We are often contacted by prospective clients who say something like this: “I’m living in a home currently. I’m moving out of the house and I’m thinking of keeping the home for a rental property – should I convert my current home, which is my primary residence, into a rental property?”
The answer is never a simple “yes” or “no”.
My name is Kenneth Ferreira, Broker for Ramona Property Managers, and today we’re talking about 6 questions that we like to ask before you convert your primary residence into a rental property.
And the first question is to ask yourself, if I didn’t own this home today, would I buy it as a rental property? Now, this is putting things just right in the table there. Would you buy this property if you had the money in your pocket? This specific property – your principal residence – as a rental property?
And the answer, more often than not, is “no”.
Maybe your principal residence does not make the ideal rental property. Maybe the ideal of a rental property is smaller, in a different location, doesn’t have as many amenities, or maybe it has more amenities. Don’t just assume because you own your house that it would be a good rental property. If the answer to this question is no, maybe you should sell your property, and if you still want to own rental property, then buy a separate rental.
Question number two.
How much will my net profit be per month? This doesn’t mean gross profit. This means what you catch after expenses. So you need to take your rental income and subtract things like your mortgage payment, but don’t forget property taxes.
Don’t forget insurance.
Don’t forget repairs. Don’t forget HOA dues. Don’t forget utilities and services. Don’t forget to factor in a vacancy loss (banks use 5% and so do we). You may also end up paying a property management company to manage that home for you.
Make sure you’re subtracting those expenses from your gross profit. What is left over is what you catch…and you catch profits with a net before putting them in your profit. So this is your net profit.
It’s time to be brutally honest with question number three. Can I emotionally detach from the home?
We have this conversation with owners all the time and this is also the difference between someone who kind of does property management and a professional property management company. Professionals tell you what you need to know – even if it’s not what you want to hear.
You need to emotionally detach from the property and if you can’t do that, then do not rent the property out. If you walk into that property, that used to be your home, that a tenant is now living in, and if you see that they removed your blinds, or they didn’t cut your rose bushes the way you used to cut them, and if that bothers you on an emotional level, then you should not be a landlord.
Question number four. What are your long-term ownership plans?
If your long-term plans are to move back into the house, then this may be a great option for you. If your long-term plans are to move out of the state and never come back again, maybe you don’t want the emotional and psychological burden of owning this particular piece of real estate (see question 1).
Maybe you do, but part of my job is to ask the question that need to be considered for your long term success.
So just consider this question as you make long-term plans.
Next up on our list is question number 5.
How far away (geographically) will you be? Are you across the street? Across town?
Are you on the other side of the country, or even the other side of the world?
The last questions is a big one: What are the tax implications? See, the government gives special tax breaks to homeowners that don’t necessarily pass through to real estate investors. The means is you could potentially sell your principal residence tax free. If you convert to a rental property, and you wait typically two years, suddenly those proceeds from the sale are no longer tax free.
I’m not an accountant, nor do I play one on TV, but you definitely want to consult a professional on this question as part of your long and short-term planning. A good CPA is an investment so invest in yourself and your future by getting good advice. A good place to begin your research is the Association of International Certified Public Accountants.
If you’re thinking about converting your property, your residence, to a rental property, call us up. We’d be happy to have that conversation with you and get you in touch with a good accountant if necessary.
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