I have enough money to put in a second home – I need a little bigger place and another bedroom. I currently live in Portland, Oregon, but am planning to move outside of Portland.
It would be nice if the tenants would pay the second mortgage, but I don’t know if it’s worth dealing with the tenants and the repairs they might be asking for all the time. After all, it’s an old house. What should I do?
Packing luggage in Portland
“The Big Move” is a MarketWatch column that researches the ins and outs of real estate, from navigating the search for a new home to applying for a mortgage.
Do you have a question about buying or selling a home? Do you want to know where your next step should be? Email Jacob Bassi at [email protected]
In the full housing markets there are many homeowners who are considering the move you are considering. Homeowners are seeing rising rental rates, and many are taking advantage. In February, rents were nearly 18% higher than a year ago nationally, according to online property website Apartment List, which is record growth.
To some extent, homeowners are fueling this rental growth by converting their initial homes into rentals. Otherwise, these homes would have provided much-needed supplies to the home buying market. Instead, there are so few homes for sale that many Americans are forced to rent them out for longer than they hoped because they can’t find a property to buy. More people renting means more competition for rented units, so rents are going up.
Just because a lot of homeowners go this route doesn’t mean you should. “It makes sense to convert a home into rental property if and only if you understand all of the potential issues that can arise from becoming a landlord,” said Michelle Gesner, founder and owner of Gessner Wealth Strategies, a Houston-based financial advisory firm. .
It’s easy to imagine the benefits of being a landlord – using the extra income to pay off your second mortgage, perhaps just by putting money into his pocket to save for retirement. But if the pandemic has taught us anything, it’s that being a small mom-and-pop owner isn’t for the faint of heart.
You have already faced some challenges in being a property owner. You will need to interact with and work with the tenants to maintain the property. And chances are, the tenants won’t treat the house as kindly as they might be, forcing you to pay to have it repaired regularly. This is just the tip of the iceberg.
““It makes sense to convert a home into a rental property if and only if you understand all the potential problems that exist with becoming a landlord.”“
You seem financially stable, but can you pay the mortgage on your first home and your new home on your own? Many landlords have found themselves facing foreclosure and bankruptcy on their rental properties in recent years as tenants have struggled to pay rent due to the pandemic. In the end, many property owners chose to sell their homes to reduce their losses.
If you think you can’t handle that pressure, I would seriously reconsider becoming an owner. There are other financial reasons to think twice. When someone sells their primary residence, they exclude up to $250,000 in capital gains (or $500,000 if you’re married and joint.) So, for example, if you sold the home for $500,000, but you only paid $300,000 to buy it originally You will not face capital gains taxes on your $200,000 winnings.
If you choose to convert the property into a rental home and then decide to sell later, you may face a hefty tax bill. To take advantage of the capital gains exclusion, you must have lived in the home for two of the past five years, but it does not need to be the last two years. So, in essence, you have a little grace period. And there are tax deductions that you can tax as a property owner.
Let’s say you rented the house for six years and then decided to sell. You will no longer get a $250,000 (or $500,000) exception, so all the money you make from the sale is considered taxable income. There are ways you can avoid this excise tax—in particular, you can reinvest this money into another rental property through a Section 1031 exchange. Otherwise, your tax bill will be larger.
Another financial consideration is whether your mortgage lender will allow you to convert the property to rent in the first place. Mortgages usually include clauses that require borrowers to live in the home for a specified period of time. If you try to move out and rent the property before this time frame expires, you may be engaging in mortgage fraud. Given that you have refinanced fairly recently, you should carefully study the mortgage documents.
You have a better sense of your tolerance for risk and financial complexity than I do. If you’re still interested in going ahead with this plan, definitely consult with an accountant and financial planner who can help you decide the best approach. My instinct is that you are not sold by that idea. If so, I will consider other options. After all, the money you make selling the house will likely go a long way toward paying off debt or other financial goals.
Additionally, being the owner is not the only way to invest in real estate. Additional proceeds can be invested to generate income, growth or even in real estate related securities,” said Kashif Ahmed, president of American Private Wealth, a financial advisory firm in Bedford, Massachusetts. Investing in a real estate investment trust for example, can expand your portfolio, but it is much more liquid than having all that money tied up in the house.
In the end, I feel that you can never go wrong by making the choice that is most comfortable for you. So whatever the choice, I wish you good luck.
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