Renting rather than selling your home means Making the Leap to Landlord

So you're having trouble selling your home. Would it make more sense to lease it instead?

Doing so could turn your property into a rent machine and open up extra tax breaks. Plus, it would buy time until market conditions improve.

"I can't believe anyone would put a house on the market now, unless they absolutely had to," said Jeff Young, a Scottsdale investment adviser and owner of two rental units.

But before you take that leap, think carefully.

Renting a home isn't a slam-dunk strategy either. Not everyone has the financial reserves, time, expertise or disposition to do it right.

"It's not as simple as just setting out a 'for rent' sign," said Stephen Phillips, a Phoenix man who owns rentals in Phoenix and San Diego with his brother. "You need a tolerance for calls at 10:30 at night."

Becoming a landlord

Before taking the plunge, assess your temperament and desire.

Landlords emphasize the need to operate this like any other business, in an emotionally detached way.

"You can't get sucked into everyone's hard-luck tale," Phillips said. It's also critical to learn about legalities. Phillips belongs to a Phoenix networking group called the Independent Rental Owners Council (www.azama.org/iroc.asp), for which Young formerly served as president. The group of small landlords meets monthly.

Along with a good understanding of landlord-tenant laws, you should be familiar with credit and background checks for applicants, and you'd be wise to develop a network of handymen, plumbers, electricians and the like.

You also should know how to keep good records. For example, it's smart to maintain separate checking accounts for each property, said Phillips. And it's wise to keep at least a few thousand dollars in reserve for unanticipated problems.

And Young cautions prospective landlords not to assume they'll earn a positive cash flow, especially if they bought at a lofty price within the past few years.

"Rents aren't necessarily going to pay all the bills, even if you made a 20-percent downpayment," he said. "You'll have to count on the tax benefits, and you'll need time."

Tax breaks

The tax benefits of owning a rental differ from those for primary residences.

On both, mortgage-interest and property-tax expenses can be deducted, but landlords also can write off all sorts of costs for repairs, maintenance, property managers and more.

"Think of it as a small business," said Jim Darling, a certified public accountant at Jenner & Darling in Tempe. "Everything you spend is deductible, one way or another."

That includes a deduction for depreciation - a noncash accounting charge allowed on business assets but not owner-occupied homes. Depreciation is based on the premise that property wears out and will need to be replaced, even when that's not necessarily the case.

The tax treatment of capital gains and losses also differs.

When owners of a rental property sell, they can defer capital-gain taxes by switching to another property through a somewhat-complex transaction called a 1031 tax-free exchange. Owners who don't make this reinvestment - or do it incorrectly - will owe taxes.

By contrast, homeowners can exclude up to $250,000 in profits ($500,000 for married couples) on a primary residence without having to reinvest in other real estate. To qualify, you must have:


• Owned the home for at least two years over the five years ending on the date of sale.


• Used the home for at least two years over the five-year period ending on the date of sale.

You can utilize this break repeatedly, though not more than once every two years.

You can get a partial benefit even if you don't meet the two-year use and ownership tests - assuming you were forced to sell the home due to an out-of-area job transfer, medical problem, divorce or for various other reasons. You would pro-rate your exclusion to reflect how long you lived in the home.

"If you lived there 18 months, you'd get 75 percent of the exclusion," said Tom Steele, a certified financial planner and enrolled agent at Steele, Larson Anderson Wealth Management in Mesa. "The IRS has left it pretty nebulous," he said, referring to the many exceptions.

Traps to avoid

One tax trap that can trip the unwary is renting out a home that you occupied as your primary residence. Doing so could wipe out that $250,000 or $500,000 tax break, which isn't available on rentals.

"Some people get confused on whether the benefit can be taken on any piece of property - rental or primary residence," said Steele. "Others aren't sure how often they can use it."

Rentals also differ from primary residences in the treatment of losses. Landlords can deduct a loss on rentals they sold for less than they paid (adjusted for improvements and a few other factors), yet homeowners can't deduct a loss on a primary residence.

Losses on an owner-occupied home can't be harvested even if you later rent it out.

"You can convert a home into a rental, but you can't take a loss in doing so," said Darling. When a property converts into a rental, he said, the home's "basis" or untaxed value would be its cost or fair market value, whichever is less.

When real estate prices were rising a couple years ago, few people had reason to concern themselves with losses. But given the state of affairs now, it's one more thing to factor into your decision.

Russ Wiles
The Arizona Republic
http://www.azcentral.com/arizonarepublic/business/articles/0904biz-HomeRental0905-ON.html