Sometimes, a homeowner can choose whether to sell a single-family residence or keep it for rental income. This option often presents itself to an owner who has saved enough cash to use as a down payment for a new primary residence. Also, this decision-making predicament is typical of someone who has inherited a house, has purchased a building for a child’s college years, or is relocating temporarily. Every one of these choices is viable under different circumstances; a homeowner who considers all the associating factors of each option will more likely reach the best conclusion.
Legal and Financial Considerations: Your Key to Navigating the Slippery Road of Rental or Occupancy
Local zoning laws and covenants occasionally prohibit rental of single-family residences. Check the local zoning authority and homeowners’ association to confirm that your rental is permitted. Mortgages on single-family residences often require the borrower to be the principal resident of a home. This will require an owner to have either paid off existing loans or work with the lender to modify the terms of those loans.
Using a house as a rental property is a form of investment. A wise investor compares a house rental with other investments to determine whether rental generates the greatest return. Return on investment usually includes both net cash flow and change in equity: a house’s resale value determines equity change. So, an investor also needs to research the housing market to know if their house is likely to increase in value over time.
Investors also consider the tax implications of renting out a house. Normal expenses—such as repair, maintenance, real estate taxes, and leasing costs—can be deducted from rents, resulting in a lower taxable income. The costs of acquiring and improving a house can be also be subtracted from taxable income by using a depreciation process. But a homeowner’s standard exemption from capital gains taxes is not allowed for rental property.
Practical and Management Factors
Renting out a house is an active (rather than passive) investment. That means the owner must deal with leasing, management, and maintenance concerns. The owner will not only have the time and ability to take care of these issues, but they must also set aside some money for scheduled maintenance or unexpected emergencies.
The landlord role can be daunting and aggravating; if a house owner instead opts to pay for professional management, that cost will substantially reduce net income flow. Risk for a rental house investment can also be relatively high. Tenants may damage the property, leave without paying rent, or require eviction. Liability insurance can offset some of these risks as well as relieve the owner of any responsibility should a tenant be injured in the rental house.
A Third Option: Providing Seller Financing
An alternative way of generating cash flow while avoiding the complications of rental is to sell a house and provide the financing for part or all of the sale price. Again, if there is still a mortgage on the house, the original loan may not allow owner financing. Even when owner financing is permitted, the original loan is primary, meaning the lender has first right to repayment; the owner-lender becomes secondary or junior. Therefore, if a buyer defaults, the first owner is still responsible for mortgage payments, and the house still is collateral for the original loan. Besides that, providing owner financing does carry some tax benefits. Income tax applies only to the interest portion of loan payments and capital gains taxes are spread over the life of the loan.
There are certain financial insecurities associated with providing owner financing. The buyer-borrower could default on the loan. Most borrowers do not remain in homes for the regular financing periods of 20 to 30 years, suggesting that the original owner will require a balloon payment upon resale. Professional legal and accounting services are necessary for the owner-lender to ensure safety and maximum investment returns.
Research, Then Decide: Equip Yourself with Market Information before Investing
A variety of factors will influence a home owner’s decision to sell or rent out their house. Rental must be permitted under local zoning laws and covenant restrictions. The existing loan on a primary residence will likely prohibit rental use. Rental might be dependent on free and straightforward ownership or available commercial financing. Once in a while, other investments out-perform rental houses: a homeowner should thoroughly investigate the rental market, probable expenses, and potential rental income, and compare the net income to competing investments. Part of the total investment income will be the eventual resale proceeds from a house. In a stagnant or declining market, those proceeds may be minimal. Managing rental property requires time, resources, and resilience. A possible alternative is selling the property with owner financing to generate an income stream with much less active owner involvement, yet with tax benefits.