Can You Turn Your House Into a Rental Property?

Converting your primary residence into a rental property moves you from homeowner to real estate investor, introducing new financial, legal, and operational duties. This transition requires careful planning and an understanding of the responsibilities of being a landlord.

Initial Financial and Regulatory Review

Before renting your home, review your financial and legal obligations. Your mortgage agreement likely has an occupancy clause requiring you to live in the property for a set period, often at least 12 months. Violating this could trigger a “due-on-sale” provision, making the entire loan balance due immediately. Review your mortgage documents and contact your lender about your intent to convert the property.

Your homeowner’s insurance is not sufficient for a rental; you must switch to a landlord policy. This insurance covers the physical structure and provides liability protection, but it does not cover the tenant’s personal belongings. For this reason, you should require tenants to get their own renter’s insurance. Landlord policies also offer coverages like loss of rent, which reimburses you for lost income if the property becomes uninhabitable.

If your home is in a Homeowners Association (HOA), examine its bylaws for rental restrictions. Some HOAs limit the number of rental units, enforce minimum lease terms, or prohibit rentals. You must also research city ordinances, which may require you to get a rental license, pass inspections, or register the property with the local government.

Calculating Profitability and Setting Rent

To determine if converting your home is financially viable, you must analyze potential income and expenses. First, establish a competitive market rent by researching comparable properties online or consulting with local real estate agents. This research helps you set a price that is both attractive to tenants and profitable.

To forecast profitability, account for all potential expenses. Your calculations must include mortgage principal and interest, property taxes, and the new landlord insurance policy. Also, budget for ongoing repairs and maintenance by setting aside 1% of the property’s value annually. Establish a vacancy fund of 5-10% of the annual rent, and factor in property manager fees, which range from 8% to 12% of the monthly rent.

Once you have your income and expense figures, you can calculate your potential cash flow. Subtract your total monthly expenses from your monthly rental income. A positive cash flow means the rental income covers all costs and generates a profit, helping you assess the investment’s financial performance.

Navigating the Tax Implications

Converting your home to a rental introduces new tax rules, including the ability to claim depreciation. This is a non-cash deduction for the property’s wear and tear over time. The basis for depreciation is the lesser of the property’s adjusted cost basis or its fair market value at conversion. The IRS allows you to depreciate a residential rental property’s building value over a 27.5-year period.

All rental income must be reported to the IRS on Schedule E. You can deduct a wide range of expenses, which can offset your rental income and reduce your tax liability. Deductible expenses include:

• Mortgage interest
• Property taxes
• Landlord insurance premiums
• Costs of repairs and maintenance
• Property management fees
• Advertising costs
• The depreciation allowance

Consider the impact on the Section 121 exclusion, which allows you to exclude up to $250,000 of capital gains ($500,000 for married couples) from your primary residence’s sale. To qualify, you must have owned and lived in the home for at least two of the five years before the sale. Renting your home for more than three years could make you ineligible for this exclusion. Any depreciation claimed during the rental period will be “recaptured” and taxed at up to 25% upon sale.

Landlord Responsibilities and Property Management

Your practical and legal duties as a landlord begin with making the property “rent-ready.” This includes making necessary repairs, ensuring safety equipment like smoke detectors is functional, and deep cleaning. You are legally bound by an “implied warranty of habitability,” which requires the property to be safe and fit for occupation with working plumbing, heat, and electricity.

Landlord-tenant laws, which vary by location, govern the rental relationship. The federal Fair Housing Act prohibits discrimination against tenants based on race, color, religion, national origin, sex, disability, and familial status. You must also follow local regulations for handling security deposits, which dictate maximum amounts and require separate accounts. Rules for landlord entry, which require providing reasonable notice to the tenant, must also be followed.

Finding and managing tenants starts with screening, including applications, background checks, and credit reports to find a reliable occupant. Once a tenant is selected, a legally sound lease agreement outlines the rights and responsibilities of both parties. You should also understand the legal process for eviction in case issues cannot be resolved.

You must decide how the property will be managed. Self-management gives you direct control but demands significant time to handle tenant communication, maintenance, and rent collection. Alternatively, you can hire a professional property management company to handle the day-to-day operations for a fee. This is an option for those who prefer a more passive investment.