Don’t Convert Your Primary Residence Into a Rental Property

 In #Real Estate Investing, #Real Estate Tips, #Selling Real Estate, #Thoughts

Don’t convert your primary residence into a rental property. Hi, Zach McDonald, your real estate agent with Real Property Associates here. And I wanna share with you a couple different reasons, and one primary reason why it doesn’t make a lot of sense to convert or take your primary residence and make it a rental property.

Now, there are countless videos that you’ll find on YouTube or all over the internet that talk about why you should convert your primary residence into a rental property or how to do it or the benefits of doing so. And so I wanna add the contrary opinion and share my own philosophy about this. And as I say that, I want to preface it with, there are certainly good reasons to convert your primary residence into a rental, or even if it’s just temporarily, but I think many people don’t really count the cost or think through the other side of it before making that decision. So let’s just get the benefits out of the way. Okay, let’s get the positives out of the way because that’s not what this video’s going to be about, but I wanna share some of those just real briefly. So if you do have a primary residence and you want to hold onto it as a rental, maybe it’s going to generate cash flow for you, right?

You might own it free and clear, or maybe you have a super low mortgage and can rent it for a lot more. So there is a cash flow aspect. I think there’s also appreciation, right? You might have a house that’s worth more in the future. And if we look back at history, well, real estate tends to appreciate and value, especially in desirable areas. You’ve also got some tax benefits. There are tax benefits to having a rental property. And again, that’s not what this video is about. So we’re not gonna spend a lot of time on that piece going overseas or relocating. Maybe you’re planning to go out of the country for a little bit, or you’re going to relocate somewhere and you’re not sure if you’re going to stay. Maybe it makes sense to hold on to your property and keep it for the time being as a rental.

Maybe you plan to return. I think if the market’s down and you’re going to lose money and you can kinda stay afloat with the house as a rental for a short time, maybe it makes sense to hold on to it. Maybe you want to move back into it later, or maybe you had to relocate or move and you don’t wanna lose that money, but you also don’t want to live in the house any longer. That might be a time to rent it out. A lot of people did that in 2007 to 2012 when the housing market was really bad and maybe even longer into like 2015 in the Seattle area where we started to see prices climb up out of that pit that they were in. And then I think, you know, the last reason is that you want to build a rental portfolio. Some people want to accumulate a mass of rental properties, and that might be a reason that they would keep their primary residence typically with a lower mortgage rate and turn it into a rental property.

Now that we’ve got those out of the way, and you might find a few more, there might be some other ones you want to drop in the comments or whatever. If you’re into doing this, feel free, I’d love to see those and uh, dialogue with you. But I think the biggest reason that you wouldn’t want to convert your primary residence into a rental property is the capital gains. Now, according to the irs, if you are single, unmarried or filing, uh, on your own, you have a $250,000 exemption on capital gains. So what that means is if your house has gone up in value enough and you’ve, you’ve profited, there are other factors, right? Things you’ve invested in the property, but if your profit on the sale of your house is up to $250,000, that’s tax-free gain to you. Now, again, I’m not an accountant and there’s technicalities and you gotta work through that with your accountant, but in general, that’s the idea.

Up to $250,000 in tax-free money to you as a homeowner, if you are married or filing jointly up to $500,000 of tax-free gain, what can you do that gets you $500,000 of tax-free gain? It’s not the stock market right now. It’s a, it’s an advantage, it’s a tax advantage. You already paid taxes on it. So it’s kind of like a Roth ira. If you look at it like that. You paid the taxes before you invest and then afterwards the money grows tax free in this case only up to a certain point. But if you sell, you don’t have to pay the taxes on it. That’s awesome, right? So I guess philosophically, why would you do that and then sell and have to pay the taxes on it again? So when you have the opportunity to have the tax-free money, why would you keep it and let it become taxable again?

So there is a process, eventually it becomes, it becomes a rental. It does, it’s no longer your primary residence and you can’t sell it as your primary residence. Now there’s, there’s ways to do it for a short time and then still sell it. I guess the, the negatives of that would be now you have to be a landlord, right? Manage the property. The condition of the property also becomes a, a factor. Maybe, maybe get a bad tenant in there. They don’t take great care of it. Now, again, that’s nightmare stories. A lot of people do a decent job, but still, you’re going to have to do things to get it ready to sell again. Um, but there might be reasons, right? Maybe some of those that we already talked about for keeping it for a short time, but still selling and trying to capture those gains.

But I’ll share a story that happened during the Covid pandemic. I had a client who had a primary residence. They bought another house. We were selling their house and we were, it just wasn’t gonna sell for what they wanted to get. The market had been slowed down. It was 2018, 19 when the market was a little bit slower. Their house wasn’t worth quite as much as it had been. So they said, Hey, let’s hold onto it as a rental for a little bit and then we’ll sell it when the market picks back up. Well, the tenants didn’t wanna move out and we were in the middle of a pandemic and you couldn’t kick the tenants out. That was the rules. So they had to allow the tenant to stay in place and by the time they were allowed to ask the tenant to move out and leave with the proper notice and such, well their three years were up.

There’s a window of two out of the last five years, you have to occupy the home in order to qualify. Now again, there are some technicalities, but that’s the general rules. And in this case, it went beyond that three years after they had moved out and they were not able to sell that house as a primary residence anymore, it became a rental property, it was an investment property, and now they became liable for the large amount of capital gains, the, the increase in value of their home. So just conceptually as a homeowner, again, there are reasons why you might keep it as a rental, especially if your goal is to accumulate rental properties. But I would push back on that. Even that, why wouldn’t you take the tax-free money and then reinvest it? When you think about investing, you want to be tax-advantaged.

That’s a massive plus if you can be, and at the same time, you want to continue to invest. So if you take money out tax-free and reinvest that money, whether it’s in other real estate, maybe you have enough equity to buy a couple rental properties, right? Maybe the interest rates are a little higher, but rental properties have different funnels. You have what’s called a 10 31 exchange to help offset taxes. It’s more of a deferral than it is a, um, you know, it’s not an exemption. It’s still money you’ll have to pay taxes on eventually, unless again, you do it certain ways. But why wouldn’t you take the tax-free money and then reinvest it in a different way, whether that’s in the stock market or back in the housing market. Maybe you invested in another business. You have a lot of freedom and flexibility, but the idea is that you’re always reinvesting the money and continuing to grow it.

And it doesn’t have to stay in that property. It could be taken out and put into other properties. So conceptually speaking, if you own a primary residence and you’re able to sell it and not have to pay the gains on it, I think it’s a no-brainer. There are situations where it makes sense to hold onto it. And again, you can watch lots of videos and talk about that and different strategies for building rental portfolios. This video is not for that person and I probably will make a separate video I could about the benefits and how to do that if that’s the strategy you want to take. But I would say for the general person that’s watching this video and the general person out there, the the average homeowner, most people, if you find yourself in that boat, you’re probably going to be better off selling your primary residence, taking the tax-free gain, and then repurposing that money and investing it in other ways. Thanks so much for watching this video. As we talk about why you should not convert your primary residence into a rental property, if you got some value out of this video or hey, heck, if you even got some comments or feedback you wanna drop down below, I’d love to see that and engage with you. And if you want to talk about your situation, whether you’re thinking about buying or selling in the Seattle area, I’d love to be a resource for you.

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