When Renting Out Your Home Makes Sense

CBS
Homeowners who want or need to move don't necessarily have to sell their house. It might make sense to rent it. In this column, "Early Show" financial guru Ray Martin gives the lowdown on renting out your residence.

For many people who cannot or don't want to sell their home in this depressed market, renting it out can be a viable option. Folks in this situation have lots of company - it's even reported that Treasury Secretary Timothy Geithner is leasing out his Mamaroneck, N.Y. home after failing to get a bid for it that he was willing to accept. If you are one of the many folks who are in this situation, consider renting your home -- it can lessen the financial burden, and you might be able to turn a small profit.

Circumstances prompting the possible renting of your home include:
• Living in another location temporarily
• Cannot sell house for acceptable price
• Rental Income provides good cash flow

Pros and cons of renting out your home include:

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

Cons:
• You are the landlord
• Tenants may damage your property
•Could be taxed on gains if you later sell

If all other considerations work for you, then consider the tax breaks you can get from renting out your home. You can deduct pretty much any out-of-pocket expenses related to owning and managing your property when you rent it. This includes deducting your mortgage interest payments, insurance, property taxes, maintenance, repairs, cleaning services and even the cost of travel and local transportation expenses incurred in the maintenance and management of the property and the collection of rent.

Then, there is the other deduction, called "depreciation. This is the portion of the property value you can take as a deduction each year. To calculate the applicable depreciation deduction, you will first need to get an appraisal or a written statement from a local realtor as to 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 this 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 depreciation deduction you can take each year.

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). For those with income above $100,000 this tax break begins to be phased out and is phased out completely above $150,000.

So let's look at an example: Say you paid $300,000 for your home and could only sell it for $225,000 in the current market. A realtor says your house can easily be rented out for $1,750 per month. The base amount used for calculating depreciation is about $200,000. Here is how the numbers would work out:

Monthly Rental Income: $1,750

Monthly Expenses:
Mortgage Interest: $1,150
Property Taxes: $500
Insurance: $100
Maintenance, etc: $200
Total Monthly Expenses: $1,950

Monthly out-of-pocket cost: ($200)

Monthly Depreciation Expense: $606

Monthly Net Rental Loss Deduction: $806

Annual Rental Loss Deduction: $9,672

Annual Tax benefit from loss deduction: $2,400 (assuming 25 percent effective tax rate)

Monthly tax benefit from tax deduction: $200

If you plan to sell a home you've converted to rental property, you should be aware of how the gains could be taxed. If you lived in the property for at least two years ,then rented it out for less than three years, you may be able to still 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 this: renting a home will come with headaches and problems. You'll still need to maintain the property or pay someone else to do it for you. You'll also need to check with your home insurance company to make sure you are still covered for damages while renting your home. If not, then revise or change your coverage. Finally, real estate experts warn against hanging onto real estate for extended periods when the rent falls short of your pre-tax out-of-pocket costs - so only look to the tax benefits to sweeten the financial results, not drive them.