Rental Properties: An Overview
The idea of buying a home or apartment to rent out for profit may sound alluring. But owning a rental property for income and long-term capital appreciation can have its ups and downs. For example, the housing market can fluctuate depending on location, supply and demand, and the economy.
Financially speaking, in order for the rental property to be really profitable, the return you reap should be greater than what you could earn in conservative investments, such as bonds and dividend-paying blue-chip stocks, because of the real risks involved. And on the human side, not everyone has the ability to manage property and tenants. At Corken + Company, we feel it’s important to go into this decision with the pros and cons in order to have the right expectations moving forward, and to set you up for success!
Pros of Rental Properties
Tax Benefits:
The Internal Revenue Service allows you to deduct many expenses connected with rental property in the categories of: Ordinary and necessary expenses, improvements, deprecation.
This means that you can deduct your insurance, interest on your mortgage, maintenance costs, and physical wear-and-tear on your property.
Seasonal Rentals:
If you rent your property seasonally, you may use it yourself for 14 days per year—or 10% of the number of days that you rent to others at a fair market price—and still be able to deduct your expenses.
Renting Extra Space:
You can also treat a room or area of your home—such as a garage, basement, or accessory dwelling unit—like a rental, writing off a percentage of the mortgage interest and other expenses against its income, although you should be aware of the potential pitfalls of renting out extra space, including local zoning rules.
Cons of Rental Properties
Lack of Liquidity:
Real estate is not a liquid asset. Even in the hottest market, it can easily take several months to complete a sale. And if your timing is driven by an emergency or other unexpected event, your need to sell fast might not garner the best price.
Rising Taxes and Insurance Premiums:
The interest and principal of your mortgage may be fixed, but there is no guarantee that taxes will not rise faster than you can increase rents. Insurance premiums may also spike, as they have in the wake of natural disasters.
Difficult Tenants:
Despite your due diligence in vetting prospective renters, you could wind up with tenants who are not ideal. For example, they could be needy or demanding, pay late, forget to turn off the water, and so on. Or they could be destructive, in which case the depreciation allowance in the tax code may be sorely inadequate. You can, however, always add a rider to the standard lease form that spells out rules about occupancy, pets, smoking, tenant insurance, and the like. A security deposit can also be helpful here.
KEY TAKEAWAYS
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Rental properties can be financially rewarding and have numerous tax benefits. Including the ability to deduct insurance, the interest on your mortgage, and maintenance costs.
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The drawbacks of having rental properties include a lack of liquidity, the cost of upkeep, and the potential for difficult tenants and for the neighborhood’s appeal to decline.
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It’s key for investors in any type of real estate to stay on top of interest rates. It is important to contact a tax professional, particularly with the recent changes to the tax code.
