Should I rent my home or condo, while I try to sell it?

To answer the question, ‘Should I rent my home or condo, while I try to sell it?’, consider these additional questions:

1) Do you have a mortgage? Does your mortgage permit you to rent the property?

If you have a mortgage, then in addition to your Promissory Note (your contract / promise to pay the mortgage debt), you signed a Mortgage at closing that gives your lender (“Mortgagee”) a security interest in your home. If this is a “uniform” security instrument then the Mortgage includes many promises.

Look for the following promise (or a similar clause), in a residential mortgage:

Occupancy. Borrower shall occupy, establish, and use the Property as Borrower’s principal residence within 60 days after the execution of this Security Instrument and shall continue to occupy the Property as Borrower’s principal residence for at least one year after the date of occupancy, unless Lender otherwise agrees in writing, which consent shall not be unreasonably withheld, or unless extenuating circumstances exist which are beyond Borrower’s control.”

No lawyer should ever tell you that you can breach a contractual promise, out of convenience.

If you rent your property before one year from the date of occupancy, you have breached your agreement and you risk the lender defaulting you. Lenders have a way of finding out that you have moved out of the property.

If your mortgage restricts you from renting, you will have to ask your Mortgagee for permission to rent. This will likely come with a cost. Good luck getting a large banking institution to agree to this. If your Mortgagee is a small bank, you will have a better chance of working something out, at a lesser cost.

2) Does your condominium association permit you to rent the property?

You may have signed an affidavit relating to occupancy of the property. Find out if the occupancy affidavit or condominium rules committed you to reside at the property, or if it merely asked what your current intention was (i.e. on the date you signed it). Find out if the Condominium Bylaws prohibit renting. You might need to determine if the occupancy affidavit is connected to / supported by, the Bylaws. It is possible that the association is trying to enforce a ‘no-renters policy’, but the association doesn’t have the authority to do this.

3) Will your homeowners insurance cover your loss, if the property is rented?

Assume the answer is “no”. It is crucial that you address this problem. You must keep insurance in place because it would be catastrophic if there were a significant loss that went uncovered during a rental period.

Ask your insurance agent if you can get a rider to allow rental, and find out the cost. You may have to change insurance companies.

4) What are the tax consequences?

Capital Gains:

If and when you do sell your property, your closing attorney will ask you a series of questions to determine if you are subject to capital gains reporting. To claim an exemption, you will need to answer (amongst other questions) that you have “owned and used the residence as my principal residence for periods aggregating 2 years or more during the 5-year period ending on the date of the sale or exchange of the residence.”

Occupancy need not be continuous, nor must the residence be the seller’s principal residence at the time of the sale. If you owned the home for two years, and then rented it for three years, you will likely qualify (if other criteria is met). However once the tenant stays longer than three years, you no longer qualify for the capital gains exemption.

Income Taxes:

Don’t forget about income taxes, for the rental proceeds (assuming your tenants actually pay – giving you income). Consult with your tax advisor to determine your own tax consequence (i.e. given your individual circumstances). Expect to start keeping receipts for all work done on the property. You are now operating a business. Also ask your tax advisor if interest paid towards your mortgage, will remain deductible.

5) Do you need to register your rental property with your municipality?

Many municipalities are requiring that tenant-occupied properties be registered. Expect to see smoke detector requirements, rights of inspection to determine compliance with building codes, and fees. You may have to get a “Certificate of Occupancy” each time a property is rented. As an aside, did you know tenants may be protected from eviction, if your property is not up to code?

6) What is the personal liability risk?

If someone is injured at the property, will they sue you personally? Can they try to attach your wages, or your bank accounts, or even your home? Do you need to convey the property to an LLC, to minimize your personal liability? What are the costs and benefits of conveying the property to an LLC? Is the hazard insurance coverage (See Question No. 3) sufficient to protect you from risk? Do you need an umbrella policy? What is the effect of conveying the property to an LLC, on capital gains when you sell? (See Question No. 4 and consult your tax advisor.)

7) Do I need a written lease?

The answer is “yes”. It is still possible to evict a tenant with an oral (month to month) lease, but with a written lease, you can enforce many more provisions that are important to you, such as: don’t keep pets at the property; don’t smoke; and don’t paint the walls mauve. Each of these actions by a tenant will cost you money. The eviction process will cost you money. With a written lease the eviction process should go smoother, but it is rarely easy.

In Connecticut, expect that the eviction process will take several months, even with a written lease, and expect that during this time your tenant will pay you nothing. The tenant is given a 10-day grace period to pay the rent, by law. If the rent is not paid within the grace period, you will need to serve your tenants with a “Notice to Quit”. There must be three intervening days between the date of service of the Notice to Quit, and the move-out date shown on the Notice, for a ‘Non-Payment’ eviction. If you don’t know the rules, you may make costly mistakes. For a lapse of time eviction, you will need to give the tenant until the end of the rental period, i.e. until the end of the month, for a month-to-month tenancy. This is only the first step. Now you need to sue the tenant who fails to leave voluntarily. This means filing a Summary Process Eviction Complaint, serving the tenants (again), waiting for the tenant to file their “Answer and Special Defenses”, which once filed (even if the tenant admits all allegations) entitles your tenant to a day in court. If you make a mistake, you may not find out until late in the process and you will need to start all over again. Think of the financial impact of 6-months with no rent from your tenant! If your tenant appeals the judgment of a trial court, the delay and cost is even greater.

8) Can I sell a tenant-occupied property?

Yes, but probably only to an investor. A potential investor will want to see that the existing tenant has been making consistent payments, and that you have a written lease agreement. Don’t expect an investor to buy the property if rentals are prohibited by the Condominium Bylaws. Also, a potential home-owner (non-investor) does not want to buy your property only to have to evict the tenants. See Question No. 7 to understand why.

Don’t expect your tenant to move out voluntarily just because you have sold the property, and don’t expect your Buyer of the property to be comfortable with the mere promise that a tenant will move out. Even if your tenant promises to move out when the property is sold, he/she probably won’t.

Nothing that a lawyer includes in a written lease agreement, will entitle you to a “quick” eviction. Tenants are not permitted to waive statutorily granted housing rights, and judges know this.

9) Can I get a mortgage loan, if I am already on a mortgage loan?

Ask your lender if you can be on two mortgage loans at the same time. Even if lending rules allow this, and you meet eligibility criteria, do you really want two mortgages? Talk to an experienced mortgage broker or lender, but also think about your long-term financial plans, and whether this is consistent with your plans and willingness to take on risk.

10) Will my tenant(s) pay me?

Just because there is a written lease does not mean you are guaranteed payments. Speak to an experienced attorney about drafting a lease, and getting security. You may also want to do a background check on your potential tenants. Your lease may require extensive discussions with your attorney which are beyond the scope of this short article.

11) Do I really want to be a landlord?

Dave Ramsey cautions against becoming a landlord ‘by default’ (i.e. falling into it, as opposed to deliberately becoming a landlord. He would also tell you not to own a rental property unless you can buy it wish cash.) Putting aside the cash / debt debate – Do you really want to be a landlord? If these eleven questions scare you, and you don’t want to take the time to understand all of the issues, you should not be a landlord. It is much safer to wait until the right buyer comes along, to sell your property. However don’t just wait for a sale. Find an aggressive, experienced real estate agent who will take control of the sale process. Your agent should tell you exactly how to show and market the property. Showing the property will be difficult when tenants paint the walls mauve and don’t clean up after their slobbering litter of Neapolitan Mastiffs.

In conclusion, renting a house or condominium while you try to sell it brings significant risk. Always understand these risks. Speak with your attorney, tax advisor, insurance agent, and experienced mortgage professional first.

Joel A. DeFelice is a partner at Marder & DeFelice Law Offices, LLC, located in Vernon, Connecticut.