14 Nov I might buy a rental property. How do I decide?

Q. I’ve been thinking of buying a two-family vacation home. Someday I would live in one half, but for now, I would rent both halves and maybe stay in one side for a month. How can I figure out how much rent the property needs to make, compared to the sales price, to decide if it’s worth it? Is it just about renting it enough to cover the bills? The homes in the area I’m considering rent often, so the one I buy will probably have a few years of rental history.
— Landlord, maybe

A. That sounds like an exciting proposition.

There’s a lot to consider when it comes to owning an investment property like the rental you are describing.

You’ll essentially be a landlord whether you live there or not.

As you noted, it’s extremely important to understand the “cash flow” that the house may generate in terms of rental income and how it compares to the all-in costs such as a mortgage, insurance, rental agent, a property manager, a cleaning service and maintenance, said Claudia Mott, a certified financial planner with Epona Financial Solutions in Basking Ridge.

Ideally, she said, the rental income from both units would enable you to cover the necessary expenses and perhaps make a bit of extra cash on the side that can be used to pay down any debt on the property or saved for other purposes.

It would be worthwhile to meet with a local realtor to get an understanding of the rental market in the area where your second home might be located. This will help you determine the right rental price and what the demand for a home like yours might be, Mott said.

Another important conversation would be with a mortgage lender to determine if you would qualify for a loan to purchase the home, how much you could borrow and what that monthly cost would be, she said.

“Before moving forward with your decision, a meeting with your tax advisor would be in order as there are a number of limitations you will need to consider regarding the expenses you can claim and how rental income is reported especially if you plan to use one of the units for personal vacations,” she said. “This will also help you understand the profitability of the investment.”

From a tax perspective, the number of days you use the property each year has a bearing on what the IRS will allow you to claim on Schedule E: Supplemental Income and Loss, Mott said.

“The IRS will not consider your vacation home a rental if you use it more than 14 days per year or more than 10% of the days you rent it, whichever is greater,” she said.

“Expenses for the vacation home will need to be prorated based on the time it is occupied for personal use and as a rental.”

You can find the details on the types of expenses that can be used as deductions in IRS Publication 527: Residential Rental Property.

It is important to recognize that you usually cannot claim a loss on your vacation property if the expenses exceed the rental income, she said.

Along with the tax-related issues, there are decisions that will need to be made regarding both managing the rental process and the property, Mott said.

“A local real estate company can work with potential renters for a fee or you may wish to list the property on a website where you deal directly with those interested in your home,” she said. “If you feel that you won’t have the time to respond to the inquiries about your home, using a rental agent might make more sense.”

You’ll also want to think about whether you want to manage the property yourself or have a local company do it for you, Mott said.

“When the air conditioner breaks in the heat of the summer or the plumbing backs up, tenants will want it repaired immediately,” she said. “Using a local property manager can save you both time and headaches as the primary contact for your renters.”

Mott said individuals and real estate companies that provide these services can also oversee the cleaning companies that need to get the property ready for the next tenant, inspect the property for damage and schedule minor repairs.

Owning an investment property can be a sound financial decision so long as the necessary research is done to make sure the cash flow makes sense, she said.

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This story was originally published on Nov. 14, 2023.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.