Turning Primary Residence to Rental- Make sense?

Starting Out
13yFollow

Turning Primary Residence to Rental- Make sense?

Chris DeTreville
Real Estate Agent · Columbia, SC · Member since 2012 · 112 posts · 106 votes

Hey everyone. First I'd like to say that I enjoy reading this forum and as a wannabe investor I have found the community useful.
Some background on me before I get into my plan...
I am 29 and I have been in the real estate business for 6 years. I worked as an agent out of college and two years ago switched to a property management company where I draw an hourly wage on top of some leasing and sales commissions. (I'm in a pretty good spot, finally).
I have zero savings but plan on saving 10% of every paycheck from here on out to use as a cushion. I also bought a house in 2009 where my dad cosigned on the loan for me. It is a 2br 1 bath in a good neighborhood where home values are pretty high and steady. I paid 105k and did some rehab using a construction loan then wrapped it all back into one loan. So I have about 130k into the house. My loan balance this past month was 119k. I had been mulling over selling and buying a bigger house to take advantage of the market...or doing a refi and getting my payment down. In talking to a lender recently, we recognized that because I closed in March 2009 I qualified for that FHA "streamline" or whatever it is called that allows me to refi with no appraisal and very little closing costs. By doing this my rate drops from 5% to 3.25 and my mortgage payment goes from $830 to $650. My estimated cash at closing is around $550. I decided to go this route (seems like a no brainer) and spend the next several months to a year saving and building my "cushion".

Because I am getting my payment down substantially, it SEEMS that I could take a decent stab at eventually renting this house and then finding another deal where I can owner occupy (buy-hold) and do the same thing. Maybe even find a duplex to move into as an owner occupant. My worry is this- everywhere I read I read that you make your money when you buy. In 2009 I was green and did not have the investor mentality that I have now. When I bought the house it was not necessarily so that I could rent it later. I don't think I'd have a problem selling it and breaking even, but I think it'd be wise to hold out longer until the market rebounds (plus I have this house already and I am in the process of getting the payment down so much, I just feel like I can work with this instead of starting over). I'm just nervous about taking the risk of renting it when I didn't go into the purchase with that in mind. I've played around with some of the spreadsheets on here and read a lot about the rules of thumb. At my current tax rate of 4% I would cash flow about $250 assuming a $900 rent amt. That is without taking into consideration damages and such, so if I read closely enough on this forum, I need to expect about half of that cash flow to go towards expenses. (is that right?). Now, the biggest worry for me, then "non legal residence" tax increase. In South Carolina, when I am no longer the legal resident my tax rate goes from 4 to 6%...which according to my county tax estimate calculator would catapult my taxes from around $700 (what I'm paying now) to $2,800 a year. !!!...That's $230 a month I have to account for. So there goes my cash flow.

So I guess my questions are...do any of you in South Carolina (or anywhere else for that matter) have any experience turning your primary into a rental? Does the scenario above scare you as a seasoned investor? Is there an alternative to getting absolutely crushed on these taxes that I am missing? Should I save for a while, sell and use the cash out to make a better investment? (I am ready to get started with my investment career and waiting a year or two to do anything will drive me crazy). Advice? Opinions? Anything above not make sense? I am just trying to learn and explore all options. Thank you so much for taking the time to hear me out.

0Reply
39 views

Most Popular Reply

Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
13y
Originally posted by Chris D.:
... Now, the biggest worry for me, then "non legal residence" tax increase. In South Carolina, when I am no longer the legal resident my tax rate goes from 4 to 6%...which according to my county tax estimate calculator would catapult my taxes from around $700 (what I'm paying now) to $2,800 a year. !!!...That's $230 a month I have to account for. So there goes my cash flow.

...

I don't quite get your math here, in how you calculated that increase.

I will write it in math equations to show you how I arrive at my number.

0.04 x value = 700 -> implies value = 700 / 0.04 = 17500

So, from that new value we re-compute:

0.06 x value = 0.06 x 17500 = 1050

So I don't know where your 2800 number came from. Common sense says that 6% is 1.5 times 4%, so the 700 x 1.5 is what your increased tax should result in (1050 is that answer as well).

1Reply
See this reply in the discussion

14 Replies

Jump to latestLatest
  • Jeremiah B.
    Investor · Portland, OR · Member since 2012 · 266 posts · 128 votes
    13y

    Chris D.

    I'm no pro, but I did a very similar thing to you. When we upgraded from our first house, we kept it as a rental. And while I would do it again, it's not a move for everyone and there are some things to consider:

    This is a risky move, and I would strongly recommend a cash reserve if you have a rental. My personal target is 10k cash. To me, the worst case scenario is that my investment somehow bankrupts me.

    When we made the move, we lost around $250/month for several years. In fact now, 3 years later, we are still losing around $100/month. However, even ignoring appreciation, we were still increasing our net worth due to paying principle and tax benefits. Given our long-term time horizon, this is OK for us, but wouldn't be for a lot of people.

    If selling would just break even, then there is literally no value in selling. This is not to say that renting is necessarily the right option.

    I wouldn't get hung up on why you bought the house, or what your plans were. Plans are good, but base your decision the future, not the past!

    Regarding the refi, going from 5+ to 3.25 sounds like an easy call. Even if you do not keep it as a rental, my hunch is that it would only take a year or so to break even - and it sounds like you will not sell in the next year.

    IMO: Saving 10% is too low. If you have a decent job with no liquid assets in our late 20's, I would recommend saving north of 20%.

    Sorry for the long winded response, but those are my novice thoughts.

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    13y
    Originally posted by Chris D.:
    ... Now, the biggest worry for me, then "non legal residence" tax increase. In South Carolina, when I am no longer the legal resident my tax rate goes from 4 to 6%...which according to my county tax estimate calculator would catapult my taxes from around $700 (what I'm paying now) to $2,800 a year. !!!...That's $230 a month I have to account for. So there goes my cash flow.

    ...

    I don't quite get your math here, in how you calculated that increase.

    I will write it in math equations to show you how I arrive at my number.

    0.04 x value = 700 -> implies value = 700 / 0.04 = 17500

    So, from that new value we re-compute:

    0.06 x value = 0.06 x 17500 = 1050

    So I don't know where your 2800 number came from. Common sense says that 6% is 1.5 times 4%, so the 700 x 1.5 is what your increased tax should result in (1050 is that answer as well).

    1Reply
  • Marc Bodinger
    New York City, NY · Member since 2012 · 253 posts · 7 votes
    13y

    If you are looking to move to a larger home in order to take advantage of interest rates and are having trouble selling your current residence then it absolutely makes sense to rent it out. I am sure in your area there are plenty of SFR's filling up with rising rents.

    I also recommend that you build cash for a rainy day like Jeremiah B. mentioned because one day you might need it. There are a lot of people on this forum that specialize in SFR's so I would ask around and you will find see some incredible stories.

    0Reply
  • Chris DeTreville
    OP
    Real Estate Agent · Columbia, SC · Member since 2012 · 112 posts · 106 votes
    13y
    Originally posted by Steve Babiak:
    Originally posted by Chris D.:
    ... Now, the biggest worry for me, then "non legal residence" tax increase. In South Carolina, when I am no longer the legal resident my tax rate goes from 4 to 6%...which according to my county tax estimate calculator would catapult my taxes from around $700 (what I'm paying now) to $2,800 a year. !!!...That's $230 a month I have to account for. So there goes my cash flow.

    ...

    I don't quite get your math here, in how you calculated that increase.

    I will write it in math equations to show you how I arrive at my number.

    0.04 x value = 700 -> implies value = 700 / 0.04 = 17500

    So, from that new value we re-compute:

    0.06 x value = 0.06 x 17500 = 1050

    So I don't know where your 2800 number came from. Common sense says that 6% is 1.5 times 4%, so the 700 x 1.5 is what your increased tax should result in (1050 is that answer as well).

    Sorry I was pretty vague on that part. Here is how my county calculates it:

    Taxable value $105,000.00
    Homestead (if applicable) - $0.00
    ----------------
    Net taxable $105,000.00
    Ratio X 0.04
    ----------------
    Total taxable $4,200.00
    Millage rate X 0.2592
    -----------------
    Estimated tax for: 2012 $1,088.64

    Local Option Sales Tax Calculation
    Net taxable property value $105,000.00
    Local option sales tax factor X 0.003124
    -------------------
    Local option sales tax total $328.02

    Estimated tax total $1,088.64
    Local option sales tax - $328.02
    ------------------
    Estimated tax for tax year: 2012 * $760.62

    I tried to copy and paste and I had to play around with it to be readable.. Hope that isn't a mess. 105k is what I bought the home for but the county has not adjusted yet to the new value of around 130k

    Here is if I am the non legal resident:

    Taxable value $105,000.00
    ______________


    Ratio X 0.06
    _____________

    Total taxable $6,300.00

    Millage rate X 0.5023
    ____________

    Estimated tax for: 2012 $3,164.49

    Local Option Sales Tax Calculation

    Net taxable property value $105,000.00
    Local option sales tax factor X 0.003124
    ____________
    Local option sales tax total $328.02

    Estimated tax total $3,164.49
    Local option sales tax - $328.02
    __________
    Estimated tax for tax year: 2012 * $2,836.47

    0Reply
  • Chris DeTreville
    OP
    Real Estate Agent · Columbia, SC · Member since 2012 · 112 posts · 106 votes
    13y
    Originally posted by Jeremiah B.:
    Chris D.

    I'm no pro, but I did a very similar thing to you. When we upgraded from our first house, we kept it as a rental. And while I would do it again, it's not a move for everyone and there are some things to consider:

    This is a risky move, and I would strongly recommend a cash reserve if you have a rental. My personal target is 10k cash. To me, the worst case scenario is that my investment somehow bankrupts me.

    When we made the move, we lost around $250/month for several years. In fact now, 3 years later, we are still losing around $100/month. However, even ignoring appreciation, we were still increasing our net worth due to paying principle and tax benefits. Given our long-term time horizon, this is OK for us, but wouldn't be for a lot of people.

    If selling would just break even, then there is literally no value in selling. This is not to say that renting is necessarily the right option.

    I wouldn't get hung up on why you bought the house, or what your plans were. Plans are good, but base your decision the future, not the past!

    Regarding the refi, going from 5+ to 3.25 sounds like an easy call. Even if you do not keep it as a rental, my hunch is that it would only take a year or so to break even - and it sounds like you will not sell in the next year.

    IMO: Saving 10% is too low. If you have a decent job with no liquid assets in our late 20's, I would recommend saving north of 20%.

    Sorry for the long winded response, but those are my novice thoughts.

    Thanks for the advice. I failed to mention I have a 401k so when I say I have zero saving thats not entirely accurate, but I cringe looking at that 401k statement. I'd rather have my money in a self directed ira or something like that where I could put it to work myself but I digress.

    I struggle to accept the prospect of losing money on the house as a rental even if in the long term the equity may make up for it. This is my entire dilemma. I am confident of the location of the property. When I bought the house, across the street was a cul de sac full of duplexes (actually, they were my grandfathers duplexes) and they were run down. But I knew that the entire cul de sac was going to be sold and that they were going to tear out the duplexes and build new homes. That is why I jumped all over the property at that time. The subdivision took several years to take off but it finally started popping recently and the homes range from 250k-350k and they are selling and building like crazy as we speak.

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    13y

    Ah, so it's not the 4% vs 6% that is killing you on the taxes - it's the millage rate that nearly doubles on top of the 1.5 times value percentage.

    0Reply
  • Joe G.
    Rental Property Investor · San Angelo, TX · Member since 2013 · 104 posts · 27 votes
    13y

    Chris D., I have been in the military for almost ten years now and in three location where I spent the longest time I purchased a home. After I departed the area, military move, I hired a property manager and rented out the home. None of the homes are in SC nor have I looked into the numbers as much as you have, but I have to say it has paid off for me.

    Like Jeremiah B., I can't say I bank tons of money each month, especially using property managers, but I know I do bank over $900 in principle each month. I also agree with him about cash reserves, nothing beats that...the next best thing is having a credit card with a HIGH limit, but I don't recommend that. Depending on the mortgage payment, I am of the mind that a couple hundred dollar loss each month over a year or two is easier to handle than 1-3 months of a vacant home. Recently a friend of my had the Heat Pumps/AC units at his vacant home stolen...who wants to rent a home without them. Even if insurance does for the replacement, more time lost.

    Sorry, back to your questions...turning a primary home to rental has worked for me for several reasons: Lowest interest rate, care and maintenance of the home is understood before tenants moves in, jumping in and getting your feet wet is easier with a 'known' home.

    Hope this helps. Looking forward to what you decide to do. Please keep me posted, very interested.

    0Reply
  • Chris DeTreville
    OP
    Real Estate Agent · Columbia, SC · Member since 2012 · 112 posts · 106 votes
    13y
    Originally posted by Steve Babiak:
    Ah, so it's not the 4% vs 6% that is killing you on the taxes - it's the millage rate that nearly doubles on top of the 1.5 times value percentage.

    Not to get too far off track..but what do your local taxes look like? Is there such a dramatic difference in owner occupying/ non-owner occupying where you live? I know my county is high..but I'm just curious as to how it compares around the country.

    0Reply
  • Chris DeTreville
    OP
    Real Estate Agent · Columbia, SC · Member since 2012 · 112 posts · 106 votes
    13y

    Joe G. I appreciate your input. I work for a property management company and Fort Jackson plays an important role in our rental and sales markets. We manage a lot of owners who have done the exact same thing you have done. Some have worked out, some haven't. Working at this company has really opened my eyes. We have a lot of units that we manage so we see it all as far as service and maintenance issues. For me, when I bought the home 4 years ago I put in a brand new heating and air unit, new windows, appliances, etc. So I know this house inside and out which gives me some comfort. Also, though I haven't discussed it with my broker, if I were to have my own rental, I'd essentially be managing it myself even though I'd try and hang it under my company as long as she'd let me (for free or at a huge discount, of course).

    As far as cash reserves, based on y'alls suggestions maybe I should bump my 10% savings and try to save more. Also, I have a credit card with a low balance that I could use for extreme emergencies but I don't like the idea of that. Also, I have read some on this forum about using a HELOC as a cash reserve but I am hesitant about that as well. Any input there?

    What intrigues me the most about my position is the chance to hang on to this house, and go out- when I'm ready- to find a great deal (possibly a duplex ) and use the same buy and hold strategy and get the great rate as an owner occupant. If I were to put it on the market and try to sell, there are a lot of unknowns and I wouldn't be as flexible when it comes to finding the next deal. I don't know, it's a lot to consider. Sorry for the rambling.

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    13y
    Originally posted by Chris D.:
    ...
    Not to get too far off track..but what do your local taxes look like? Is there such a dramatic difference in owner occupying/ non-owner occupying where you live? I know my county is high..but I'm just curious as to how it compares around the country.

    There is "homestead exemption" that lowers real estate taxes for owner occupants, but nowhere near that much difference. Definitely not that factor of 3+ that you are seeing.

    0Reply
  • Chris DeTreville
    OP
    Real Estate Agent · Columbia, SC · Member since 2012 · 112 posts · 106 votes
    13y

    Steve Babiak here is what my county says regarding the homestead exemption:

    "The homestead exemption is not to be confused with legal residence. The elderly (age over 65), the blind, the disabled, and a surviving spouse of an eligible Homestead Applicant may be eligible for a $50,000 deduction from the Assessor's market value appraisal of their legal residence. The owner's tax bill will show the assessed value reduction amount if the owner has qualified and applied for the homestead exemption."

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    13y

    The "homestead exemption" I mentioned was for my area :) I don't have exact figures on the difference, but it is way smaller than in your area.

    0Reply
  • Chris DeTreville
    OP
    Real Estate Agent · Columbia, SC · Member since 2012 · 112 posts · 106 votes
    13y

    So, does the 50% rule apply here? Tell me what I'm doing wrong...

    assuming my new mortgage payment + taxes and insurance is $650 and the rental amount when rented is $925...

    Gross rents: $950
    Operating Expenses using 50% rule: $475

    Mortgage payment: $650

    Thats a -$175 cash flow

    If/when my taxes increase it is even worse. So I'm really struggling with this strategy...

    If I were to save more and stay in my house as long as I can stand it, and then put it on the market once I have enough saved up...get it sold use the equity as a down payment on a new property-preferably a duplex that I can live in one side for the time being..isn't that a much better strategy? That way my savings would be cash reserves (or I could use some for closing costs, etc).

    The problem with this is the timing of it all. I can sell my own house, but I can't guarantee when it will sell. (Not to mention I have to show it) Also, when it sells I have to be ready to move. What if I don't find the right deal by the time it sells? I'd have to rent month to month somewhere...And what if the right deal comes along for a duplex and my house is still on the market- I have to hope the owner is willing to accept a contract contingent on the sale of mine.

    It would be a pain, but the more I think about it, getting out of this house seems to be the way to go. Any words of wisdom here? I'll add this, I want to keep the house and rent it. But what I want isn't always the smart way to go.

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    13y

    Taxes and Insurance are expenses under the 50% rule, and so they are taken from that side of the split. The debt service is not part of the 50% rule's expenses, so principal and interest do not come from the expense side of the 50% rule.

    The debt service is taken from the other 50% (non-expense part), so that your "net" cash flow is what remains. For property with no debt service, the cash flow is estimated to be 50% of gross scheduled rents according to the 50% rule, with expenses being the other half.

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free