Converting Primary Residence into My First Rental Property!

14 Replies

First posting!

I am about to convert my primary residence into a rental property (I had lived there for three years, so no issues there). I have been reading articles all day, and I am having trouble figuring out the best way to proceed. Here's what I think I have learned to be true: 

*I must call my homeowners insurance and convert my policy to a landlord policy. Not doing so would be very stupid and dangerous. However, landlord insurance tends to be a bit higher, potentially cutting into the cash flow.

*Since I have occupied the house for more than 2 years, the conventional mortgage loan that is in place is fine as is.

*There may be some significant tax benefits for me. I should find a CPA with expertise in rental properties.

Are all of these things correct?

If so, the real question I have is how should I proceed?

My mind is swirling with the possibilities. Perhaps I should refinance the home (my current interest rate is at 3.9%)...perhaps this would mitigate cash flow losses due to higher "landlord" insurance. I plan to hold on to this property for at least 5-10 years.

What would the order of events be and does that matter? Change insurance first, then look at possible re-fi, etc.? Is it too early to consider creating an LLC?

One thing that I think a lot of folks might relate to is this question: Is this something I should handle myself, or should I consult with an expert? In other words, should I just call my insurance and change it to a landlord policy? Should I shop rates? If I wanted help in this situation, who would I hire or consult to optimize the process? 

Big thanks in advance for any thoughts you have to share.

@James Mason

1. Yes, you should change to a landlord policy. BTW, I had rentals, as well as at one point operating businesses under LLC's, C Corp as well as S Corp and found buying insurance through a knowledgeable agent invaluable. I bought a business from an owner with the business in a S Corp who was sued for $3 million. I placed the business in an LLC, and when I bought my liability insurance, the agent told me to pay for an endorsement that covers me personally as owner as well. I asked why and was told litigants sue the LLC and the owner by default and many owners thought they're safe just with an LLC. Checked with attorneys they said the same thing, owners get sued also by default. When I was chatting with the seller of the business, he disclosed that the liability policy doesn't cover him, was told while the insurance company had lawyers covering them, he had to get his own to represent himself. His lawyer tried to get the suit against him personally dismissed but was denied. Problem was, he didn't use an insurance agent, and he wondered out loud if that was a big mistake.

2. Occupying a house for 2 years is more than enough. That was the requirement some 20 years ago, but was advised it's currently one year.

3. Having a CPA for expertise is always a good thing. But the better thing is if errors are made, CPA's I use will handle problems that pop up in audits, so you don't get run over by the IRS.

Hey @Karee Martin

When I bought the property three years ago, I didn't know what the BRRRR method was, and I am still very much a newbie. However, the way that things have played out over the last few years--it definitely resembles a BRRRR. Basically, I bought it wanting to live there and bring it back to its former glory (it was built in 1910). I was only thinking about it in terms of #1. living there and #2. I knew the house was in a location that would appreciate well.

So I did Buy, Rehab, and now it will be Rented. I may take some time before the Refinance part, because I need some more knowledge and advice there. I definitely intend to Repeat because I've got the real estate bug now :-) 


@James Mason

Hello James

I’m a newbie myself. I was going through your post and noticed that your current interest rate is around 3.9%.  I thought it be a good idea to  get refinance your home refinanced as interest rates are low.


Note: This is solely my opinion and not a professional advice
.


@Adithya Y.

If OP refinance now to a 3.9% mortgage, still lives there, found an investment property, then moves out in less than a year, rent out his old home, then he'll be in trouble if he got an OO mortgage.

I ran into this problem in 1993 when I refinanced all my mortgages including the home I lived in as mortgage rates fell from 13% plus in the mid 80's to 7.5% by the mid 90's. It's the bottom of the crash with foreclosures everywhere and I bought one, $100K below market at auction. One property I got was so much newer and roomier than the one I lived in and I thought of moving there. Problem? I just refinanced and the OO mortgage required me to live there for 2 years under the new mortgage. The fact I live there for the last ten years under the old mortgage doesn't count.

Took me a few months to fix up the new place, thought of renting it out and then move in two years. Finally, took a chance, kept everything under the radar, kept my mail going to the old address for a while, and waited things out nervous any day I'll be found out. Don't want to do that again if I can help it.

OP should keep these issues in mind, timing of refinancing, acquisition of new properties to stay out of trouble.

If you bought with 5% down 3 years ago it's likely you don't have enough equity tool refinance at 80% LTV. Have you gotten a rental insurance policy quote? When I switched a primary residence to a rental my insurance rate went down. If it doesn't cash flow at 3.9% interest it isn't good for a rental.

@James Mason

It’s a really good idea to consult an attorney and your CPA. Your attorney may know who to go through for better insurance rates, policies, etc., or have better recommendations like umbrellas. They’ll also have recommendations for rental agreements that follow state and city/county laws.

If you can do a rate refinance, 3.9 isn’t that high but you could probably drop that down a bit to save a few bucks. Information we’re missing to help you more is your market, rent rates, mortgage, maintenance, management, cap X, etc.

@Frank Chin Thank you for that tip! So basically what you are saying is that if I were to refinance now knowing that it will be rented soon, that would essentially be fraudulent because it would need to be refinanced as an investment property?

@Eric James and @Kimberly Carver -- I just got off the phone with Geico, and you were both correct! The landlord policy was about $100 less--that was a relief. I read several seemingly credible articles which stated that landlord insurance would be 20-30% higher. I am glad it wasn't. Thankfully it will be cash flowing at $500 a month with the 3.9% rate.

@Lawrence Potts Thanks for the tips. My next step is to find a good CPA who is knowledgeable about real estate. Also, I need to learn more about running numbers, and I know that boils down to practice :-)

@Gerard Charles Good question--I don't know how the capital gains would be handled if we hold on to it as a rental for 10 years or so. I assumed since we had lived there for 3 years, the tax benefits would carry over to when we sell the property--but maybe not?

Originally posted by @Gerard Charles :

@James Mason

Suppose you sell it after 10 years , do you still have to pay capital gain it ? Above 250k (single) and 500k (married couple)?

The 2 of the last 5 year rule applies. See: Capital gain in selling home 

I have lived in a home 10 years, then moved, rented it out for another 10 years, sold it. I have to pay capital gains tax in it's entirety.

In OP's case, he mentioned he lived there for 3 years. On year six, or 3 years from now, he would have lived in it 2 of the last 5, if he sold it before then, he can still enjoy the exclusions that apply in the 2 of the last 5 rule. After that, full capital gains.

Originally posted by @James Mason :

@Frank Chin Thank you for that tip! So basically what you are saying is that if I were to refinance now knowing that it will be rented soon, that would essentially be fraudulent because it would need to be refinanced as an investment property?

Not to say you committed fraud, but you have inadvertently violated the terms of the mortgage, and with the violation, the mortgage could then be declared void and due in full by the bank. It says so in the mortgage. I have a co-worker once who encountered an inspector at her home to check that she is actually the owner occupant of her home that she obtained a mortgage on.

In my case, when I did the re-financing, I had no idea I would be a successful bidder at an auction shortly after, the auctioned house was only 5 years old, and roomy inside, modern, much better than my home. Then the home I lived in made a good rental because of nearby public transit even though it was over 50 years old. My overall cash flow would be greater. I thought of staying in my home for 2 years, rent the newly acquired property, but the attraction of the newly acquired home was too much to overcome. Since the home I lived in was a triplex, I took my chances by having all my mail continued to be sent to my old home if anyone checks. I have to stop by once or twice a week to pick it up, a pain. My co-worker mentioned the inspector checked her mailbox to see who's receiving the mail before she got home. With a triplex though, if I still got my mail there, and there's mail for other tenants, it's more confusing for a nosy inspector.

Bottom line, it worked, 2 years went by, nobody found me out.