At some point, nearly every homeowner will have more room than he or she needs. This is bound to happen. Take a common scenario: a couple moves into a new home which has 4 bedrooms. The master bedroom is used by the couple, and the remaining 3 bedrooms are used by the couple’s 3 children. Then, the oldest child graduates from high school and leaves the nest. Suddenly, the house which was previously filled to capacity now has an extra bedroom to spare. In this type of situation, homeowners handle this spare room in a variety of different ways. Some homeowners may convert the extra space into a new guest bedroom or recreational room. Others may use it for storage. And some may turn the room into a rental. Of course, the rental option is only available when other conditions are present – closeness to a bathroom, kitchen, laundry room, etc. – but when this option is available, homeowners should seriously consider this opportunity.
In this post, we will discuss a few reasons why you should consider converting your spare room into a rental. We will discuss three reasons, but there may be plenty of others.
Earn Extra Cash
When you rent out your spare bedroom, you’ll earn extra cash, and that extra cash can go toward any purpose. Perhaps you’d like to save up for a new college fund for your child. Or, perhaps you’d like to save for a new emergency fund. The possibilities are endless. We live in a capitalist society, so there’s no loss of honor in putting this reason at the top. Depending on where your home is located, you may be able to charge a hefty sum for rent; you can put those additional funds to any number of useful projects.
Maximizing Your Space
If a room which was previously occupied suddenly becomes vacant, there’s a good chance that it may become underutilized. No matter how you approach the spare room, the probability is high that the new purpose of the room won’t be as significant as its earlier purpose. If you decide to use it for storage, for instance, this might be convenient, but it’s probably going to be less productive than renting it out to generate income. Think about it: if you need storage space, you could acquire an outside storage unit with only a small percentage of the income you generate from using the spare room as a rental. By converting to a rental, you’re really maximizing your space and putting it to its fullest potential. In many cases, spare rooms are rented out to a younger demographic, such as college students. If you rent out your spare room to a student, you’d be contributing to that student’s college experience in addition to fattening your pocketbook.
Potential Benefits Under Sec. 1031
When you rent out your spare room, you’re converting part of your home into an investment property. When you do this, you become eligible for certain benefits which wouldn’t be available if you convert your spare room for some other purpose. One of the biggest benefits which would become available is the “allocation” treatment under Section 1031 of the Internal Revenue Code. This means that, if you ever decide to sell your home, the portion of your home allocated to investment use would be eligible for tax deferral under Section 1031. This could be a great way to continue earning passive income after you sell your home. Section 1031 allows you to defer capital gains taxes when you reinvest the funds from your sale into more investment property. So, when you sell your home, you’d be able to reinvest part of the funds into another investment property – you could buy a Delaware statutory trust, a commercial property, or another rental property. And you’re still able to take advantage of the “principal residence exclusion” under Section 121, which means you’ll be able to eliminate a big chunk of your tax bill! Bottom line: when you convert to a rental, you’ll be able to take advantage of a very big tax benefit in the future.
Image credit: Wicker Paradise