Real Estate Investing Basics

Hang On! Do Not List Your House—Rent It Instead (Here’s Why)

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Here are a couple of primary residence hacks to help you break into real estate investing or ramp up your current investing. These strategies take advantage of the financing and tax opportunities unique to your home. You can harness either or both of these to jump-start your portfolio growth. In addition, you can make them part of your ongoing investing plan.

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Primary Residence Financing

It’s no secret that banks and lenders prefer to underwrite loans to homeowners. They consider investment property a higher risk. Their investment mortgages reflect this with larger down payment requirements, tighter loan-to-value restrictions, and higher interest rates. Your intended use of a property significantly impacts the financing terms and conditions. It's in your best interest to secure favorable primary residence financing for as many of your holdings as possible.

How can you use this to your advantage? Instead of selling your current home when you are ready to move, convert it into a rental property. This allows you to maintain the advantageous payment structure and financing for that holding. Then, deliberately choose your next home with an eye for current comfort and future rental potential.

for rent tag and cardboard cutout of house

Most residential mortgages do not require the owner to remain in occupancy for the entire term of the note. Banks typically require owners with this financing to move in within 60 days and personally occupy the property for six months (one year for federal loans). Read your loan documents carefully because once you have satisfied the lender requirements per your loan documents, you may change the use to investment.

While holding multiple primary residence mortgages at once is possible, originating more than one with your existing lender may not be. You may need to seek financing from a new source with each primary residence purchased this way. Anticipate that the underwriter may require justification, so be ready to explain your move to a new primary residence while maintaining the old.

Related: 4 Outside-the-Box Ideas for Financing Real Estate Investments

In addition, the new financing may come with special requirements. When using this strategy, I have been required to have a long-term lease in hand for my existing home before they would finance my new primary residence. But it can be worth the effort as the favorable terms and conditions of properties purchased with owner-occupied financing can enhance your return.

Primary Residence Tax Exemption

Internal Revenue Code Section 121 spells out the primary residence tax exemption that is generally available to U.S. homeowners. To qualify, you must hold (own) and use (live in) your home for two of the five years prior to sale. Then, when you sell your home you can take up to $250,000 in gains tax-free. And it’s $500,000 if you’re married and file a joint tax return.

One option would be to simply sell your primary residence every two years and put any tax-free gain to work in your investment portfolio. However, you can take this tax break a bit further by converting the use of your home for a portion of the time you own it.

Primary Residence to Rental

The most straightforward conversion is from primary residence to rental. Nothing in Section 121 prohibits the conversion of your primary residence into an investment property. You simply need to live in it for two of the five years prior to the sale. That means you can:

  • Live in your home for two years
  • Convert this primary residence into a rental property
  • Generate up to three years of income
  • Sell it without paying tax on the first $250,000/$500,000 of profit, excluding depreciation recapture for the years of rental
  • Use the tax-free gain to purchase more investment property

Related: The Tax Implications You MUST Understand Before House Hacking

Rental to Primary Residence

You can also do the reverse with your residential rental property. But the rules are a little different. When converting a rental into your primary residence, you have to meet the following requirements:

  • Convert a rental property into your primary residence
  • Live in it for at least two out of the five years prior to sale (if the property was the product of a 1031 Exchange, you also must have owned the property for at least five years)
  • Upon sale take a portion of the tax-free gain based on the proration between periods of qualified use (as your primary residence) and non-qualified use (the time it was a rental before you converted it)
    • Example: If you bought a rental and used it as a rental for two years and then moved in for three years, you would be eligible to take 60 percent (three-fifths) of the gain up to the $250,000/$500,000 limits tax free, excluding depreciation recapture for the years of rental
  • Use the tax-free gain to purchase more investment property

That’s a pretty slick way to generate income and secure your profit tax-free. It can also be a great way to relocate or transition into retirement. Buy your rental first, then when you’re ready to move, sell your primary residence, and take advantage of the tax exemption.

Is House Hacking for You?

Man sitting in the office at the table making notes in a notebook

Strategic use of your home to advance your investment portfolio may not be for everyone—but it can be done. Plus, it has the added benefit of upping your rental acquisition game. This is because with this approach you look at every investment as a potential home. You also look at every home as a potential investment.

A deliberate utilization of both the favorable financing and tax benefits of your primary residence can accelerate your portfolio growth. Use of the strategies outlined here can provide capital to fast-track your real estate investing.

Have you considered house hacking an investment property—and what’s your reasoning?

Share with a comment below!

Dave Foster, real estate investor and qualified intermediary, has 20 years of experience working in all phases of real estate investing, from large scale development to single family homes and vaca...
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    Jaysen Medhurst Rental Property Investor from Greenwich, CT
    Replied 7 months ago
    Great article, Dave! This is why you're a BP rockstar.
    Dave Foster Qualified Intermediary for 1031 Exchanges from St. Petersburg, FL
    Replied 7 months ago
    Thanks, Jaysen. Glad you liked it.
    Tareq Salaita Investor from Decatur, GA
    Replied 7 months ago
    Amazing info and insight! This is very valuable. Thank you Dave !!
    Dave Foster Qualified Intermediary for 1031 Exchanges from St. Petersburg, FL
    Replied 7 months ago
    Glad you found it useful, Tareq.
    Barry W Bahr from Tampa, FL
    Replied 7 months ago
    Way to go Dave. Giving back to others so that we can learn! Great information.
    Edward Briley None from Virginia Beach, Virginia
    Replied 7 months ago
    I am someone that will tell you if you can keep real-estate you have purchased, never sell it if you can afford not to. I am going to tell you a story about a 2nd Cousin of mine. It is rather lengthy, but it is a good story you may need to read. Cousin Jack is now long passed away, however, his story needs to be told. When cousin Jack was 20 years old, he got a letter that he was being drafted for WW2. Cousin Jack could not pass the physical at the time, however, they needed people in supporting services, so they enlisted him anyway and sent him to Barber School, to be a Barber. Cousin Jack cut hair his 3 years in the service until the end of the war. While he was serving the country, he met a women that was a waitress and got married just prior to being discharged from the Military. They lived in a boarding house, in which he cut the hair of the other residents of the boarding house etc... When he got out of the military, him and his wife had saved enough money so Cousin Jack could open his own Barbershop. (Believe this or not, the Barbershop still exist today, and is still named Jack's) After a year or so in business the Government came out with the VA loan program, and Cousin Jack was looking for land to have a house built on. He asked his customers if they knew of any Waterfront Property for sale, and one day a customer came in and told him he knew of a piece of land that was on a wide Creek that was available. Cousin Jack and his wife took the bus to go look at it, and bought the 4 acres of land on the spot. They used the VA loan to have their 4 bedroom brick home built in which they lived in about 50 years or so. Before their house could be completed, another of his customers told Cousin Jack about another piece of land for sale, and it was located on the Ocean. Cousin Jack did not have a car at the time, so he called my Father and asked him if he could take him to where the land was located. My Father took him and his wife to view the land, in which my Dad advised Cousin Jack not to buy the land, because it appeared to Swamp land in his opinion, however, the price of the 20 acres was so low, Cousin Jack had to buy it. Well, 2 or 3 years went by, and an oil company offered to buy the land for twice the amount of money that Cousin Jack paid for the land. - Now the story gets good - Cousin Jack went to an Attorney for advice on selling the land? He could not understand why this Oil Company wanted the land so bad. The land was located in what is now a city, at that time it was in the county. It was between 2 cities however, about 15 miles apart, and set about 5 miles from the Airport. Yes the land was Oceanfront, however, only a two lane highway went by it. The attorney could not figure out why the Oil Company wanted this piece of land so bad either. They went to the county and asked about mineral rights for the land, because the attorney and Cousin Jack both figured that there had to be oil under that land? The county did not know what to do, and told them that it would cost a lot of money to get the mineral rights, and just put in the dead that if any valuable minerals were found on the property, that Cousin Jack was to receive 50% of the profit from such minerals. The Attorney came up with a brilliant Idea. He went to the oil company and told them he would lease the land to them for 5 years for what they had offered to buy the land for. The oil company refused the offer, however, they did come back with a counter offer. The oil company wanted a longer lease, but would pay the amount offered for the land for the first 5 years of the lease. The Lawyer called Cousin Jack for them to talk about it. The Lawyer advised him of the following. First that this was a great deal worth consideration. The oil company wanted a 50 year lease, however, the attorney told Cousin Jack this is what we will do. We will counter with a 99 year lease, and the lease terms will be that the oil company pay the full amount of the lease for the first 5 years. After the 5 years the lease will be tied to the cost of a barrel of oil, and the rate of inflation. Because the length of the lease was so long, and that the oil company could sublease the land, that any legal responsibility of the land the oil company would have to pay for. The reason is in case the property was not insured etc... - Story is getting better. Well after about 2 years in the lease, the reason the oil company wanted the land became apparent. The State was putting in a highway that cornered the land, straight to the Airport. The oil company valued the land, because they could store fuel in the location for both cities and the airport from the land. - More time passed. The oil embargo of the early 1970's. Not only did inflation happen, but also the price of oil exploded, which you do not have to figure out made Cousin Jack a very wealthy man. After this happened, the oil company no longer wanted the land, and sub leased the land to a major Motel Chain. During the time the Oil Company leased the land, the city took over that area of the county also. The Motel chain built a giant motel on the property, and until now Cousin Jack was paying the taxes on the Land. Cousin Jack got a tax bill out of this world for the land. Cousin Jack returned to the attorney and told him that all of his profits from the land was now going to have to go to taxes. The Attorney told him, not to worry, they would take the oil company to court and sue them to get the taxes changed over to them. After all Cousin Jack was nothing more than a Simple man that was a Barber, and owned a Barber Shop. Cousin Jack asked the Attorney how much was this going to cost him, and the Attorney reminded him, that the oil company agreed when they leased the land to pay any and all attorney fees that concerned the property. Yes, Cousin Jack won, and the Oil Company had to pay to have themselves sued. So, now to this day, Cousin Jack's Aires still owns the land, and yes they get a giant lease check every year for the lease of the land. I think they are some of the few people that wish the cost of oil would really explode to $1,000 dollars a barrel. Many years have passed now, matter of fact I believe the lease only has about 20 or 30 years or so left on it. I wonder if Cousin Jack's Great Grand Children will sell the land? Oh, and by the way, he did sell the land on the creek where he lived before he passed. However, it is now a major retail type industrial area. He thought the land on the Oceanfront in Va. Beach, Va. was enough to pass to his Aires. Now do you want to know a reason to never sell real-estate you own? Also, now the Attorneys firm is one of the largest in the area, and very well known.
    Michael P. Lindekugel Real Estate Broker from Seattle, WA
    Replied 7 months ago
    great article Dave. IRC Section 121 is an exclusion not an exemption. For the general public not much difference. For a tax practitioner it is technical difference. Again, great article.
    Len Bingham
    Replied 7 months ago
    Moving that often with a family is not practical. In addition, when you have a family you want a home. Your home should never be an investment, it should be a place you love to live and can raise your family in safety and comfort while getting a good education. You must be single, or you have your priorities screwed up. Money can't provide a real home, and you can't provide a real home to your family with the above strategy. But hey, all you young single folks - I am envious. This is a great strategy to implement from your first home forward; start early!
    Amy Dorlig Realtor from Fairfield, CT
    Replied 7 months ago
    This info is exactly what I needed to know. What is your website? I need more info about advanced 1031. Thank you!
    Mary Bober from Foxboro, MA
    Replied 7 months ago
    yet again, MIND BLOWN!!!! love the tax info, thank you :)
    George Cocokios Investor from Goodyear, Arizona
    Replied 7 months ago
    Great read Dave. Love to learn more about rentals and tax code advantages. Wanted to ask you about any advantages/disadvantages of renting your own home back to yourself? Is that a smart thing to do or do you lose many deductions doing it that way? My concern is that my wife runs a business out of our primary home and we would possibly lose the home office exemption from that? Any thoughts would be greatly appreciated. thanks.
    George Lui Investor from Palo Alto, CA
    Replied 6 months ago
    I bought my first SFH rental with the possibility of it being a primary residence once day, but I didn't know the exact rules of "Rental to Primary Residence". Thx for the info!!!!
    Joe Scaparra Investor from Austin, TX
    Replied 6 months ago
    Just a couple of cautious thoughts and questions. 1. If you were a real estate investor would the house your living in be the type of property you would seek out an buy for investment? Most cases NOT! 2. This strategy you propose is usually considered by newbie investors, sounds good, but has proper thoughts about upkeep, landlording, and profit-loss risk analysis been accomplished. 3. What emotional ties to the house night interfere with the management of your property. 4. Your description of tax-free sale actually works against your strategy. Take the tax-free gain when you leave your property, use it to buy your investment property. Yeah on paper it sounds good, live in it for 2 years rent it for 3 and sell....right! Yeah, except when you get ready to sell you have numerous repairs to make that suck up your reserves because you were barely cash flow positive or may have been cash-flow negative during the rental period. You didn't calculate the time for rehab and missed the 5 year window. Oh, and the market although great when you left the property was good but now 3 years later sucks and I can't sell my home. What to do? Most of the time when I hear of people that hate real estate it is because many did exactly what you advise. They saw their beautiful home destroyed, had lacked the proper vetting of using their primary residence as an investment and were new at investing. I go back to 1. If you were seeking out a property for investment, would your primary house you're getting ready to leave be the property you would buy. If the answer is no, then don't do it.