The Independent Investor: Should You Consider Renting What You Can't Sell?

Patience is a virtue but even virtues can run their course. The housing market is in its third year of continued decline. Those who have been waiting to sell and can't are starting to rethink their alternatives.

The first thing to remember is there is no such thing as "can't" when selling your home. It is just what price you are willing to take for it. Some homeowners have no choice. Underwater owners that are running out of money to pay their mortgage must sell or face foreclosure. Their woes have been well documented. But what about those of us who would like to sell, either a primary residence or a second home, but have the money to wait for a bottom in the real estate market?

The rental market is booming across America. More than 3 million Americans have entered the rental market over the last three years and as foreclosures mount, that number will only increase. It appears that demand for rental properties is outpacing supply.

Obviously, renting your home only makes sense if you have another place to live. If you are relocating because of employment, on sabbatical for a year or two, if you have a second home, or will be moving in with someone else (because of a marriage, death of a relative, etc.) then the economics of renting may be appealing.

On the plus side, renting allows the owner to keep the property until prices bottom out and, hopefully, begin to appreciate. In the meantime, rental income can cover mortgages, taxes and insurance payments if the rental price is right. Better yet, certain expenses such as mortgage payments, property taxes, repairs, maintenance, advertising, broker's fees, transportation and insurance can be deducted from rental income.

There's also a phantom tax deduction called depreciation (the wear and tear on your property) that you can deduct each year from your rental income. All you do is divide the fair market of your home (excluding cost of land) by its recovery period, which is 27.5 years for residential property. For example, assume your home is worth $350,000 divided by 27.5 years equals an annual deduction of $12,727.27 from rental income.

But there are some negatives as well. Landlords have plenty of headaches ranging from renters who fail to pay their rent, to vandalism of their properties. Housing maintenance issues don't go away simply because you no longer live in your home. Depending upon its age, everything from leaky faucets, non-flushable toilets to really big emergencies like roof leaks, and lack of electricity and heat must be addressed immediately or you may be hauled into court and sued.

Renters too have rights and in some cases, even obvious reasons for evictions, such as failing to pay the rent, may involve the courts and we all know how lengthy court cases can be.

As it now stands, the U.S. government provides a generous tax break for homeowners who have lived in their house for at least two of the last five years. Married couples who file jointly can keep up to $500,000 in capital gains from the sale of their home, tax-free. Singles can enjoy up to $250,000 in windfall profits. By renting your home that tax break disappears under certain circumstances.

If you are renting for just a year or two, there is no problem. Simply move back within the qualifying time period, sell, and enjoy your gains. However, if you want to rent over the long term (five years or more), you need to understand the tax consequences. Of course, you can always have your cake and eat it too. If you are willing to rent for a period of years, then move back into the house for two years and then sell it, you will qualify for the tax break.

Before you decide, find out your rights as a landlord by consulting with an eviction attorney. You should interview property managers. They will charge a percentage of the rental income for handling all of your landlord duties; but it could be worth it. Finally, create a budget that encompasses all the expenses, taxes and other items you might incur as a landlord.

All of this may take more time and effort then you are prepared for, but let's face it, renting is a business just like any other and requires preparation, planning and work.
 

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net . Visit www.afewdollarsmore.com for more of Bill's insights.