By Pat Mertz Esswein, August 2011
Homeowners feeling the pinch from the stumbling economy are tapping a source of cash close to home: their basement, attic or extra bedroom. Of course, financialhardship isn’t the only reason to rent out part of your home. This option may also appeal to you if your house feels too big or too empty (perhaps because the kids have flown the nest) or you want to supercharge your savingsor pay off your mortgage faster.
How many legal hoops you’ll need to jump through depends on whether you create a separate unit in the basement or share your living space with a housemate. If you rent out a separate unit — with a kitchen and full bath — you’ll be subject to municipal rules that govern the conversion of a single-family dwelling into a multifamily one, as well as landlord-tenant laws. But if you share your space, you’re probably off the legal hook (although you should still check out any zoning or homeowners-association restrictions).
What if you ignore the rules and rent your space under the table? A lot of landlords do, but that could have legal and financial repercussions.
Advertise smart. Before you list your unit for rent, check out the amenities and rents for similar units that your competitors are advertising. The most popular spots for ads are Craigslist or www.sabbatical.com; local classifieds, list serves and bulletin boards; and the housing offices of local employers and colleges.
Most landlords include the cost of utilities in the rent or set a flat monthly fee. Often, that’s because a city may prohibit you from installing separate meters, creating a separate address for the apartment or adding a second mailbox.
Fair-housing laws will govern what you can — and can’t — say in your rental ads and the rationale that you use for choosing one applicant over another. You can, for example, prohibit pets altogether or allow them conditionally based on breed or size. As an owner-occupant of a property with four or fewer units, you’re exempt from the requirements of the federal Fair Housing Acts, which prohibit discrimination against tenants based on race, color, religion, national origin, family status, disability or gender. However, states (notably California) and municipalities may step in with their own anti-discrimination laws.
Screen tenants. Perhaps nothing could make life more miserable than a problem tenant living downstairs. You want a tenant who will pay the rent on time, take good care of your property and not create excessive noise or hassles.
Ask all prospects (including co-tenants) to fill out an application so that you can verify their identity, employment, credit, rental history and references. It’s a good idea to ask them to sign a separate release that gives references permission to talk with you.
To help you assess an applicant’s qualifications, hire a tenant-screening service (the cost is usually $30 to $50 per report). The service will draw and analyze data from multiple sources, including at least one of the three major credit-reporting agencies (Equifax, Experian and TransUnion) and public sources of eviction records and criminal history. Among services to consider: CoreLogic Safe-Rent Services, TransUnion SmartMove, MyScreeningReport.com, and E-Renter.com. You’ll need permission from your applicants; you can charge an application fee to cover the cost. If, based on a report, you decide not to rent to someone, you must notify him or her.
One downside to using screening agencies is that public data, especially criminal history, may be neither up-to-date nor accurate. To verify that an applicant hasn’t been evicted recently, you can ask for a current rental receipt. Portman says that nothing beats old-fashioned checking of references. One tip, though: A current landlord who wants to get rid of an undesirable tenant may offer a glowing recommendation. To get the real scoop, contact the applicant’s previous landlord.
Go with a monthly lease. If you lock a renter into a year-long contract and then discover that you can’t stand your tenant, you’re stuck — unless your tenant commits an evictable offense, such as not paying the rent. With a month-to-month lease your agreement will “self-renew” every month unless either you or your tenant calls it quits, with proper notice, for any reason that isn’t discriminatory or retaliatory.
The lease form provided with Every Landlord’s Legal Guide is a master document you can amend according to your state’s law regarding such items as security deposits and your access to the apartment.
You should charge a security deposit (usually limited by state law to one or two months’ rent) to cover a departing tenant’s unpaid rent or the cost to repair damage and clean beyond normal wear and tear. You may want to charge a pet-damage deposit, too. State law may require you to put the security deposit into an escrow account and pay interest on it.
Call your insurance agent. With a tenant comes increased risk. Loretta Waters, of the Insurance Information Institute, which represents the insurance industry, suggests that you take these precautions: First, require tenants to show you proof of a current renters insurance policy. That will decrease the likelihood that they will sue you for the loss of their possessions after theft, flood or fire, if they could show negligence on your part. Second, notify your homeowners insurance company so that it is aware of this change in your risk profile. Eric Vaith, of USAA, says that given the access your tenant may have to your home and because theft of certain valuable items — such as jewelry, fine art, guns and the like — will be subject to the limits of your homeowners coverage (typically a total of $2,000 to $3,000), you should purchase a rider to cover them.
Finally, consider buying a personal umbrella policy to provide liability protection beyond the limits of your homeowners policy. Don’t assume that your current liability coverage will sufficiently protect your assets. Injured renters will try to find money wherever they can, and if they sue, they may go after your future earnings, says Vaith. You can get a $1 million policy for about $150 to $200 annually; each million thereafter will run you another $60 to $100 annually.
Report the income to the IRS. You generally must add rental income to your gross income for tax purposes. But you can offset it with deductible expenses related to the rental unit, such as the cost of painting the unit or buying an umbrella liability policy. You can depreciate the rental unit and the furniture and equipment you install in it, as well as deduct a prorated portion of your mortgage interest, qualified mortgage insurance premiums and real estate taxes on Schedule E of your Form 1040. For more information, see “Renting Part of Property” in IRS Publication 527, Residential Rental Property.