Renting out your second home - tax breaks and profit potential

1. Figuring the Tax Benefits of Renting – by AMY GUNDERSON/NY Times

Morphing a vacation home into an income-generating rental property can mean taking on an extensive to-do list. But along with all the tasks that go into the general maintenance of the property, homeowners have one more thing to deal with: Uncle Sam.

The decision to turn a second home into a rental, whether for a few prime vacation weeks a year or for several months throughout the winter ski season, has several tax benefits (think writing off the cost of that new water heater) beyond the standard perks of deducting mortgage interest and property taxes. But do not start gathering Home Depot receipts yet. Qualifying for these additional tax benefits depends largely on income and, most important, on how often a property owner might use the home.

In fact, figuring out the potential tax implications will affect the decision on whether and how often a property owner will want to rent out the home, said Barbara Steinmetz, a certified financial planner in Burlingame, Calif. “I give my clients the good, the bad and the ugly,” she said. Here is a look at three types of second homeowners and the potential tax breaks and pitfalls that come along with becoming a landlord.

Rarely Rented

HOMEOWNER: Uses ski condo primarily for own purposes and only rents it out for a week in December.

TAX IMPLICATIONS: This is the most straightforward scenario. If a vacation house is rented out for less than 15 days each year, the rental income does not have to be reported. While the house can still qualify for the mortgage interest, property tax deductions and write offs for casualty and theft losses, in this tax category, a property owner cannot deduct any other expenses associated with operating and maintaining the house.

Frequently Rented, but Rarely Used by the Owner

HOMEOWNER: Visits a beach house for just a single prime week in August, while the rest of the summer and fall the house sees plenty of foot traffic from renters.

TAX IMPLICATIONS : Since the property is rented out for 15 days or more, that rental income will have to be reported. But these homeowners are now qualified to deduct expenses associated with maintaining the house and marketing it to renters. Everything from utilities, cable television, commissions paid to a property manager and insurance may be deducted. The cost of basic home repairs, like fixing a broken window, may be deducted, and larger home improvements, anything that “extends the life of the house,” said Greg Rosica, a partner at Ernst & Young, may also be depreciated over several years.

The I.R.S. sets the usage bar at 14 days or 10 percent of the number of days a property was leased out at fair market value as the maximum amount of time at which a property owner may take a loss. Say that $25,000 in annual rental income meant $30,000 in home maintenance, improvements and other expenses, a homeowner may take a $5,000 loss on that property.

But for homeowners making more than $150,000, “They are not going to be able to write it off because they make too much money,” said Dave Bergman, a certified financial planner in Marina del Rey, Calif. Instead the loss goes into what the I.R.S. dictates as a “suspended loss,” Mr. Bergman said. However, once the rental property starts turning a profit, a homeownermay take advantage of the losses incurred years ago. “It’s a deferred tax benefit,” he said.

If a homeowner makes a profit on the property with its sale, but has been depreciating the house, that homeowner should expect a 25 percent tax bill, regardless of whether they have been taking a loss on the property or not. It is the I.R.S.’s way of saying, Mr. Bergman said, “this was your business renting out real estate, you were depreciating the business because of abuse and wear and tear on the property and now you have made a profit on the sale, so we are going to tax you at a higher rate.”

Frequently Rented and Used by the Owner

HOMEOWNER: Rents out a mountain cabin for three months of the year but uses it the entire month of November.

TAX IMPLICATIONS: The property owner will have to report the rental income and may deduct the expenses associated with operating the house as a rental, but because it was used for more than 14 days, the I.R.S. does not allow the property owner to write off more than the value of the annual rental income. In short, that homeowner cannot take a loss on the property.

But not all of the days a property owner spends at the house have to count toward personal use.

“If you are there for a week and for six of those days you are going to fix up the property, then those days don’t count as personal use,” Mr. Rosica said.

Not only can those days spent working on the house and meeting with local property managers not count as personal use, but travel expenses to the property, from filling up the gas tank to airline tickets, can qualify as deductible expenses. “The trip to China to buy Oriental rugs to furnish the house might get called in to question,” said Mark Luscombe, a principle analyst at CCH, a tax information firm.

The best advice for property owners is to keep good records. “If you want to qualify it for rental activity, keep a log that lays out how many days you were there so you can say, ‘here is the Home Depot receipt for the hot water heater and here is a list that lays out what I did each day in terms of repairs,’ ” Mr. Bergman said. “Keep anything that can help to substantiate your trip there.”

And find a good accountant.


2. Renting Out Your House -- by VIVIAN S. TOY

JOYCE AND ERIC PETERSEN started renting out their house in Westport, Conn., about four years ago when they realized that they didn’t need to be rooted to one place anymore.

Since then, life and family have taken them to Colorado, to Alaska and most recently to California for months at a time. But the Petersens, who are both 61, love their Westport house, and they haven’t considered selling it, even though these days they spend only a few weeks there each year.

“We’re at a very flexible time in our lives, and because we can be mobile, we are,” Mrs. Petersen said. “The challenging part about renting the house out is to make sure that it doesn’t look like a rental, that it’s still your home.”

Accomplishing that, of course, requires an owner to consider and contend with a laundry list of details and concerns. “When you rent,” Mrs. Petersen said, “there are definitely a lot of things to think about.”

From deciding what should go into storage to finding the right tenant to keeping the yard from becoming overgrown when the gardener suddenly stops showing up, the Petersens have learned a number of lessons in their time as temporary landlords.

The most important is probably this: they have hired someone to act as a property manager to avoid trying the patience and good will of neighbors and friends when things go wrong. And they pay all their bills online because mail forwarding “is not what one would hope it would be,” Mrs. Petersen said.

The most obvious benefit from renting out an otherwise unused house is the income, which can pay the mortgage and other bills. “I wouldn’t do it to make money necessarily, but to maintain my property and have my costs covered,” said Kathy Coleman, an agent at Coldwell Banker Doernberg in Scarsdale, N.Y.

So whether you’re having trouble selling your house and have already moved to a new home, or you want to find a winter tenant for a summer vacation home, or your house will be empty because you’re being temporarily relocated for work or just because you want to travel the world, the following is a checklist of things you should consider before handing over the keys.

Choosing a Broker

Taking out a newspaper or online ad may work for owners trying to rent their houses without using a broker, and the popularity of Web sites like Craigslist and Sublet.com have made the process far easier. But brokers can facilitate the process by helping set the rental price with up-to-date comparable rental information, by showing the house, by helping to screen prospective tenants and finally by helping to watch over the property while it is rented out. Brokers typically charge landlords a fee equal to a month’s rent for finding a tenant, although in New York City , the tenant usually pays the fee.

Robert T. Frye, the director of rentals at Brooklyn Heights Real Estate, said, “We have the resources, and we do all the work to find the perfect candidate with excellent credit and job references.”

If you don’t already have a trusted broker, he said, “then I’d recommend shopping for a full-service broker who has a strong presence in the general market where your home is and who really knows your specific neighborhood.”

Perhaps more important, if the tenant suddenly stops paying rent, you can always go to the broker for help. “We’d of course be willing to intervene because we placed the tenant, so it’s somewhat our responsibility,” Mr. Frye said.

Finding the Right Tenants

Any landlord’s greatest fear is a tenant who refuses to pay rent and who also refuses to leave, because the eviction process can be lengthy, litigious and expensive. Finding a reliable tenant is crucial.

Brokers typically run credit checks and ask for letters of reference from employers to screen potential tenants. Sometimes, they even ask for personal references. But you can also do all these things on your own.

Gerald Garber, a retired lawyer who divides his year between Great Neck, N.Y., and Florida , rented out his Great Neck house about 10 years ago through a broker, but this year he decided to do it on his own.

He had left the house vacant for many winters but decided to rent it again because of rising energy costs. “I figured I’d let somebody else pay these ridiculous heating bills for a change,” he said.

He said he planned to run credit and criminal background checks on any serious applicants. “For a couple hundred dollars, you get a service to run these checks and find out who you’re dealing with,” he said. “But to me the most important thing is meeting the people.”

Finding someone to run a background check is as easy as a quick search on the Internet. A criminal check can cost as little as $20 to search criminal records in one state, but they can run as high as $300 for a thorough review that includes nationwide criminal, civil and bankruptcy searches.

Dan Bowersock, a broker at Ferguson Dechert Real Estate in Avalon, N.J., warned that good credit and glowing references could sometimes be misleading. “You can’t know how people are going to live,” he said. “Maybe they have friends who say great things about them, but what about the sister from Texas with three kids who are going to draw on the walls? There are so many ‘what ifs’ that could drive you crazy and which would not be satisfied with a background or credit check.”

He rents out his own vacation house in Avalon, but he doesn’t bother with the usual background checks. Instead, he finds out where prospective tenants have rented before and calls their previous landlords. “That’s the most important thing, if those respective owners give them a clean bill of health,” he said.

Even when a broker has carefully screened potential tenants, Mary Tetzloff, an agent at Montclair Realty in New Jersey , said, homeowners should make a point of meeting the new tenants.

“That way, the owners know who’s going to be in the house,” she said. “It’s also good for the tenant to put a face to the owner because then they make the connection that they are in a real person’s house and they won’t ill-respect their possessions.”

Furnished or Unfurnished

One of the first decisions you have to make is whether to rent your house furnished or unfurnished. Your own reasons for moving out may dictate which route you take. A work reassignment, say for a three-year stint, would suggest an unfurnished rental because you’re probably going to want to take your own things with you. But you’re more likely to rent out a vacation house fully furnished.

Furnished houses tend to appeal to people looking for a home for a few months. Mrs. Petersen said that because she and her husband rent their house furnished, “we tend to have people who are in a transitional part of their lives, too, people who are here on business for a few months, or people whose marriages are falling apart, and they’re trying to pull themselves together, or people who are renovating their homes and need someplace to stay while it’s being done.”

Unfurnished houses are more likely to attract people who want leases that are at least a year long, usually because of corporate relocations. When Maria Hayes and her family moved from Scarsdale to London for a few years because of her husband’s job, they packed up their belongings and rented out an empty house to a German family who had been temporarily relocated to New York.

Adriana O’Toole, the owner of Montclair Realty, said that even in a furnished rental, you should consider putting some of your things into storage, which could be as simple as locking them in a closet. Personal items like photographs and clothing should be put away, and expensive furniture or anything of sentimental value should also be considered for storage, she said.

“If you have valuable antiques, you can maybe charge higher rent, but then you risk damage to those items,” she said.

The Lease

Standard blank leases can be had for just a few dollars at any office-supply store, but for peace of mind, you should add riders that spell out specific maintenance requirements or that list important pieces of furniture that have to be safeguarded. Adding a rider is as simple as typing or writing in a new item on a standard lease. You can hire a lawyer to review the lease, but even without a lawyer, it becomes a binding legal document once it is signed by both parties.

Jay M. Heidt, an associate broker at Citi Habitats in Manhattan , said owners should consider collecting two months’ rent as a security deposit, which has to go into a separate interest-bearing account. Specify in the lease that the deposit will be returned by mail only after the renters have moved out and the owner has thoroughly inspected the space.

“You should also include a rider that says what you consider to be beyond usual wear and tear, things like cracks in the floor,” he said. “You just never know, and it’s good to be safe.”

Mr. Bowersock, the Avalon, N.J., broker, said he routinely adds a clause telling tenants that they will be responsible for having his house professionally cleaned, and he includes the name of a recommended cleaning service. “This gets you away from: ‘How do you define clean, and how do I define clean?’ ” he said. “Plus, they know going in that there will be this additional cost at the end of the lease.”

Other things that can be spelled out in the lease include what the deadlines are for paying rent, how much notice you must give before visiting the house, how much notice you must give if for some reason you need to move back and who is going to pay various maintenance costs.

Paying the Utilities

For a short-term rental, you will probably keep the utilities in your name, pay the bills and then charge the tenant, either as part of the rent or in a separate bill. But for longer-term rentals, it makes sense to have tenants take over telephone, cable, electricity, gas or oil, and garbage collection accounts, particularly because it means that much less for you to manage from afar.

Colleen Porteus, who helps her 84-year-old mother, Margaret Fay-Fleminks, rent out her summer bungalow in Putnam Valley , N.Y., once made the mistake of leaving the electrical service in her mother’s name. “That was the time we rented it out to two young campaign workers who were in their 20’s, and they were nice young men, but they didn’t clean up after themselves, and they left a $600 electric bill, which I was responsible for,” she said. “I did that rental by trust, and I don’t do that anymore.”

Maintaining the Property

Homeowners typically continue to pay the usual service contracts that come with home maintenance, including those for the lawn, furnace and air-conditioner.

“You could try to push these costs off to the renter, but it’s probably easier just to take care of it because otherwise they might not know who to go to,” said Anita Newman, the manager of Coldwell Banker Doernberg in Scarsdale. Hire someone to take care of the yard, she added, “because if you leave it up to renters, they won’t do it.”

Getting the House Ready

For the most part, if you’re renting out a furnished house that you’ve been living in, it probably doesn’t need much work.

Before renting, you should either check with a broker who is familiar with local laws or put in a call to local officials to find out about rental code requirements. Ms. Tetzloff, the Montclair Realty agent, said she routinely hands out a list of “must do’s,” including compliance with local laws requiring smoke and carbon-monoxide detectors and a fire extinguisher near the kitchen.

If you’re renting your house unfurnished, though, it might need some additional work because once your furniture is moved out, the walls will probably need to be painted, and the floors may need to be refinished to make the space presentable.

Preparing for Emergencies

If you’re going to be far away and difficult to reach, you will have to leave emergency contact numbers for your tenants.

In many cases, the broker who has helped rent out the property can play that role for a fee or by the hour, as needed. Ms. Tetzloff said she helped manage a property for a couple who moved to Texas from Scarsdale and wound up charging them only about $100 for an entire year because the house was in very good shape.

She said the tenants called on her only twice, once because “they had an odor in the house they couldn’t place a finger on” — it turned out to be an odd chemical reaction between sunlight and the material in some blinds — and once because someone had driven onto the lawn, and they needed to track down the gardener.

An alternative would be to leave a list of service people whom your tenants should use in an emergency and to set up ground rules on who pays for different services. A tenant, for example, might be expected to pay any service cost under $100, since that could be assumed to fall under usual wear and tear. The list should include a trusted electrician, plumber and roofer.

The costliest, but in many ways easiest, way to make sure your house is well maintained is to hire a property manager. Management companies are easy to find in vacation and second-home areas but much harder to come by in New York City and in the suburbs, where most management companies handle co-ops and condominiums, but not single-family houses.

The Petersens, of Westport, have turned to Janine Scotti, a friend who used to own a house-cleaning business and who now works part-time as a property manager. The Petersens are paying Ms. Scotti a $100 monthly fee to be on call once their house is rented out and to check on the property regularly while it is still vacant.

Ms. Scotti said she charges $10 to $20 a visit depending on how frequently a client wants her to check on a property.

“People who are away for months and who don’t think they need someone to check on their house are crazy, because you just never know,” she said. Once while visiting a client’s vacant house, she noticed that the furnace wasn’t working properly and discovered a leak in the underground oil tank. “That could have been a big leaching problem, so I got that tank out right away,” she said.

Bob Harding, the president of RLH Management in Port Washington, on Long Island , which manages single-family homes and condominium developments, said a management company comes in especially handy when problems arise with a tenant.

“We’re responsible when the rent is late, and we’ll loan up to a month’s rent to the account to make sure the mortgage gets paid,” he said. “It’s also the manager’s job to evict a tenant that needs to be evicted, and that can take a long time and a lot of work.”

Managing Your Finances

Finally, after you’ve rented out your house, don’t forget you have to report the rental income to the Internal Revenue Service . “You’re essentially running a business,” said Brian F. Zucker, an accountant in Morganville, N.J. “The objective is to have your revenue exceed your expenses as well as hope that the market value will continue to appreciate.”

To minimize taxes on rental income, he said, you can take the usual deductions for mortgage interest and property taxes, and you can also deduct all your expenses for the property while you have it rented.

Those expenses can include insurance, repairs, maintenance, landscaping and property management fees. You can also deduct for depreciation on the house, but check with an accountant or the I.R.S. to get the formula for calculating the allowed amount. If you capture the depreciation on the house while you rent it, though, your cost basis will be reduced commensurately when you finally sell it. Also bear in mind that when you sell, your exemption from capital-gains taxes will not be available if you have not lived in the house for at least two of the last five years.