Using Primary Residence as a Vacation Rental

[stachedpotatos]

Hey everyone! I'm not new to the forum, been reading and gleaning from the expertise for a while, but this is my first topic thread. I figured it's time to jump into the conversation!

My wife and I just bought our second home. Our first is rented and has a positive cash flow, the second we bought because it had an unfinished basement (which I'm about to complete with 2 beds 1 bath) and we want to rent out the basement, which has a separate entrance, on a nightly basis using VRBO, AIRBB, Craiglist, etc. while we also remodel the upstairs. The plan is to eventually sell the house after the remodel is complete and after we've been there at least years (to satisfy the 2 of 5, no capital gains tax requirement). However, upon completion of the remodel and before we consider selling I'd like to cash out refi or get a HELOC to shop for other investment properties. Given our current income (my wife is now self employed/growing her business, so it's smaller right now than it used to be) we probably couldn't qualify for traditional financing on a third property if we were only considering our 2nd home as our primary residence. Would the income from the basement rental count against our mortgage for the whole house, basically moving it into the rental category as far as financing goes? How much rental history would I have to show, typically? Anyone got a creative workaround they've employed in the past?

Thanks! 

[DoubleDown]

The plan is to eventually sell the house after the remodel is complete and after we've been there at least years (to satisfy the 2 of 5, no capital gains tax requirement).

Thanks! 

Welcome!

The law on this has changed in recent years, it is now prorated based on the amount of years you lived in the house. For example, living in the house 2 out of the last 5 years gives a 40% write-off on capital gains I believe. See irs.gov for details.

As far as qualifying for loans, I think each lender might have different underwriting rules. In general, they will probably allow you to offset your costs by the rent you receive, and most lenders I've worked with have not required any long term rental history, just a signed lease showing that the property will continue to be rented.

Even if financing was not going to be a stretch, I would just caution that you make sure you have more than enough income to cover all the costs with the purchase of another rental property, figuring in periods of extended vacancies, large repair bills, and so on. For example, having at least 6 months in reserves to cover the total cost of the property while receiving no rents. If you're stretching to attain financing, then possibly consider waiting until you've saved up more, incomes have become more stable, you have an idea of what income you can actually get from your periodic basement rentals, and make sure any future purchase will have rock solid positive cash flow.

[stachedpotatos]

Has anyone ever used vacations rental income to offset their mortgage when applying for a loan? With a traditional rental, rental income proof or a signed lease validate your income, however, what would validate your income (to the bank) for a vacation rental property?

[stachedpotatos]

The law on this has changed in recent years, it is now prorated based on the amount of years you lived in the house. For example, living in the house 2 out of the last 5 years gives a 40% write-off on capital gains I believe. See irs.gov for details.

This is from the IRS website and is only 6 months old: http://www.irs.gov/Help-&-Resources/Tools-&-FAQs/FAQs-for-Individuals/Frequently-Asked-Tax-Questions-&-Answers/Capital-Gains,-Losses,-Sale-of-Home/Property-(Basis,-Sale-of-Home,-etc.)/Property-(Basis,-Sale-of-Home,-etc.)-5

[DoubleDown]

Looks like you are correct on the 2 of the last 5 years requirement, that law has not changed (so far). Thanks for the clarification.