For many homeowners, using rental income to offset a portion of the monthly mortgage payment can sometimes seem like an attractive option. The income boost can make homeownership more affordable. Or it can put a nicer, more expensive property within your reach.
If you’re thinking about renting out your spare bedroom, in-law suite, or basement apartment, a floor in your house, or a garage, or another part of the property, be aware of these potential problems before you take on a tenant.
- If you rent out your property, you’ll pay the marginal tax rate on your rental income, along with state and local income taxes.
- In some cases, you can 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. So, if you’re in the 25% marginal tax bracketand 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, repairssupplies, utilities, depreciationand 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 you charge will also be taxable). You are required to report your rental income and expenses on Form 1040Schedule E.
When you rent out your extra space, one of the most important things to consider is weighing 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; a security deposit is intended to cover any potential damage to your property that exceeds normal wear and tear. While you might expect and be understanding of accidental damage, it’s important to 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. In these instances, 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. It also cannot replace any personal or sentimental objects. Your tenant could also introduce bedbugs or roaches to your property; these pests 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 an illegal operation out of their property. In these worst-case scenarios, it may be necessary to file criminal charges 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 they are 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 (and 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 or the number of bedrooms it contains.)
- Failing to provide or maintain promised amenitieslike 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 research your state laws.
Your Renter Won’t Leave
You probably won’t want to rent out part of your home forever. If your family situation changes—for example, 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. At this time, you may 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.