Can you rent your primary residence if you have a mortgage?

Homeowners often consider converting their primary residence into a rental property due to relocation, lifestyle changes, or to generate additional income. This transition involves navigating financial, legal, and practical considerations that differ from owning an owner-occupied home. Understanding these complexities is essential for a smooth transition.

Understanding Mortgage Occupancy Clauses

Most residential mortgage contracts include an occupancy clause, requiring the borrower to occupy the property as their principal residence for a specified period after closing, typically at least 12 months. Lenders include this clause to reduce their risk, as owner-occupied properties generally have a lower default rate compared to investment properties.

Failing to adhere to the occupancy clause can have serious repercussions. Lenders may declare the loan in default, potentially leading to immediate repayment of the entire loan balance, known as loan acceleration. Mortgage types like FHA and VA loans have particularly strict owner-occupancy requirements due to their government backing, as they are designed for primary residences.

Before converting a property to a rental, homeowners should review their mortgage documents for occupancy clauses and terms. While a change in circumstances, such as a job relocation, might allow for exceptions, these are typically at the lender’s discretion and require notification. Conventional loans for investment properties often have different terms, including higher interest rates and larger down payment requirements.

Financial and Tax Considerations

Converting a primary residence to a rental property significantly alters its financial and tax treatment. Rental income, including regular rent, advance rent, and tenant-paid expenses, becomes taxable income reported to the IRS.

Landlords can deduct various expenses related to the rental property to reduce taxable income. Common deductible expenses include mortgage interest, property taxes, insurance premiums, repairs and maintenance, utility costs (if paid by the landlord), advertising, property management fees, and professional services.

Depreciation is a significant tax benefit for rental property owners. The IRS allows landlords to deduct a portion of the property’s value each year, reflecting wear and tear. For residential rental properties, the depreciation period is typically 27.5 years, applied to the building’s value, not the land. This non-cash deduction can offset taxable rental income, but depreciation taken will be “recaptured” and taxed upon the property’s sale, often at a maximum rate of 25%.

The property’s tax treatment shifts from personal to business use, requiring rental income and expenses to be reported on IRS Schedule E. This contrasts with personal tax deductions for homeowners, such as the mortgage interest deduction on Schedule A. Converting a primary residence to a rental can also impact the capital gains exclusion upon sale. Single filers can generally exclude up to $250,000 and married couples up to $500,000 of capital gains from a primary residence sale, provided they lived in the home for at least two of the five years prior. However, any depreciation taken will be subject to recapture tax, and the exclusion may be prorated if the property was not used as a primary residence for the entire five-year period.

Insurance and Local Regulations

A standard homeowner’s insurance policy is inadequate once a property becomes a rental. Homeowners must transition to a landlord insurance policy, also known as a dwelling fire policy, for proper coverage. This policy provides protections tailored to rental scenarios, including liability coverage for tenant injuries, property damage, and loss of rental income if the property becomes uninhabitable due to a covered event.

Landlord insurance generally costs more than a standard homeowner’s policy, often 15% to 25% more, due to increased risks with tenant occupancy. While both policy types cover structural damage, landlord insurance does not typically cover the tenant’s personal belongings. Inform your insurance provider about the change in occupancy to maintain continuous coverage and avoid claim denials.

Beyond insurance, homeowners must research and comply with local regulations. Zoning laws may dictate whether a property can be used as a rental. Many municipalities require rental property permits or licenses, and some mandate safety inspections. Landlords must also adhere to fair housing laws, which prohibit discrimination, and understand local landlord-tenant ordinances governing lease agreements, security deposit handling, and eviction processes.

Preparing for Tenancy

After addressing financial, tax, and regulatory aspects, prepare the property for tenants. The property must be safe, habitable, and meet all local housing codes. This involves making repairs, ensuring systems like plumbing, electrical, and HVAC are in good working order, and thoroughly cleaning. Utilities might need to be transferred to the tenant’s name or set up for landlord billing, depending on lease terms.

A legally sound lease agreement is paramount for protecting both landlord and tenant. This document should outline the rent amount, payment due dates, lease term, and tenant and landlord responsibilities, including maintenance obligations, rules regarding pets or smoking, and procedures for repairs. A well-drafted lease minimizes misunderstandings and provides a framework for resolving disputes.

Effective tenant screening is crucial for finding reliable renters. This process typically involves background checks, credit checks, employment verification, and contacting previous landlords for references. Thorough screening helps assess a prospective tenant’s financial responsibility and rental history, reducing the risk of late payments or property damage.

Understanding legal requirements for security deposits is essential. Laws govern the maximum amount that can be collected, how the deposit must be held (often in a separate, interest-bearing account), and the timeline for its return. Landlords must provide a detailed accounting of any deductions, adhering to local and state regulations to avoid legal issues.