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8 Things You Should Know Before You Rent Or Sell Your Home

Author : Richard Sootkoos

Submitted : 2008-10-23 00:00:00    Word Count : 2037    Popularity:   11

Tags:   renting your home, rental home, selling vs renting your home, home rentals, pros and cons of renting

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Recently, Sharon Gless, a 42-year old administrative specialist, from San Jose, CA, was laid off. She entered the job search mode over the next few months and decided to relocate to Atlanta, hoping to take advantage of a better job market in the South East, especially in her area of expertise, and also a more attractive housing market and generally a more affordable standard of living. She also felt that she didn't need to sacrifice too much on the great weather she has been accustomed to.

Now, that she decided to move, Sharon had one bid decision left to make. Should she sell her home in the San Jose suburbs or rent it out.

"I am not sure what is my best move expressed Sharon. I don't know what is involved with renting out my home and I am not sure what is the best financial move for me to make. If I sell my home I will make a 100% profit, but what if I don't like Atlanta and want to move back to California? I won't have a house and don't know if I will be priced out of the market then. I have heard horror stories on both sides, but am most concerned that if I move back I won't be able to afford renting a home or an apartment for that matter. Should I sell and take the profit and run? If Sharon sells now, she will lock in tremendous gains, but that same appreciation could price her out of the market if she returns in a year or two.

Sharon's situation is quite common. More than 5,000 US homesteaders move every day, according to the U.S. Census Bureau. Underscored by a weak labor market, many people have to move to find employment. According to a survey by a leading job posting site, half of U.S. job seekers were willing to reallocate for employment.

In most instances, moving requires selling one's home because the equity of the former home sale affords the purchase of the next home. However, for differing circumstances some homeowners choose to rent out their homes instead. In some instances, the intended move is only temporary and they know they will be returning to back home in the near future-perhaps while they pursue a second degree or take on a short term contract work. Sometimes the seller simply can't sell at an acceptable price so they opt to hold on to the house until the market picks up. A more likely scenario, however, is that the owner wants to hold on to the house in anticipation that its value will continue to escalate.

The situations are varied, however, there are a 8 Tips You Should Know Before Selling or Renting out your home.

1-The Tax Impact When Selling Your Property

As is well known, the IRS provides a generous tax break for homeowners that have lived in their home for at least two of the past five years. Married couples who file jointly can earn up to $500,000 in capital gains tax-free, while singles can enjoy $250,000 in tax-free gains.

Also, homeowners who plan to rent their home for a short duration (one or two years) will still be eligible for these tax breaks if they have lived in their home for at least two of the past five years. However, If they sell more than three years later, they lose the tax exemption. In other words, their gain would be taxable as a capital gain. Thelong-term capital gains are now taxed at a maximum rate of 15%.

The 3 year clock starts once you start renting.
Because of this tax rule, at the risk that renting plans would lose this attractive financial benefit, the general consensus would be to sell. Most financial planners and CPA wouls agree that if you have a large gain on your personal residence, you would be better off to sell rather than rent it out. It would be a great loss if you had to pay taxes on this capital gain for the small upside benefit of short term rental income. Its would be the equivalent of throwing money down the drain. However, there is another alternative to renting if the homeowner is willing to move back into the house. If he lives there for two more years again before he sells, he will re-qualify for the exemption.

2- The Tax Impact When Renting Your Property

Renting your home and becoming a landlord also has some handsome tax perks. Rental income is taxed as ordinary income and your taxes could be largely eliminated with the numerous deductions on expenses and depreciation. Please note the there is on major tax rule that may mitigate this benefit. If the house is eventually sold and you qualify for a capital-gains tax exemption discussed earlier, you'll be taxed on the amount you depreciate, which would make renting out your home considerably less attractive than selling.

With respect to expenses, you can deduct almost any out-of-pocket expenses related to owning and managing the home including property taxes, mortgage interest payments, advertising or broker fees, the costs of repairs, maintenance, other cleaning services, utilities, management fees, fire, earthquake and liability insurance and other expenses associated with keeping the property running and the collection of the rental payments.

There is also a deduction called depreciation that is included that is calculated by taking the value of the property and dividing that by 27.5 years (the recovery period) and deducting that as an expense deduction on your taxes. For instance, if your home is worth $500K at time of renting, your annual depreciation deduction would be $500K divided by 27.5, or $18,182 a year. In other words, you can get $18,182 in rent tax-free just on the depreciation tax benefit.

Any improvements made to the home, such as adding a second story or a new updated kitchen remodeling wont qualify for a deduction, but this cost can be recovered by the increase in depreciation deduction as the value of the home would increase. You can in most cases depreciate the cost of any carpeting, plumbing, appliances, and furniture over only five years. So if you bought a new $2,000 refrigerator for your rental, you can deduct $400 a year from your rental income for five years.

Renting

Pros
*Good investment to keep if it continues to appreciate
*Tax-break benefits that offset income tax on rent
*Rent income covers the mortgages, taxes and other property expenses

Cons
*Damage may occur to the property from the renters
*You may miss the tax benefit window and taxed on the whole profit if you sell
*Could have a number of financial/legal issues with the renters

Selling
Pros
*The tax-free capital gain benefits
*Lock in profits that can be used or reinvested in other investment vehicles
*Don't have the headaches with renting a property

Cons
*May not be able to afford a comparable home if you decide to move back
*If market is hot, you may lose out on more home appreciation
*It may not be the right time in the marketplace to sell a home

3-Can You Afford to Rent?

In reality, for most homeowners, renting out a home is not an option for them. The sale of their home is necessary in order to put down a downpayment for their next home. Many homeowners only have enough capital to purchase one home, let alone 2 homes. There is a capital reserve required when renting properties.

Tenants come and go and the homeowner has to pay the mortgage payments on the rental property regardless of whether or not he has paying tenants at the time. These are valid risks to consider when deciding to rent your property.

When renting a property, there is also the risk that a tenant could damage the property or cause other issues that would lead to an expensive eviction process. In most states, the legal process to carry out an eviction could cost up to $5,000 and the process could take 1 to 2 years to complete. During this time the tenant will most likely refuse to pay rent as well.

4-Will Your Home Appreciate in Value?

Many homeowners decide to rent as they anticipate the appreciation of homes in their area will continue to soar upward. Generally speaking, if the home prices in your area are expected to climb considerably over the next three years, it may be a good idea to rent it out. Speculation aside, you may want to consider historical real estate appreciation statistics which equate to roughly a 3 percent annual appreciation over the long run. Just because property values have increase in the last few years, its not certain that it will continue to do so for the next 3 years.

If you are looking at your home as an investment vehicle, it is generally a good idea to talk to a financial planner and include your home investment as a part of your overall investment portfolio strategy. Again generally speaking, its not a good idea to put all of your eggs in one basket and is a safer strategy to stay diversified with multiple investment vehicles. If you do not feel that you are diversified enough, you may want to consider selling your home.

5-Is The Market Good To Rent or the Sell?

Sometimes the market is better for sellers than for landlords. If you look at the last 10 years, the values of properties have appreciated considerably, whereas rents have increased only marginally notes Gordon Lewis a real-estate broker in San Francisco, CA. Contact your local board of realtors or neighborhood real-estate agent and have them appraise your house, then get the statistics for local rentals and do a comparison. Only then can you see whether renting makes sense. If it is a stable market and the rent will cover your mortgage and other related expenses, it make the decision process easier.

6-Do You Ever Plan to Return back Home?

Given the recent run-up in home prices, you may want to consider what the viability of purchasing a home in your neighborhood years from now if you decide to return. Will you be able to purchase a comparable house with your projected income is a question you will need to thing about.

7-Strange People Living in Your Home

For Gless, one of the most important issues is how you feel about the property. If you're very attached to it, then you might "feel like [the tenants] are invading your space," she says. "It's very hard to rent out a home and come back to it to find out someone has trashed it." This may be especially true if you leave your furniture behind. "You have to take off the personal hat and remember this is now a business," she says.

8-Are You Ready to Be a Landlord?

Last but not least, are you ready to be a landlord? Being a landlord isn't an easy undertaking. You need to be ready for phone calls anytime during the day is something happens to the plumbing, heat, electricity, broken window, broken appliances etc., the long list continues. Bottom line is you can't be a landlord unless you are close to the property, or have an acting property manager in the vicinity, which will cost you money. Hiring a property-management company will cost you 10% of your rental revenues to manage it. Agreements may vary with each property management company but you will be able to negotiate an agreement with one to pretty much handle everything that is involved with renting out and maintaining a property, including your mortgage payment and processing.

Author's Resource Box

Carls Sonnabend is a world traveler and truly a jack of all trades. The world is your canvas. Find the best travel and rental deals at his website http://www.rentinglist.com

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