Can I Buy a House as a Primary Residence and Rent It Out?

Purchasing a home to live in and later deciding to rent it out is a common financial strategy. This approach involves navigating distinct rules from mortgage lenders, tax authorities, and insurance providers. The process requires careful attention to timelines, legal attestations, and policy adjustments to ensure compliance.

Understanding Lender Occupancy Requirements

When you secure a mortgage for a primary residence, you enter into a specific agreement with your lender. Because lenders view owner-occupied properties as lower risk, these loans offer more favorable terms, such as lower down payments and interest rates.

A primary residence mortgage includes an occupancy requirement. The borrower must move into the property within a “reasonable time,” often specified as 60 days after closing, and live in the home as their primary residence for at least one full year. This means the home is your main dwelling and the address on your driver’s license.

At closing, you will likely sign an occupancy affidavit, which is a legally binding statement affirming your intention to occupy the property. Misrepresenting your intent on this document can have serious consequences.

If a circumstance like a job relocation requires you to move before the year is up, communicate with your lender. They may grant an exception for legitimate, unforeseen reasons.

Tax Rules for a Converted Primary Residence

Converting your home to a rental property means following Internal Revenue Service (IRS) rules. As a landlord, you must report all rental income. You can, however, deduct numerous expenses, such as mortgage interest, property taxes, insurance premiums, maintenance costs, and depreciation.

A significant tax consideration upon selling is the Section 121 exclusion, or capital gains exclusion. This IRS rule allows you to exclude a substantial amount of profit from your taxable income. To qualify, you must have owned the home and used it as your primary residence for at least two of the five years before the sale.

The exclusion is up to $250,000 for single filers and $500,000 for married couples filing jointly. For example, if a single individual buys a home for $300,000, lives in it for three years, rents it for two, and then sells it for $600,000, they have a $300,000 capital gain. By meeting the rule, they can exclude $250,000 and only owe capital gains tax on $50,000.

Any depreciation you claimed while the property was a rental cannot be excluded from your capital gains. The IRS requires you to “recapture” this depreciation, meaning that portion of the gain will be taxed.

Adjusting Your Homeowners Insurance

A standard homeowner’s insurance policy is designed for owner-occupied homes, so you must update it when converting to a rental. If you fail to inform your insurer of this change, you risk having a future claim denied or your policy voided.

You will need to switch to a landlord insurance policy, sometimes called a dwelling fire policy. This insurance covers the physical structure of the home and provides liability coverage, which protects you if a tenant or their guest is injured on the property and you are found legally responsible.

Landlord policies do not cover the tenant’s personal belongings, so many landlords require tenants to obtain their own renter’s insurance. Some landlord policies may also offer coverage for loss of rental income if the property becomes uninhabitable due to a covered event.

Potential Consequences of Mortgage Fraud

Violating the occupancy clause in your mortgage agreement is known as occupancy fraud. This occurs when a borrower intentionally misrepresents their intention to live in a property to secure better loan terms.

If a lender discovers occupancy fraud, they can invoke the loan’s acceleration clause. This clause demands the immediate and full repayment of the entire outstanding mortgage balance.

Beyond demanding full repayment, the lender can impose financial penalties and may initiate foreclosure proceedings. Mortgage fraud is also a federal crime, which can lead to substantial fines and imprisonment. A finding of mortgage fraud will also severely damage your credit score, making future loans difficult to obtain.