The hold-harmless clause: This clause protects the property manager from liability for their own errors in judgment or the mistakes of the workers the firm sends to your rental unit. One solution is to include a reasonable-care provision so that the property manager is motivated to be diligent in their management and avoid workers whom they know have had problems in the past. Your agreement should also mention such obvious requirements as informing you of what’s happening with your rental property.
The long-term management contract request: Some property management companies request long-term management contracts that can’t be canceled or can be canceled only for cause. Avoid signing any contract that can’t be canceled by either party with or without cause upon 30 days’ written notice. A company that knows it’s only as good as its most recent month’s performance will stay motivated to treat your property with the time and attention needed to get top results. But the company can make a reasonable argument that it needs a minimum term to amortize the significant time and cost of taking over a property. So rather than agree to a long-term, noncancelable agreement, I suggest that you negotiate an early-termination fee that’s waived after a certain number of months (typically, a year).
The confusing-language trick: If the property manager won’t agree to reasonable clarifications of the contract language or a complete list of the services provided for their fee, they may not go out of their way to help you later. Consider this refusal to be a warning sign, and find a property management company that is willing to accept your reasonable terms.
The “I’ll use my own agreement that suits my best interests” maneuver: Many property managers use their own in-house proprietary agreements, which are written strictly in the best interests of the property management company. Be sure to have your attorney review this agreement very early in the discussions with your potential property manager, and/or propose using an industry-standard management agreement from IREM or a local or state affiliate of the National Association of Realtors.
www.wiley.com/go/propertymanagementkitfd4e. Use this sample to familiarize yourself with such contracts.
Being aware of the tax consequences
As a rental property owner, you’re running a business and must file Schedule E with your federal tax return. The tax laws allow your rental housing business to deduct all operating expenses, including the costs of advertising, maintenance, payroll, insurance, property taxes, and management fees, whether those expenses are paid to yourself or a property management firm. Note: Federal and state tax codes change from year to year, so discuss your tax situation with your accountant or tax preparer in advance. The Internal Revenue Service (IRS) and state taxing authorities will also be expecting you to declare any income you may have paid yourself as a property manager.
Although your expenses are deductible, they erode the net income from your property. If your annual expenses are greater than your rent revenue, you may find that you can use those losses to ease the tax burden from your full-time job or other sources of income unrelated to your rental property. But a loss is a loss, and trying to keep your rental property in the black is still a good idea, even if you have to pay some taxes on the income.
The IRS’s passive-loss rule states that all real estate rental activities must be treated as passive, with an exception that some taxpayers are allowed up to a $25,000 annual deduction, with this deduction being phased out as the taxpayer’s reported income increases. There is also some limited ability to carry-back or carry-forward unused losses if the rental property owner meets certain criteria. A net operating loss (NOL) allows a rental owner to apply any unused NOL to a previous year’s tax return for an immediate refund of previous taxes paid. Although a tax-loss carry-forward applies a tax loss to future years’ tax returns, again it is subject to limitations or phasing out of the deduction based on the rental property owner’s overall reported income.
Real estate investors who can be classified as real estate professionals, however, are permitted to deduct all their rental real estate losses from their ordinary income, such as current employment income (wages and commissions), interest, short-term capital gains, and nonqualified dividends. See Chapter 20 for more information on whether you meet the stringent IRS requirements to qualify as a real estate professional. If you do, you have a significant advantage that makes real estate investing more lucrative. Check out Real Estate Investing For Dummies, 4th Edition (John Wiley & Sons, Inc.), for the latest information on the tax advantages for real estate investors in the 2017 Tax Cuts and Jobs Act (TCJA).
Chapter 4
Taking Over the Property
IN THIS CHAPTER
Sometime during the process of thinking about investing in residential rental property, you may have considered acquiring a property already occupied by tenants. Or maybe you just found out that your dear old Aunt Beatrice left you an occupied rental property in her will. On the surface, these opportunities seem to be positive because you don’t have to advertise and select tenants yourself — at least not right off the bat. But just how positive an experience you have taking over an occupied rental property depends on the quality of your tenants. Some real estate investors prefer to acquire vacant properties so they can renovate and upgrade the rental property and select their own tenants.
This chapter focuses on some of the important issues involved in taking over rental property, whether you’re purchasing a property or you’ve inadvertently become the proud owner of one. Here, you find out how to begin the all-important task of implementing your own policies and procedures with the existing tenants, who may be living under an entirely different set of rules. The proper procedures for taking over a rental property actually begin before you’re legally the new owner. Ensuring that your transition goes smoothly requires some know-how, and in this chapter, I give you exactly that.
For more information on rental property acquisitions, proper due-diligence steps, property inspections, and renegotiating the deal or seeking credits in escrow, plus ideas on how to hold title to your rental properties, check out Real Estate Investing For Dummies, 4th Edition, by Eric Tyson and myself (John Wiley & Sons, Inc.).
Knowing What to Get Up Front
If you’re thinking about buying a residential rental property, you need to start by thoroughly investigating all aspects of it and its current tenants, if any. After all, no one is going to represent your interests as well as you.
The formal due-diligence