Are you considering turning your home into a rental, or investing in a residential rental property? If so, speaking with a Certified Public Accountant or licensed financial advisor is a great place to start. We understand that not everyone has readily available access to their own advisor, so we took notes recently when we sat in on an informal lecture by a prominent Denver Colorado based CPA on the subject of residential rental properties as investments. The following is an outline of that talk and will be a helpful review before having a similar conversation with your own CPA or financial advisor.
1. You should hire a realtor who is knowledgeable regarding rental properties. An agent familiar with the rental market can guide you towards a good rental at the right price. Remember you will not be living in the home so it should suit a renters needs rather than yours.
2. Rent should exceed the mortgage payments with an additional amount for expenses.
a. The tenants will in effect pay the mortgage.
b. The principle of the mortgage will be reduced, which will increase the equity in the property.
c. Allow any surplus funds from rents to accumulate. They will be needed for expenses and vacancy cash flow.
3. Hiring a good property manager will bring you peace of mind in owning a rental property.
a. The property manager will handle the tenants, collect the rents, and make sure that the property is maintained properly.
b. They will screen and acquire quality tenants for your rental.
c. Fees paid for property management are deductable.
d. Peace of mind is well worth management fees. Management companies pay for themselves.
4. Investment in real estate is long term.
a. Do not pay cash. If you must then put a mortgage on the property, then re-invest again.
b. Do not invest all of your savings in real estate alone.
c. The value of real estate in the long run has always increased and more than kept up with inflation.
d. In the short run, there is, and will be some declines.
5. A separate bank account for the rental property can make the bookkeeping easier.
6. On your tax return, you can reduce the rental income for all expenses of the property including the interest, taxes and insurance which combine for the largest portion of the payment. However, you cannot deduct the reduction in principle.
a. All expenses are deductible from the rental income: Auto expenses, cleaning & maintenance, advertising, utilities and all other expenses related to the property.
b. You can also deduct about 3% of the cost of the building as depreciation each year.
c. And if in the first few years you show a loss on your tax return, you can reduce your other taxable income.
d. But keep in mind any profits are taxed as ordinary income.