, using addenda to the standard lease agreement as necessary. Every state has different legal requirements. Who will be responsible for lawn maintenance; when is the tenant responsible for repairs or pest control; will you allow pets; are there HOA rules or parking regulations that need to be followed; will the rental include access to HOA facilities such as pools? Once you become a landlord this is a business and you will need to treat it as one.
What is the Condition of the Home? Make sure the home is well maintained and all appliances and systems are in working order before you list the property for rent. If there are any items in the home that are costly or sentimental, consider replacing that item with a less expensive alternative while the home is rented. Take photos or video of the home to document the condition it is in prior to renting and make sure to repair any items that need it. You may have tolerated something because it was not important to you, or you “learned to live with it,” but renters will expect everything in functioning condition. Leaving a broken or non-functioning item may also expose you to liability if someone is injured because you did not repair something.
Remember your Taxes. With a rental you will need to file a Form 1040 with Schedule E, where you will deduct the following from the rent you actually receive: mortgage interest, taxes, insurance, HOA fees, lawn maintenance, repairs and any other expenses. Payments on the principal are deducted from income as depreciation, which is the way that the cost of any asset is deducted over the time that it is generating income. To depreciate the property, you will need to know the value of the home and the land. In most cases you will use the purchase price of the home less the value of the land, which should be listed on the initial property tax statement. If the home has decreased in value before it is converted into a rental you will use the value of the home and land on the day it was converted. You will always use the lowest value of the home for depreciation. It can be tempting to skip this part on your tax return, but do not skip it. When you sell the home you will be required to pay capital gains tax at a specific rate on the amount you took, or could have taken, as depreciation. Even if you normally complete your own tax return, the first and last year of having a rental may be the time to see a professional. More information is available in Pub 527-Residential Rental Property and in Pub 534-Depreciation, which can be downloaded at Irs.gov.
What sort of emergency fund would you recommend to a client who wants to be a landlord?
How would you advise a client who does not want to rent a home but cannot sell before a PCS?
Guest Contributor: Cheryl Myrick, AFC®