If you can't sell your house, should you rent it?

Credit: Flickr user 401K

(MoneyWatch) Given the tight labor market, many people hoping to land a good job may ultimately have to move. That raises a related challenge -- selling their home at a reasonable price or that will pay off their mortgage.

If you are one of the many folks facing this situation, consider renting your home. It can lessen the financial burden, and you might even be able to turn a small profit.

Here are reasons why renting your home might make sense:

  • You temporarily need to live in another location
  • You can't sell house for an acceptable price
  • Rental Income provides good cash flow

When deciding whether to rent out your home, consider the pros and cons:

Rental pros:

  • Keep property to sell later at a better price
  • Rental income covers mortgage, taxes, insurance, and other costs
  • Tax breaks offset rent or other income

Rental cons:
  • You are the landlord
  • Tenants may damage your property
  • You could be taxed on gains if you later sell

Then there is the deduction for depreciation on a home. This is the portion of the property value you can deduct from your taxes. To calculate the applicable depreciation deduction, you will first need to get an appraisal or a written statement from a local realtor on the current value of the building (excluding the value of the land). You will use the lesser of what you paid for the property or the appraised value as the base for calculating depreciation. Then divide the base amount by the recovery period for residential property, which is 27.5 years.

The resulting amount is the amount you can take as a depreciation deduction each year. For example, if the lesser value is the current value of the building of $200,000, then divide that by 27.5 and you'll get $7,272, which is the annual depreciation deduction you can take annually.

Now here is the really good part: The amount by which rental expenses exceed rental income is a tax deduction that can be used to offset or shelter up to $25,000 of other income, including salary. This juicy tax break is available as long as your adjusted gross income is $100,000 per year or less (this applies to single filers as well as marrieds). That tax benefit phases out gradually for anyone with annual income of more than $100,000 and may not be claimed at all by those earning more than $150,000.

If you later plan to sell a home that you've converted to a rental property, you should be aware of how the gains could be taxed. If you lived in the property for at least two years and then rented it out for less than three years, you may still be able to use the provision that allows you to exclude up to $500,000 of gains tax-free. But you will still have to pay income tax on any deductions you claimed for depreciation while renting it out. If you sell at a loss, the only deductible portion is the loss that occurred after you converted the house from personal to rental use (This is another reason you will need an appraisal when you begin renting out your home.)

Remember: Renting a home will come with various headaches and problems. You still need to maintain the property or pay someone else to do it for you. You also must check with your home insurance company to make sure you are still covered for damages while the home is rented. If not, then revise or change your coverage.

Finally, housing experts warn against hanging on to real estate for extended periods when the rent falls short of your pre-tax, out-of-pocket costs. Only look to the tax benefits to sweeten the financial results, not to determine whether to rent. 

Image courtesy of Flickr user 401K

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.

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