Can You Rent Out Your Primary Residence?

Converting a primary residence into a rental property can generate income and build wealth, but it involves several considerations. A primary residence is the dwelling where a person lives for most of the year, serving as their main home. This is often the address on official documents. Renting out your home requires careful planning across financial, legal, and practical aspects, including understanding obligations related to your mortgage, taxes, insurance, and local regulations.

Understanding Mortgage and Lender Requirements

Your mortgage lender is a party to involve when considering renting out a primary residence. Most residential mortgage agreements include “owner-occupancy clauses” that require the borrower to live in the property as their primary residence for a specified period, often at least one year. Violating this clause can lead to consequences, including fees, a change in loan terms, a higher interest rate, or the lender demanding immediate repayment of the entire loan balance, potentially leading to foreclosure.

Lenders offer lower interest rates and more favorable terms for primary residences because owner-occupied properties are less likely to default. If you intend to rent out the property, you must inform your lender. This may require refinancing your existing loan to an investment property mortgage. Investment property loans come with higher interest rates, often 0.50% to 0.75% higher than primary residences, and may require larger down payments, sometimes between 15% to 25%.

The distinction between owner-occupied and investment property loans reflects the perceived risk for the lender. While a 30-year mortgage term is common for investment properties, higher interest rates mean more interest paid over the loan’s lifetime. Communicate with your lender to understand their specific policies and any required actions, such as obtaining consent or initiating a refinance, to ensure compliance and avoid financial repercussions.

Navigating Tax Obligations

Converting a primary residence to a rental property introduces new tax obligations and potential deductions. All rental income must be reported on your federal tax return, typically on Schedule E (Form 1040). Landlords can deduct ordinary and necessary expenses incurred in managing and maintaining the rental property.

Deductible expenses include:
Mortgage interest
Property taxes
Insurance premiums
Costs for repairs and maintenance
Utilities (if paid by landlord)
Advertising costs for tenants
Legal and professional fees
Property management fees

Depreciation is another deduction, allowing landlords to recover the cost of the building over its useful life, typically 27.5 years for residential rental property. This deduction reduces taxable income, even if the property generates positive cash flow.

Rental activities are classified as passive activities for tax purposes. Losses from rental property, known as passive activity losses, can only be used to offset passive income. However, individuals who actively participate in their rental real estate activities may deduct up to $25,000 of passive losses against non-passive income, subject to Modified Adjusted Gross Income (MAGI) limitations.

Renting out a primary residence also impacts the capital gains exclusion when the property is sold. A homeowner can exclude up to $250,000 ($500,000 for married couples filing jointly) of capital gains from the sale of a main home if they have owned and used it as their primary residence for at least two out of the five years preceding the sale. If the property was used as a rental, that time may be considered “non-qualified use,” which can reduce the exclusion amount. Maintaining records of all income and expenses is important for accurate tax reporting and maximizing deductions.

Adjusting Insurance Coverage

Standard homeowner’s insurance policies do not provide sufficient coverage once a residence is rented out. You must obtain specialized landlord insurance, also known as rental property insurance. Landlord insurance covers damage to the physical structure of the property caused by perils such as fire, storms, or vandalism. It includes liability protection for injuries or property damage to others that occur on the rental premises.

A key difference is that homeowner’s insurance covers the owner’s personal belongings, while landlord insurance does not cover a tenant’s personal property. Landlord policies may include coverage for certain landlord-owned furnishings or appliances left in the rental unit. Many landlord insurance policies also offer “loss of rent” or “loss of use” coverage. This compensates the landlord for lost rental income if the property becomes uninhabitable due to a covered event during repairs, helping maintain financial stability.

Landlords should require tenants to carry their own renter’s insurance. Renter’s insurance protects the tenant’s personal belongings from damage or theft and provides liability coverage for incidents that may occur within their rented space. This ensures the tenant’s possessions are covered and supplements the landlord’s policy.

Complying with Local Regulations

When converting a primary residence to a rental, research and adhere to local regulations, which vary significantly by city, county, and Homeowner Associations (HOAs). Local zoning laws may restrict rental activity, differentiating between short-term and long-term rentals or limiting single-family homes for multi-family occupancy. Some jurisdictions may require specific rental permits or licenses to operate a rental property.

Building and safety codes must be met, ensuring the property complies with habitability standards. These include requirements for smoke detectors, carbon monoxide detectors, and proper maintenance of essential systems. Landlord-tenant laws govern aspects of the rental relationship, such as lease agreements, security deposit limits, and eviction procedures. These laws protect both landlords and tenants.

Homeowner Associations often have rules regarding rentals, which can include restrictions on rental terms, tenant screening, or even outright prohibitions on renting. Property owners should consult their HOA’s governing documents to understand any limitations. To identify all applicable requirements, contact local planning and zoning departments or review municipal websites.