Retreating to a warmer climate for the winter may sound like an ideal way to spend a few months. To help make this dream a reality, some individuals choose to rent out their second homes when they are not in use. Before listing your property for rent, however, consider the financial, legal, tax, insurance, and practical responsibilities involved.
Benefits of Renting Out Your Property
Rental income can help offset mortgage payments, property taxes, insurance premiums, maintenance costs, and other expenses associated with owning a second home. Having responsible renters in the home may also reduce the amount of time the property sits vacant and provide some deterrence against theft or vandalism. However, you will still need appropriate arrangements for security, maintenance, property management, and any necessary seasonal preparation.
Check Local Zoning Ordinances and Property Restrictions
Before renting out your second home, confirm that rental activity is permitted under applicable zoning ordinances, licensing requirements, and short-term rental regulations. You should also review your deed, declaration, restrictive covenants, and any homeowner’s or condominium association rules.
Contact the appropriate local government office and property association to determine whether rentals are prohibited, restricted, or subject to approval, registration, occupancy limits, minimum rental periods, or other requirements. Violations may result in fines, enforcement proceedings, suspension of rental privileges, or other legal consequences.
Make Sure That You Have Appropriate Insurance Coverage
It is also important that you contact your insurance provider to determine whether your homeowner’s insurance policy covers rental activity. A standard policy may exclude or limit coverage when the property is rented, particularly for short-term rentals. You may need to add an endorsement or purchase a landlord policy, vacation-rental policy, or other specialized policy.
Although this coverage may increase your costs, it can provide important financial protection if a renter or guest is injured on the property or if the property is damaged during a rental. You may also want to ask your insurance provider whether you have sufficient liability coverage and whether an umbrella policy would be appropriate.
Evaluate Your Liability Exposure
Renting your property may increase the risk of liability if a renter or guest is injured or the rental causes damage to another person’s property. In addition to maintaining appropriate insurance, you may want to discuss whether owning the property through a limited liability company (LLC) is appropriate.
An LLC may help separate liabilities arising from ownership and operation of the rental property from the owner’s personal assets. For example, if a renter successfully brings a claim against the LLC that owns the property, recovery may generally be limited to applicable insurance coverage and assets owned by the LLC. However, LLC protection is not absolute. An owner may remain personally liable for the owner’s own negligence or misconduct, obligations personally guaranteed by the owner, or liabilities arising when the LLC is not properly formed, maintained, or treated as a separate legal entity.
State law also determines the extent to which an LLC protects a membership interest from claims brought by an owner’s personal creditors. In some states, a creditor of the sole owner of a single-member LLC may have remedies beyond those available against an interest in a multimember LLC. This issue is different from protecting personal assets against liabilities arising from the rental property itself.
Before transferring a second home to an LLC, review the mortgage and obtain guidance from the lender. A transfer without the lender’s written consent may violate the loan documents or permit the lender to enforce a due-on-sale clause and require repayment of the outstanding loan balance. Federal law protects certain residential property transfers from due-on-sale enforcement, but a transfer to an LLC is not one of the expressly protected categories. You should also consult your legal, tax, and insurance advisors about the transfer’s possible effects on insurance coverage, property taxes, transfer taxes, homestead benefits, financing, and your estate plan.
Consider the Tax Implications of Renting Out Your Second Home
Federal tax treatment depends partly on how many days you rent the property and how often you use it personally. If you use the property as a home and rent it for 14 days or fewer during the year, you generally do not report the rental income or deduct rental expenses. If you rent it for 15 days or more, you generally must report the rental income.
When a property is used for both rental and personal purposes, certain expenses must be divided between those uses. This allocation is generally based on the number of days the property is actually rented at a fair rental price compared with the total days of rental and personal use. Days when the property is merely available for rent but remains vacant generally do not count as rental-use days.
Your deductions may be limited if your personal use exceeds 14 days or 10 percent of the days the property is rented at a fair rental price, whichever is greater. Other rules, including passive activity loss rules, may also affect which expenses and losses you can deduct.
Work closely with your tax advisor or preparer to properly report your rental income and expenses, determine which deductions are available, and maintain appropriate records of rental days, personal-use days, income, and expenses.
Prepare Your Home for Renters
Before your first renters arrive, remove or securely store valuables, medications, financial records, personal documents, family photographs, and anything else you do not want used, damaged, or taken. Create an inventory of the furnishings and other items that will remain in the home.
Make sure that the property is clean, safe, and ready for occupancy. Test smoke and carbon monoxide detectors, inspect locks and safety equipment, address potential hazards, and confirm that the property satisfies applicable occupancy and rental requirements. Arrange for professional cleaning and an inspection between rental stays to protect the property and provide a welcoming experience for each renter.
Take clear, dated photographs or videos immediately before each rental period and again after the renters leave. This documentation, together with an inventory and written inspection records, may help establish the property’s condition if a dispute arises over damage or missing items.
We Are Here to Help
While owning a second home can be expensive, it can offer a lifetime of memories for you and your loved ones. We are here to help ensure that your second home is properly addressed in your estate plan and protected for years to come. Call us today to discuss ways to maximize and protect your second home.