Tips on Turning Your Vacation Home to a Rental

With the high cost of fuel combined with the tax benefits of owning investment property, it could be a good time to capitalize on the rental market with your vacation home. Depending on your reasons for investment property, it is important to understand some IRS rules before going forward. The main one is the "Passive Loss" rule.

Many people buy investment property for two reasons - income revenue and tax breaks. Typically vacation properties are not near your home and could require someone to manage your property. If this is the case, then you might consider these tips.

Decide Whether You Will Be an Active or Passive Investor

Now, those of you who need to hire a rental management company to manage your rental home might want to think about the definition of what IRS considers active and passive activity participation as an investor. As stated above, one reason people have rental property is to be able to write off expenses along with depreciation.

When hiring a rental management company, in their contract with you, you should request that you make the major decisions on the home from choosing the tenant to deciding major repairs. The reason is because of what constitutes active and passive involvement with your rental home. If the taxpayer makes the major management decisions, he generally can deduct up to $25,000 in losses against non-passive income, subject to the $150,000 adjusted gross income limitation. This is only if you can prove you are an active investor in your rental home. If you do not make the major decisions you might be considered a passive investor. Your loss is limited to your income that you receive on your rental property. Please consult with your tax accountant or attorney for verification.

Now a rental management company's written contract might say they make the major decisions. If taking losses on your investment is important to you, remember everything is negotiable. If your rental management company won't re-word the contract so that you make the major decisions, then find one that will. I'm sure there is a hungry rental management company out there that will.

Placing your Property for Rental Use

If you decide to change your vacation home to rental use at any time in the tax year, besides the beginning of the year, you must divide the yearly expenses like taxes and insurance between rental and personal use. For depreciating your rental home, you will have to look at the IRS conversion chart for when it was placed in service. The time you used the property for your personal use can not be depreciated. So, it is best to consult your tax accountant or attorney for more information on placing the vacation home in service for the first year especially.

Maintain Good Records

You can deduct the cost of travel expenses to set up the rental property and every time you must go to the property to check on it. However, make sure you save your receipts and maintain good records for IRS purposes. Clarity and proof is the name of the game.

Umbrella Insurance

Many people think that Umbrella Insurance is for the rich. Wrong! Umbrella insurance is for anyone who has contact with the public; whether it is business activities or rentals. Umbrella insurance takes over where your homeowner insurance stops. You can get them in different increments starting with 1 million dollars and up. You typically need a certain criteria from your insurance company to get the Umbrella insurance. For example: My insurance is USAA. They require at least $300,000 liability insurance on my regular homeowner and auto policy. So, for a one million dollar umbrella policy, it would cost me less than $400 extra a year on top of my homeowner's policy to have my car, homeowner liability including my rental property covered under an umbrella policy.

Here is an example. If I was sued for let's say $700,000. The $300,000 homeowner's insurance would kick in first. Then the Umbrella insurance policy would pick up the difference of $400,000. So you see, this is not just for the rich. In today's litigious society, a family who suffers some fatal injury on your property could wipe you out financially without an Umbrella policy.

An Umbrella policy also offers psychological comfort. For me, it's worth the extra $400 a year.

How to Select a Good Rental Management Firm

It's important to interview a few rental management firms along with getting recommendations from satisfied people. Nevertheless, one thing I like to zoom in on, is to see how they respond to my "what ifs." Here are a couple of examples of my "what ifs" that I asked my rental management firm:

What if something breaks down? Do you call someone out to fix it or try and look into the problem first? A good answer is that the rental manager tries to see if it warrants a repair call by going out there and checking on the problem.

What if I want to know how the tenants are taking care of the property inside? Ask the rental manager, how he inspects the property and how often. My Realtor uses a good plumber for his eyes and ears. He tells the tenants after they are in there for 6 months that we need to do plumbing maintenance. He says that most tenants won't tell you if there has been a leaking drip in the plumbing if it doesn't affect them monetarily - like a leaky faucet. Yet, it could cause serious damage to your home. So, the plumber will go out and check the plumbing as a preventative maintenance every 6 months and he can also see if the people might be damaging other parts of the house or is doing something against what was signed in the contract.

Utilities

Check with your utility company if they have a landlord account. This means when the tenant moves out and cancels their utilities; the utilities aren't completely shut off, but would revert back to your name. This way there is no break in service so that you can still have people come in and clean the house or Realtors show the house. It's a good idea to also put the rental management company on the account so they can make changes for you when you are out of town.

The Rent

Getting the highest rent isn't always the best thing to do. Sometimes, it's best to be on the lower end in order to get more responses. Then you can have a larger selection of potential renters so you can choose the best out of the bunch.

Before converting that vacation home into a rental investment, it's best to be prepared. Following the above suggestions will give you a good start.