How to Buy a Second Home and Rent the First

There’s a growing trend with homeowners to buy second properties while keeping their first homes. The goal is to turn the second home into the primary residence while using the first home as an investment property.

This could be a good option if you want to grow your wealth through real estate. Even if you only break even on your expenses now, you can wait for your first home to increase in value and then sell it for a higher profit than you would make if you entered the market now. 

However, there are plenty of risks that come with turning your primary residence into an investment opportunity. Use this guide to learn how to buy a second home and rent the first while making the transition as smooth as possible.

Benefits of Renting Out Your First Home

There are several benefits if you want to learn how to buy a second home and rent the first. This could be a smart financial decision depending on your current mortgage payments on the property and interest rates. Here are a few reasons to go this route: 

• You can let your home’s value appreciate without living in it. This allows you to potentially grow your wealth over the next several years. 
• You can collect rental income from tenants, which covers your home-related expenses and could help you turn a profit.  
• Interest rates are higher for second homes and investment properties, so transitioning your existing house into a rental home could be more affordable.
• You can always move back into that home if you decide to return to the area. 
• When vacant, the property can be used by family members who need it – like a child who graduates college and needs to start saving money. 

Calculate how much you could potentially charge to rent your home and compare that to your monthly costs to maintain it. Once you subtract the mortgage, insurance, taxes, and maintenance expenses from your rental rate, you can see how profitable the house will be to rent in the short run. 

Many homeowners need to focus on the long-term investment of renting out their first house. The rent payments might allow them to break even now, but the home sale will be lucrative in the future.

Understanding the Timeline: Primary Residence Requirements

The first step is to understand what counts as a primary (or principal) residence. The IRS says that you can only have one primary residence, which is where you live most of the time.

Your primary residence is the address you have on your driver’s license, passport, or voter registration card. Even people who move seasonally or travel throughout the year only maintain a single primary residence that they call home. When you move into your second home, your first house will no longer be your main residence. 

You must also have lived in a house for at least two years of the past five years to have called it your principal residence if you want to receive tax benefits when you sell it. This isn’t currently an issue if you plan to hold on to the property for the next several years, but it is something to keep in mind in the long run.

You might have to pay capital gains taxes on the home sale if you no longer live there or move back into your first home for two years before you sell it. 

Outside of legal requirements, some investment professionals recommend living in your principal residence for at least a year before you move out and use it for rental income. This will help you understand the state of the house, including potential repair expenses that could crop up in the future.

Criteria for Securing a Mortgage on a Second Home

Buying a second home comes with some limitations if you need to secure a mortgage for the property. Lenders have restrictions on these houses, no matter the size of your down payment. Here are a few rules you might encounter: 

• You must purchase a single-unit dwelling. 
• You must have exclusive ownership of the property, as opposed to buying a house with a pool of investors. 
• The second home cannot be controlled by a property management company. 
• The second home needs to be a certain distance from your first house. Each lender has its own guidelines. 

Most of these rules are irrelevant if you plan to live in your second home full-time. You don’t have to worry about the lender questioning whether you will turn the second home into a rental property as well.

As you map out your finances, decide whether you want to take on a mortgage on the second house or use the equity of your first home to pay for it. You might be able to secure a home equity loan to get a bigger down payment or cover the cost of the second home entirely.

In this case, you can live in your second home with a small mortgage and use your rental income to cover the costs of the first house. Consider meeting with a financial advisor to review your options.

Preparing for the Transition to a Rental Property

Once you decide to turn your first house into a rental property, start preparing the home. Now is a great time to make any repairs or adjustments to the house – especially if you are moving far away from the property. You don’t want to be called in for unexpected maintenance issues that your tenants expect you to address quickly.

Your home improvements should move beyond basic repairs. You want to make your house desirable to rent and need to convince tenants that your asking price is fair. Now might be a good time to repaint your exterior, update the flooring inside, and install new appliances. 

You can also decide whether you plan to rent the property as a furnished home or unfurnished. Furniture is more common for vacation rental listings but some people will rent furnished houses if they travel a lot for business or if they need a multi-month place for a work contract. You might be able to charge more for furnished housing but will also have to invest in various beds, sofas, and cookware beforehand. 

Next, decide whether you want to work with a property manager to keep up with the house. While you will have to pay property management fees, these experts can handle your tenants and upkeep for you. This could be a good option if you are moving to another state. 

During this time, you also need to call your home insurance provider and let them know that the property is transitioning from a primary dwelling to a rental home.

You might want to seek out multiple quotes if your insurance costs increase significantly. When requesting quotes, look into landlord insurance to see if this added cost could protect you. 

Taxes and Other Rental Income Considerations

Rental income counts as regular income, which means you need to report it to the IRS and pay taxes on it. If you can charge $1,500 per month to rent your house and expect to collect $18,000 in rent over a year, you need to deduct your taxes on that income before you start calculating your total rental profits. 

Fortunately, there are multiple deductions that you can factor into your rental income to reduce your tax bill. Your mortgage interest, utilities, homeowners association (HOA) fees, property taxes, and maintenance costs are all deductible. You can also deduct advertising costs related to filling the home and any legal and professional fees related to renting it.

Even though your property is used as an investment that is expected to appreciate in value, you can also deduct depreciation on the rental property. This depreciation rate is around 3.6% annually. 

Understanding tax obligations and opportunities can help you set a reasonable budget for the year. You can either meet with a financial advisor before renting your house out or wait to see how the finances play out during the first year before making adjustments moving forward.

Establishing a Property Management Plan

If you can afford to hire a property manager, they will walk you through the various rules and guidelines that are standard with their business.

In most cases, you can agree to their terms and let the management firm take over. However, if you decide to take on the management of the rental property yourself, you will need to develop these processes on your own.

Start by looking up property management documents and lease agreement templates online. These will serve as a starting point for developing your plan. Here are a few aspects of rental agreements to look into: 

• Set a rental price for your property and determine how much tenants need to pay as a security deposit before they move in. 
• Make a plan for collecting rent and penalties for tenants who do not pay on time. 
• Explain requirements for background checks and credit score inquiries for potential tenants to make sure they are in good financial standing. 
• Establish a cancelation policy to terminate the lease agreement and a fair window for your tenants to move out. 
• Determine who pays utilities and how your tenant will pay any bills that you expect them to cover. 
• Write policies for maintenance requests and emergency contacts if there is a flood, fire, or other serious issue. 
• Create policies for damage that tenants cause to the rental – like smoke damage or issues caused by pets.
• List the repairs and maintenance tasks you will cover the cost of – like lawn care. 

Many prospective tenants will want to look at the lease agreement before signing it. They want to make sure they are protected and your policies are fair. Writing your guidelines and expectations out can help you enforce them while also ensuring everyone is on the same page. 

Legal Obligations and Rental Regulations

It’s easy to dream about establishing an investment property where you collect income each month and enjoy passive profits. However, managing tenants takes work and you need to learn their rights and yours before you let them move in. 

Learn about tenants’ rights in your state, including fair housing practices, and the types of accommodations that your renters can expect. You need to respond quickly to any issues with the house and will most likely have to cover the repair and maintenance costs.

For example, if the heat breaks in the middle of winter, you can’t ask your tenants to wait until spring to schedule the repairs. Your job is to provide a safe, sanitary environment for people to live in.

You will also need to pay state and local taxes on the rental property just like any other house you own. When in doubt, meet with a tax attorney. They can go over any tax laws that pertain to rental property income and how you should pay them. An attorney can also go over any legal requirements you should know about, like carrying home insurance, landlord’s insurance, and reporting income on your house. 

Make sure that your desired rental property type is allowed in your area. Some neighborhoods and cities have banned short-term rentals like VRBO and Airbnb listings. You might be required to turn your house into a long-term rental. Learn about any permits you need to turn your house into a rental so you don’t accrue fines from the city.

Maintaining a rental property isn’t as easy as moving out of your first home and letting someone move in. Stay on the right side of the law and your tax bill to protect yourself.

Transitioning to Your New Primary Residence

One of the benefits of buying a second home without selling the first is that you can take your time with the move. Decide whether you want a turn-key property that requires minimal repairs and upgrades or if you want to renovate a house to adapt it to your needs. You won’t get stuck in between houses and might decide to remodel your next home before you move in. 

The longer it takes you to move out of your current house, the more rental income you lose. Any period without a tenant costs you money. You are still responsible for your monthly mortgage payment and property taxes even when you don’t have income. This is why buying a second home still requires careful timing. 

Set a budget so you know how long you can afford for your house to be vacant. Know that even once you have residents on your property, there might still be times when you miss out on monthly rental income. Some tenants could make late payments, miss them entirely, or move out early – leaving the house empty.

It takes around two weeks on average to turn over a house, but your home could be vacant for longer depending on the market. To be safe, budget at least a month of vacancy annually when estimating your income. 

Once you have moved out of your first house, you can settle into your second. Update your driver’s license and passport, then register to vote in your new district. From there, you can become a part of the local community and thrive in your new location. 

Find a Local Real Estate Agent to Buy Your Next Home

Moving to another house and converting your current home into a rental property is a big step in your life. You have an opportunity to grow your wealth by investing in real estate and learning what goes into property management. 

If you are ready to start looking for a second property, find a real estate agent in your area. A qualified Realtor can help you find the right home that’s priced within your budget. 

To find an agent, turn to the professionals at FastExpert. Find experienced Realtors who can meet your needs. Hire an agent who can help you find your second home or market your rental properties to qualified tenants. Try FastExpert today.