Using rental income to offset a portion of the monthly mortgage payment is an attractive option for many homeowners. The income boost can make homeownership more affordable or put a nicer, more expensive property within reach. If you're thinking about renting out your spare bedroom, in-law suite or basement apartment, be aware of these potential problems before you take on a tenant.
- Renting out a room in your home, a floor in your house, or a garage or other part of the property may seem like a great way to make extra bank, but it's not without its risks.
- You'll pay the marginal tax rate on your rental income, along with state and local income taxes; on the upside, you can, in some cases, reduce taxable income by reporting your expenses.
- You don't know exactly what you're getting with a renter, whether the person intentionally or unintentionally damages your home, whether they pay rent on time, and whether they vandalize your property.
- You might find yourself facing a lawsuit if you either intentionally, or in some cases, unintentionally, violate the law because you were not aware of all the rental regulations in your state.
- There's a risk that your renter will refuse to leave after the lease is up and you will have to go through formal eviction proceedings, which are both costly and stressful.
Rental Income Is Taxable
If you need to generate a minimum amount of income per month from your rental, keep in mind that taxes will take a chunk out of your rental revenues. The rate of tax you'll pay on this income is your marginal tax rate. If you're in the 25% marginal tax bracket and you receive $800 a month in rental income, you'll only be able to pocket $600 a month after taxes. State and local income taxes will take another bite. Make sure to calculate whether you'll still receive enough rental income to meet your needs after taxes.
The good news is that you can reduce your taxable rental income by any expenses associated with the rental. These include advertising, cleaning and maintenance, insurance, repairs, supplies, utilities, depreciation, and a few other costs.
You may be able to charge higher rent to help offset your rental tax bill, but you can only charge what the market will bear and anything extra will also be taxable. Report your rental income and expenses on Form 1040, Schedule E.
When you rent out your extra space, you have to weigh the risks of having what is often a stranger in your home, versus the benefits of the extra income.
A Renter May Cause Damages
You're probably savvy enough to know that you should collect a security deposit from your tenant before they move in to cover any potential damage to your property that exceeds normal wear and tear. You might expect and be understanding of accidental damage and you'll probably collect a sufficient deposit to cover foreseeable events.
However, sometimes tenants cause massive damage to the properties they rent. It could be thoughtless or accidental—they leave a door unlocked and your home gets burglarized, for example, or a frayed electrical cord starts a fire—but just because the damage wasn't intentional doesn't mean it won't have a major negative impact on you.
Your homeowners' insurance will probably cover the financial losses, but it won't compensate you for the time and stress of making your home more secure or having it rebuilt and it can't replace any sentimental losses. Your tenant could also introduce bedbugs or roaches to your property, which can be costly and difficult to get rid of.
What's more, sometimes tenants will intentionally vandalize your property and steal from you. In some nightmare situations, landlords have discovered that a tenant was running a drug operation out of their property. In these worst-case scenarios, it may be necessary to file criminal charges and/or sue in court.
You Could End up Breaking the Law
In an attempt to protect tenants against unscrupulous landlords, landlord-tenant law contains many pitfalls that even the most conscientious landlord can fall into if he or she is not aware of the rules. Here are some areas where you might slip up:
- Failing to provide proper advance notice or obtain permission before entering the tenant's unit, thus violating the tenant's privacy
- Failing to provide housing that is safe, habitable and in good repair. Upkeep and repairs that you might be inclined to let slide when they're only affecting you can become potential liabilities when a renter lives in your home
- Renting a unit that contains mold, which can make a tenant sick
- Violating city housing codes. For example, some locales limit the number of people who can occupy a property based on square footage and/or the number of bedrooms it contains
- Failing to provide or maintain promised amenities, like a swimming pool, therefore violating the terms of the rental agreement
- Charging a security deposit that exceeds state maximums, using it improperly or failing to return it within a required timeframe when the tenant moves out
- Failing to provide sufficient heat or air conditioning
At best, these mistakes could simply cause you to lose your tenant. At worst, you could be sued and lose. Landlord-tenant laws are state-specific. Make sure to read up.
Your Renter Won't Leave
You probably won't want to rent out part of your home forever. If your family situation changes—say, you decide to have children or you want an elderly parent to move in—you might need your renter to move out.
Another likely possibility is that at some point, you'll be able to pay the full mortgage comfortably and you'll want your privacy back. Sometimes a particular renter hasn't technically done anything wrong, but they're just not a good fit personality-wise. Sometimes a tenant will stop paying rent but keep occupying your property.
Most renters are decent people who will move out when they can't pay or when their lease expires, but sometimes a renter won't leave when they should. In these cases, you'll have to go through eviction proceedings. Eviction laws are strict and landlords must follow them exactly for an eviction case to stand up in court. Proceedings can be time-consuming and costly—you may have to hire a lawyer.
The Bottom Line
Regardless of the reason for choosing to rent out part of your property, there are important pros and cons that all would-be live-in landlords should consider before taking this leap. (Knowing your type of mortgage also helps in deciding whether renting is viable.)