When Rev. Judy Chatfield was offered a position as a pastor at a church in LaSalle, Ill., the opportunity was tempting enough to persuade her to move from her Hinsdale home. But although Judy and her husband, Don, also a minister, made the move, they decided not to pull up stakes entirely and sell their home.
“It was our first home together. We lived in it about seven years, and it’s very dear to us,” explains Judy.
Like the Chatfields, many homeowners decide to call the moving van without signing a sales contract. Sometimes it’s an emotional attachment that prompts them to retain the property. Some homeowners know a move is only temporary, and that they’ll be moving back within a year or two. And, some owners are forced to maintain ownership if they’ve been unsuccessful selling the property, and they have already purchased another home.
No matter what the reason for their move, owners in these situations often decide to rent their home out during their absence. The landlord role, however, is fraught with paperwork, tax consequences and possibly nasty tangles with tenants.
In fact, homeowners who are forced into renting because they can’t sell may want to consider other options. “A home usually doesn’t sell because of a problem with its location, condition, or price,” notes Mary Ann Sullivan, an agent with John Greene Realty in Naperville. “If you really want to sell, you have to assess honestly why the home hasn’t moved. In many cases, you’re better off taking a lower price and selling rather than trying to rent to cover the extra expenses of two mortgages and a bridge loan.
“And if you do rent, you have to give consideration to how the home will show during the rental period, and the condition it will be left in. I usually advocate renting only if there is a market condition that is inhibiting your sale–for instance if your home is an early resale in a brand new subdivision.”
However, if you do become a landlord for whatever reason, do so with your eyes open to all of the responsibilities involved with collecting a monthly rent check.
Depending on their motivation for renting, homeowners will have to heed various IRS rules.
For instance, if you’re renting because of an unsuccessful sales attempt, you’ll still be under the gun to sell your home within two years. That’s the time frame that the IRS allows you to reinvest profits from a sale of your principal residence into a new home of equal or greater value, notes Mark Luscombe, a lawyer and CPA at CCH Inc., a tax information publisher based in Riverwoods.
This means that if you’ve purchased a home, but haven’t yet sold your previous residence, you won’t be taxed on any profits from the sale of that home, as long as you sell within two years of the purchase, and count the profits as going towards the purchase of the new home.
In order to ensure that the IRS doesn’t try to claim a portion of the profits from the sale, owners should not only heed the two-year time frame, warns Luscombe, but should also exhibit a good faith effort to sell during the rental period. Otherwise, the IRS might rule that your real intent was to establish a rental business and then you wouldn’t be able to re-invest profits.
“The way the law has developed,” explains Luscombe, “is that if the rental is necessitated by your inability to sell or because it wouldn’t be wise to sell because of poor market conditions, then you can still treat the home as a residence for rollover (of profits).”
If homeowners include a provision in their lease that permits them to continue to list the home for sale, and show it to prospective buyers, says Luscombe, that helps bolster their position with the IRS that they are serious about selling.
Owners forced into renting because their company transfers them, adds Luscombe, would still be able to roll over profits on the eventual sale of their home if they return within a year or two, because the home would still remain their principal residence during a short absence. It helps to leave behind some possessions–some furniture, for example–to show your sincere intent to return, Luscombe suggests.
What’s the rent?
How much should you ask in rent? “Just enough to cover my mortgage,” many harried homeowners footing the bills on two homes will be tempted to respond.
You’ll have to remember, however, that a renter doesn’t give a hoot about your expenses. He’ll be comparing your price to what similar houses in the area are renting for.
The best way to set the rent is to consider both your expenses and what the market will bear. “We want to find out what it’s going to take to make it (the rental) work for the owner,” explains Carolyn Ridge, listing director with The Apartment People, Chicago. “And we also consider information about the market and what the individual home has to offer.”
Real estate agents say a formula has been in place that translates a home’s sales value into a monthly rental charge. Specifically, 1 percent of the value translates into rent. A $300,000 home, for instance, would carry a $3,000 rent.
That formula, however, was firmer when mortgage interest rates were higher several years ago. Now, notes Cheri Turnquist, agent with Rental Homes Inc., Naperville, many homes rent for 1 percent of the mortgage amount, figuring a mortgage to be 80 percent of the total value.
Choosing a tenant
Whatever the rent charged, you’ll want the tenant to pay it–and on time. Selecting a tenant who’s reliable and respectful of the property is key to a successful rental experience.
A tenant shouldn’t have any trouble paying his rent if his gross, or before-tax, income is three to four times the amount of the rent, says Ridge. You can ask a prospective tenant to submit pay stubs to verify his or her income, suggests Robert Boron, a Chicago attorney who specializes in rental issues and who also writes the Rental Q&A column in Your Place.
You can check out whether a prospective tenant is in the habit of paying his bills on time if you ask him to supply you with a copy of his credit report. Although professional landlords usually hire a service to provide them with credit reports, the cost and legalities involved for an individual homeowner to do such snooping make it more practical simply to ask the tenant to obtain his own report, says Gene Sherman of Computerized Information Service Inc., Northbrook. Individuals can obtain a copy of their own report from services such as Equifax (800-685-1111) or Experian (800-682-7654).
You can refuse a tenant, notes Boron, if he refuses to submit a copy of his credit report, or if his credit is marred. You can also refuse if his income falls short of being three times the rent. When a tenant does pass muster, you’ll then want to ask for a month or a month and a half of rent upfront as a security deposit. Wait until the check clears before allowing the tenant to move in.
Needless to say, investigating tenants and negotiating a lease may not be palatable to owners with pushover tendencies. You can hire a realty firm or apartment finder service to do the legwork for you. “An owner need get involved only as much as he chooses to,” says Ridge of The Apartment People. “We will negotiate the lease, add riders to the lease according to the owner’s request, and supply credit and employment checks.”
Although you can hire help for lease negotiations, it’s difficult to find firms willing to collect the rent and provide management services. Rental Homes Inc. of Naperville charges 10 percent of the monthly rental as a management fee, fielding tenant calls about repairs, supervising the lawn maintenance, etc. Many apartment management firms, however, will not take on an individual unit.
In many cases, though, out-of-town homeowners can enlist the help of a trusted friend, or even a real estate agent, notes Nancy Whitehurst of Baird & Warner, Hinsdale. “Realtors might do this as a favor,” in order to build good will and garner future business.
Look at the lease
While screening tenants is important, a good lease cements good landlord-tenant relations. Especially if you are doing the lease negotiations yourself, and have purchased a standard lease form from an office supply store, you’ll want to take the lease to an attorney to ensure that you’re in compliance with any local landlord-tenant ordinances.
Certain provisions must also be clearly underscored in the lease agreement, notes Boron. “Who is going to make repairs on what has to be very clearly defined. If you have a large apartment building, and there is a problem with the heating or plumbing, there’s no question that the landlord must make the repair. But in a home, where there is only one tenant, some landlords may feel the tenant is responsible.”
Whitehurst of Baird & Warner says that she often sees tenants being responsible for appliance repairs, “but not very often are they responsible for problems with basic operating systems.” She illustrates: “Certainly if something gets caught in the drain, it could be the tenant’s fault and his responsibility, but if roots grow around the plumbing line, that is the responsibility of the homeowner.”
Insurance issues involving the safety and condition of the property must also be clearly spelled out, as well as any possible provisions about the home being kept on the sale market, says Boron.
Although renting is a business venture, it can also be satisfying knowing that a home you love is still in your hands. Says Rev. Judy Chatfield: “We may return to our home someday. And in the meantime, we know that the house is being maintained well.”
