Money talk: how owning a house can bring in passive income

When I first moved to Napa, I thought I may just rent indefinitely. After owning a home for more than 16 years, I wanted a break from maintenance and upkeep. That feeling didn’t last very long, though.

I think I finally hit my limit of waiting for someone else to approve maintenance requests during Memorial Day weekend of 2016, not quite a year and a half from when I started renting. That was the weekend when the main drain line clogged, and the only bathroom in the house became unusable. I had a couple of friends visiting that weekend, and we weren’t able to take a shower or use the only toilet in the house until an emergency plumber responded. I had been reporting issues that pointed to imminent failure of the drain line for over two weeks, but the landlord was dragging his feet on approving a company to come out and address the issue. I’m sure he was regretting it when he got the bill for that emergency call on a holiday weekend.

After an experience like this, I realized that I wanted to be the one to make the choice of when and what type of repairs should be made. Yes, it could be a hassle to find good people to do the work, but I preferred that to being stuck in a situation where I was forced to find a place to squat in the yard to pee.

There are many articles and blog posts one can find about the “rent vs buy” debate that outline the pros and cons of each. This isn’t one of them. I’m just sharing one of the reasons I find that owning works for me: I can choose to bring in extra income by renting a bedroom in my house. Renters are legally bound by the terms of a lease, which usually do not allow sub-letting the unit or portions of the unit without landlord approval. As an owner, I don’t have this restriction.

I first started renting rooms in my home when I lived in Chicago. I had a fairly large house that was perfect for this arrangement. I had my own bedroom and bathroom on the main level of the house, and I rented out the two bedrooms with a bathroom on the second floor. The kitchen area was shared, and while I made it clear that my housemates could use living and dining room, too, they rarely did.

I used the equity from my Chicago home sale as a down payment on my house in Napa. Property values are much higher here, and the house I purchased is smaller than the one in Chicago. I went from owning a house with four bedrooms and three bathrooms to one that has only two bedrooms and one bathroom. I use the larger of the two bedrooms and rent out the smaller bedroom. The kitchen, bathroom, living room, and dining area are all shared space.

Potential renters are plentiful. During the harvest season or “crush,” there are frequently people hired on a short-term basis to work in the labs and support the winemakers. Additionally, many of the wineries hire interns throughout the year to work in the tasting rooms or with back office functions like marketing, sales, and events. The local hospital employs many “travelers” to fill nursing and technical positions, too. Vacancy rates for rentals is very low, and like all of the Bay Area, housing is expensive, so sharing housing is quite common here.

The local community housing organization actually has a free program to promote home sharing by matching applicants with owners. I thought about using this program to locate a new house-mate, but I wanted to have the option of having a month or two “off,” so I decided to rent my room through Airbnb.

As long as I have my listing set for a minimum rental of 30 days, I don’t trigger any issues with the city. The demographic I am targeting — people who are in Napa for short-term work assignments or internships — are also looking at online sources such as Airbnb or Craigslist to find housing, so the service works well for me. I have full control of who I accept through Airbnb, and I require that they be “verified” by Airbnb (verification of government issued IDs) before I consider their request. I also usually have some back and forth messaging with the guest first to confirm their reasons for booking. While I could make more money by renting directly through Craigslist, I prefer the extra protection provided by Airbnb and their verification process.

This may be obvious, but I rent the room furnished. I already had a modular shelving/desk unit and chair for the room, and the closet has an organizer with built-ins. I had to buy a bed, bedding, some linens, and hangers for the closet. I saved the receipts for all of these up front costs for tax purposes.

The extra income I get from renting my room is taxable income. But while I do collect income for the room, I also have expenses, such as extra costs for utilities (water, gas, electric, and internet), supplies (paper and cleaning products), maintenance, and fees to Airbnb. Keeping track of these expenses and itemizing them on my annual tax form works in my favor. For individuals with income less than $150,000 a year, the IRS allows these expenses to offset the income under their rules for “passive activity losses.” Those making less than $125,000, get the full benefit of passive income loss rules, which are gradually reduced up to the upper limit of $150,000. However, for those making more than $150,000 it’s still worthwhile to keep careful records and report expenses every year as any losses are applied when one sells the property.

When I was bringin in a lower salary in Chicago, I had passive losses most years. I was getting money throughout the year from my renters so I had cash flow, but a portion (about 40%) of the maintenance costs — landscaping upkeep, and repairs to the house — was a business expense. I didn’t end up having to pay taxes on any of that income due to the fact that I had a loss every year. Now I have a high enough income that I can’t claim any passive losses on my annual income tax return, but I still keep records because if the tax laws aren’t changed and I sell the house, I can perhaps use those losses to offset any taxes on any gains I earn.

My income in 2017 from renting out my spare bedroom has offset the expense of caring for my elderly dog and given me extra breathing space in the budget every month. I had hoped to use the extra money to pay down the mortgage faster, and eventually I may be able to do that.

I’ve also met some great people. I’ve had five people stay with me over the course of the year, and only one left me less than happy with the experience. Last year’s harvest intern was a tad immature and messy. I quickly got tired of living with a sloppy boy, who seemed genuinely clueless about his bad habits such as running the hot water in the shower to “warm it up” for so long that there was water beading in the walls. He did respond when I directly talked to him about correcting his behavior, at least.

The intangible benefits of having someone else living in the house are that I tend to keep the house neater and cleaner. I’m not generally a person who lets dishes pile up, but when I’m on my own I’m more likely to put off dusting and vacuuming. I also have some additional opportunities for socializing by occasionally sharing a meal or taking a walk with a guest.

Ideally I’d like to have the house to myself and build what is called an Accessory Dwelling Unit in my large backyard. I’ve also thought about putting an addition on the house to expand the back bedroom into a suite with its own bathroom, or perhaps add an entirely new master suite, giving the house three full bedrooms and two bathrooms. While there is plenty of room in the backyard for any of these ideas, I simply lack the capital and don’t yet have enough equity in the house to even think about using it to get a loan.

Sharing one’s home with strangers isn’t for everyone, but I often recommend it to people who live alone and have extra space. It is a great strategy for bringing in extra cash, and can provide an extra level of socializing and security.

If anyone has ideas on how to raise capital for major home improvements, I’d love to hear about it in the comments.

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The housing update

I’ve been in my house for just over eight months now, and have been living with a housemate for nearly five months. Overall, my housing situation is satisfactory and I’ve felt like I’ve made good decisions in both purchasing a house rather than continuing to rent, and taking on a housemate to increase my income.

While I had some trepidation about sharing a bathroom with a housemate, it’s worked out well. I had thought it most likely I’d be sharing my house with another woman, but the first confirmed booking I got was a young man just starting his first professional job. I think sharing a bathroom with a man is actually easier since they tend to do less fussing while getting ready.

Since I rent a fully furnished place, that means he has full use of my kitchen equipment (pots, pans, plates, cutlery, small appliances, etc.) and he’s been very good about not breaking things. He’s good about cleaning up after himself in the kitchen and bathroom, and our work schedules are complementary so there’s no problem with disturbing each other coming and going. I do the regular housecleaning myself (with the exception of his room), but he pitches in on things like rolling the trash cans to the curb and has helped me move some furniture when asked.

Although the reservation is through mid-April, he’s found an apartment that will work for him and I’m going to let him out of it early. He’s been a great person to live with and I wish him success. Last night he introduced me to one of his colleagues who is interested in finding a better place to live and we toured the house and generally eyed each other up. She seems like a nice young woman, but even if she doesn’t move in, I’m sure I’ll have no problem finding another short-term renter.

There are some downsides to renting out my second bedroom. I think the biggest one is that I have no room to host friends who are visiting the area. Last weekend my San Francisco friends were in town for the marathon, and I was regretful that I couldn’t offer them a place to stay. If or when I have any of my Chicago friends visit, I can only offer an air mattress on the living room floor as accommodation.

The only other issue I’ve run into with having a housemate is the occasional struggle with juggling the bathroom schedule. That happens pretty rarely, though. I just had gotten spoiled living in a house with three bathrooms for so many years.

The extra income has cushioned the impact of my higher housing costs and allowed me to painlessly afford the higher veterinary costs for my aging dog, as well as enjoy some luxuries such as a meal kit delivery service, and restaurant meals a few times a month. It’s also slightly softened the blow of having to buy new clothing to fit my expanding body size; I may be unhappy about the weight, but at least I don’t have the additional challenge of figuring out how to rebuild a professional wardrobe on a tiny budget.

Some of the extra income has been used to defray house repair and maintenance costs, too. While this house was well cared-for and in very good shape, it’s expected that some things will need fixing now and then.

In December I had to replace the control panel on the heating/cooling system. For some reason, it just started smoldering. My clue was the scent of burning plastic wafting through the heating ducts. With labor and shipping, it cost just under $800 to replace what looked like a pretty simple circuit board. I also replaced the laundry sink in the garage. The original, cast iron sink is very cool, but the capacity was too small for a load of laundry using the highest water setting. The plumber had looked at it back in July and said it wasn’t possible to increase the size of the drain pipe from 1.5-inch to 2-inch (the current standard) without trenching into the concrete garage floor. My only option for being able to run a load of laundry larger than a medium was to get a laundry sink with a larger capacity. (I’m saving the small cast iron sink for a garden sink; I understand it’s very valuable.)

Other maintenance/improvement expenses so far have been limited to some small handyman jobs like replacing the noisy ventilation fan in the bathroom with a quiet, properly vented one, and lawn and yard care. I don’t have a lawn mower and this house has quite a bit of lawn right now. I’d like to change that, but for now it’s less of a hassle to pay someone to do the grass cutting, edging, pruning, and fall leaf clean up than to invest in the cost of equipment and upkeep. (Not to mention the time I’d need to spend on cutting the lawn and cleaning up the leaves from several trees every year.)

I have some larger house expenses coming up this year. The trees in the back yard desperately need pruning, and I think one of them needs to come down. I had priced this work out last August, but never got it done. Now that the winter rains have slowed way down I think it’s time to get schedule that job before the tree starts putting out a lot of leaves.

The heavy rains this winter have also exposed the need for some more costly work. There is a drainage issue on this property and it could lead to more serious issues with the house. This past winter we went through periods of non-stop rain for up to 5 days at a time, with rainfalls averaging at least 2 inches a day. The soil on which the house sits is very heavy clay which absorbs water slowly. Despite using long extensions on my downspouts to direct water well away from the foundation, there will always be some rain that falls outside the gutters and saturates the soil near the house. With such heavy rain and soil that resists quick absorption, I had standing water next to the foundation in some areas. One particularly low spot accumulated so much water that it nearly reached the ventilation opening into the crawl space. The concrete pad on which the heating and air conditioning unit sits was also nearly flooded.

The lawn maintenance guy helped clear out a trench that ran to the year of the yard and seemed to be meant for channeling rain run off. I then dug a mini-canal along the side of the house where the water was pooling to connect with this trench. That helped avert disaster, at least.

I was too anxious to open up the access hatch to the crawl space to see if there was any seepage. My crawl space has a dirt floor and is very low and tight. The soil composition is almost certainly the same as the yard — heavy clay — and I noticed that the inspectors and electrician had quite a bit of damp soil clinging to them when they had to crawl under the house to work last July. I also noticed that even in the summer the house always felt sort of damp, despite this area not being known for humid summers. These are all indications that the drainage and dampness issues didn’t just occur because of an unusually wet winter.

The most likely scenario is that I’ll need to have french drains and a sump pump installed to keep water away from the foundation next winter, and to help keep the soil the house sits on more dry. I’ve been running a dehumidifier pretty much constantly for about a month and it’s amazing how much moisture has been extracted from the air, and how much more comfortable the house has been. During a rainy day I need to empty the dehumidifier twice a day; now that we’ve had no rain for a week I’ve only had to empty it about once every 30 hours. That still seems like a lot of moisture for a little 1100 sq ft house, especially when we’re very good about running the ventilation fan in the bathroom and over the range when cooking.

With a big project like this approaching, the extra income from renting the second bedroom takes on more importance. Just knowing that money will be regularly coming in gives me confidence that I can afford to maintain and improve the house and property without a lot of financial stress. I have other plans that aren’t cheap, too: adding some storage solutions to the garage, getting a new washer and dryer, putting in some xeriscaping and vegetable beds, and adding a closet organizer to my closet, among other things. There’s always something to do around a house.

With all these expenses, I still don’t regret buying a house instead of continuing to rent. It’s likely that I won’t be able to claim the passive loss from renting out 50% of the house this year since my income has increased in the past few years (yay!?), but the mortgage and property tax deductions are still a big help. My mortgage payment alone (principle + interest) is the same as I was paying in rent. And, these expenses will be fixed for the next 29 years; renting can’t guarantee that benefit.

Of the “extra costs” associated with owning — property taxes and maintenance — at least one is tax deductible and reduces my tax load. Using this tax savings calculator, my tax savings in 2016 will be over $5,000, and my after tax rate for my mortgage is just under 2.5 %. (Hat tip to Grumpy Rumblings blog for the link to that calculator!)

Even without the tax advantages, it seems like I’m getting a pretty good deal for a place roughly 300 sq ft larger, a better kitchen, covered parking (if I can just get the storage situation sorted out, that is), and a much bigger yard for the enjoyment of me and my four-legged friend. Bay Area real estate is crazy expensive, but as long as the market doesn’t plunge, I’ll be doing OK.