I currently own my home and share it with three roommates who pay me rent. They are all long time friends and like family to me. One roommate has lived with me for 6 years, the other for 4 years, and the third is my brother who has lived with me for about 9 months. It is pretty informal and we treat it as all of us sharing living expenses (split the mortgage cost and utilities with some adjustments for living space and my costs in acquiring the mortgage). We previously shared an apartment, then I bought a house a year ago and we all moved into it. They are all very responsible and never cause any problems or have issues paying rent. My mortgage costs $1100 and they pay me a total of $1150 (I take care of all the utilities).
I am saving money aggressively to afford a down payment on a rental property, probably in the 80k-100k range.
My question is this: Now that I am trying to get into the real estate investing game, will having a formal lease agreement for this make it easier to get financed for my first investment property.
Also, will it be advantageous as far as taxes go?
I would have a lease regardless of these goals. You've got no way to protect yourself.
If you've got a signed lease a good lender can count 75% of that in favor of your DTI for the next loan if needed.
As far as taxes... Depends. Are you even reporting this revenue or are they just venmo-ing you and it doesn't show up on your tax return? I assume you're not reporting it because if you were you would want the lease in order to get all of the tax breaks that real estate provides.
Read a book called loopholes of real estate.
I would make them all sign a new lease with no deposit and have it be month to month just so they're not annoyed. Tell them it's going to help you get into your next property if they get weirded out.
You don't need a lease until things go sideways, and then you will kick yourself for not having one. Since everything has been going good so far, I would get a very simple month to month lease. If problems arise, you can amend with only 30 days notice.
For taxes, you should be reporting this income already and taking necessary deductions. I do not believe a lease is necessary for that, but if you do not have a CPA you should get one. Build up that relationship now so you have him later on. A CPA's true value is not in doing your taxes in April, it is in tax planning to reduce your liability during the year.
Thanks for the responses! You are correct, I haven't reported it as income and they just Venmo me. We have always seen it as friends sharing our housing costs and I didn't think about it in terms of income until recently. I was still seeing it in the mindset of when we shared an apartment and split rent.
I have been trying to figure out if reporting it as income is necessary and worth the extra hassle. I also was concerned that since their share of utilities/internet etc is included in the payments they send me, that I would pay income taxes on what is going toward those expenses.
Cost of mortgage plus utilities: $1500
Roommate 1 rent: $450
Roommate 2 rent: $400
My share: $650 (because I take the master suite)
My brother is living with me while he tries to get on his feet in a new city, I don't exactly charge him rent but he gives me $300/month voluntarily out of appreciation, and the plan is for him live here permanently and formally pay rent (a higher amount) once he sells his out-of-state property. But I could include his contribution in a lease if it would help my DTI.
And I don't think they would be weird about signing a lease if I asked. We have built a lot of trust over the years and they know I wouldn't be unfair, just as I know I have nothing to worry about with them as roommates/renters.
@Ross Slane not having a written only means you have an assumed landlord-tenant relationship. Not ideal, but the point is you and your tenants still have legal rights. Generally for lack of a written agreement, industry standard rules apply. For example, if they are paying monthly, then 30 days notice to terminate is required by you or your tenant. If they stop paying rent, you need to serve them notice to pay or quit and evict them if they refuse to pay. The point is even though you don't have a lease, you still legally have a tenant. Even your brother who is voluntarily paying you $300 is legally considered a tenant. All the money you collect is legally considered income regardless of if you have a formal lease and regardless of payment method. Venmo may be easier to conceal income from the IRS, but even they have reporting requirements.
The first reason you want to claim the income on your taxes is because federal law requires you to do so.
More importantly, claiming the income allows you to claim expenses, interest and depreciation. Most likely you will have a tax loss, which you may reduce your taxes depending on your W2 income.
You have three room mates so you can claim roughly 3/4 of your home, 3/4 of your utilities, 3/4 of your mortgage interest as expenses. You can also claim similar portion of your home value as depreciation. Then you claim all rent as income. You may also be able to claim portion of repairs or other supplies used in your business. The net result is probably a loss, mostly due to depreciation and mortgage interest. The only thing to be aware of is that deprecation is reclaimed when you sell the home, unless you exchange it into another rental property.
I would consult a CPA to set this up. Ultimately if you plan to invest in other rental properties, it is good for you to start doing things the right way. For that reason, I would even have your friends sign leases, but just month to month. Let them know you are trying to get more professional and turn this into a business. And don't feel bad because renting a room for $400 is dirt cheap so they are getting the friend discount big time.
@Joe Splitrock Thanks for the advice. I didn't realize until recently that I might need to be reporting this as income, but I am now reaching out to CPAs to help me figure this out. I agree that I need to be doing this the right way.
@Lucas Carl I just purchased that book based on your recommendation and look forward to reading it.
I also rent out 3 bedrooms in my house, but I have leases with all 3 roommates. My roommates were not people I knew previously, but it will help you if anything were to go wrong in the future. Basically, it won't hurt, and it'll only help you to have leases. If your friends/brother ask why all of a sudden, I would just say what you mentioned about wanting to qualify your rental income towards another mortgage.
In regards to the rental income from roommates, I haven't gotten a definite answer on this. I believe you need to have 2 years of proven rental/landlord history, documented on your tax returns. Traceable income may suffice without a lease, but you do have the issue of not reporting the income on your taxes. This is also highly lender dependent. Some may count roommate rent, some may not. So you'll have to call around and see who will. I am also looking at this for buying a rental property, but haven't actively reached out to lenders since I don't have the down payment that I want yet.
@Ross Slane , I've been where you are. Brother and best friend for a few years.
Yes it's important to have a lease but I never treated my friends lease like I did my actual tenants. When your friends are your tenants it's more important to establish roles between Landlord Ross and Tenant Ross. I always made sure to have the conversation about what I cover as landlord vs. us as the tenants: repairs and maintenance.
It could definitely help you on financing for your first rental. It was already pointed out that it can get applied to help reduce your DTI.
@Kenny Dahill Can you recommend a good CPA in Phoenix? I'm in Queen Creek. Thanks!
@Ross Slane yes and yes
@Mathew Daugherty As a Property Manager in the Phoenix Metro area I have a great CPA that understands real estate very well.
Let's connect and I will get you that contact information.
Yes, a lease is a good thing to put into writing. You could use leases to support income for a future purchase. Keep good records of expenses and income.
Another good thing to look at is IRS publication 535 on business expenses to understand better what costs you can deduct. For example utilities are an expense to you and are partially deductible so it doesn't matter that part of their payment goes to utilities, you expenses will account for that. There is also another IRS publication on depreciation, not as critical but could be helpful. It is good to have a basic understanding even when you use a CPA. You can just start now with your records if you haven't kept them to date.