What Is House Hacking?
For first-time real estate investors looking to purchase their first property and begin generating passive income, house hacking is exploding in popularity. The main idea behind home hacking is;
- Investors use lead generation software or other means to find an off-market duplex (or multi-unit property) at a great deal.
- Investors buy that duplex or (other multi-unit property) and live in one while renovating and renting out the other(s).
- By renting out the additional unit(s), you reduce your living expenditures and increase the value of your property.
5 Reasons Why House Hacking Is Great
- Reduce Your Cost Of Living: House hacking helps you reduce your living costs by renting out the other unit(s) in the building. This lowers your housing bills to near-zero - and in many cases, your mortgage may actually be paid in full with leftover cash to spare.
- Create Cash Flow: Renting out the additional unit(s) can help you create positive cash flow, which enables you to pay down your mortgage quicker and begin accumulating more wealth.
- Improve Your Credit Score: As you begin to see a positive cash flow, you can use that money to pay off your mortgage and other bills, which will raise your credit score. Your credit score may rise as a result, making it simpler for you to get financing for upcoming purchases.
- Reduce Your Tax Liability: Part of building a great house hacking strategy involves reducing your tax liability. Although rental income is subject to both federal and state income taxes, you can also deduct some of your property costs from it, including mortgage interest and depreciation.
- Grow Your Property & Real Estate Knowledge: Living in the same house that you're renting out will help you learn about property management and will provide you significant knowledge that you may use when you decide to buy more houses in the future.
House Hacking Tax Considerations To Keep In Mind
- Rental Income Taxes: You must include rental income on your tax return since it is subject to both federal and state income taxes. In order to properly report your rental income and expenses on your taxes, maintaining accurate records is critical.
- Deducting Mortgage Expenses: You may deduct the mortgage interest you pay on the rental unit(s) from your rental revenue. This reduces your tax liability and improves overall cash flow.
- Deducting Property Depreciation: You can deduct your property’s depreciation on a yearly basis, which is calculated by dividing the property's cost by 27.5 years.
- Deduct Miscellaneous Expenses: You may also write off any costs associated with the rental unit(s), such as maintenance, insurance, and repairs. Keep thorough records of these costs and seek advice from a tax expert to make sure you're deducting everything legally allowed.
- Paying Capital Gains Tax: You'll be required to pay capital gains tax on the earnings from the sale of the property if you decide to sell it in the future. One way to minimize this? If you occupied the apartment for at least two years prior to the sale, you can deduct a portion of the capital gains from taxes.
- 1031 Exchange: One “hack” for your house hacking strategy is a 1031 Exchange. performing a 1031 exchange and using the funds to purchase another investment property, you can postpone paying capital gains taxes if you decide to sell the initial property.
House Hacking Legal Considerations To Keep In Mind
- Zoning And Housing Regulations: Before doing any house hacking, make sure you’re buying a property that complies with all applicable municipal zoning and housing regulations.
- Fair Housing Act: The Fair Housing Act forbids discrimination against tenants on the basis of their race, religion, or disability. This implies that you cannot exclude any possible tenants based on these criteria.
- Lease Contracts Are Legally Sound: You must have a written and legally enforceable lease agreement that spells out all of the details of the rental, including the monthly rent, the security deposit, and the duties of the landlord and renter. When you just start learning how to house hack, we highly recommend running through contracts with a lawyer that specializes in this field so you can avoid any headaches down the road.
- Homeowners & Landlord Insurance: Having insurance is essential for safeguarding your possessions and financial resources. In the event of mishaps or injuries in your rental properties, a landlord insurance coverage can assist in covering damages and responsibility.
6 Steps To House Hacking
- Find an off-market property like a duplex or multi-unit property that fits your budget and investment goals.
- Get pre-approved for a mortgage and have a good understanding of financing options.
- Hire a home inspector to ensure the property is in good condition.
- Close on the property and move into the unit you'll be living in.
- Renovate the unit you'll be renting out and prepare it for tenants.
- Find tenants and start generating passive income.
Real Life Example Of House Hacking
Meet John and Mary, a young couple aiming to start investing in real estate and purchase their first home. They learned about the idea of "house hacking" and want to give it a go. They live in an area that has experienced year-over-year population growth for the last 7 years, and they found a duplex right in their target location, within their budget, that’s perfect.
After securing a mortgage they closed on the purchase, and settled into one of the apartments. They started accumulating equity in the property by using the rental revenue from the second unit to pay their living expenses. They were able to upgrade and improve the rental property over time, which allowed them to raise the rent and provide even more positive cash flow. They now have a cozy home and a sound investment that is bringing in passive income for them.
House Hacking Financing Options
These are just a few of the many financing options available for anyone interested in how to house hack.
- FHA loan: FHA loans are backed by the Federal Housing Administration and are designed for first-time homebuyers. They typically have lower down payment requirements and more lenient credit standards.
- Conventional Mortgage: A traditional mortgage is not insured or guaranteed by the government. These loans typically have stricter credit and income requirements.
- Home Equity Line of Credit (HELOC): A HELOC allows you to borrow against the equity of your property and use that money for purchasing a new property (along with existing home renovations and repairs).
- Private Lender: Private organizations that lend money that people can use to buy property or renovate existing properties. Keep in mind terms and conditions for private lenders can be more stringent than mortgages.
For first-time real estate investors who want to live in a property while simultaneously making money, house hacking is a fantastic alternative. You'll be well on your way to building wealth through real estate investing by taking the actions and giving the financing choices mentioned above into consideration.