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Real Life Planning Podcast Episode 36: Financial Planning for House Hacking

Real Estate Coaching

In Episode 36, I'm discussing everything about house hacking. I will share how house hacking can be a gateway to building a real estate business, insights on benefits, risks, and the importance of professional tax advice for aspiring house hackers. This episode will provide valuable guidance for those looking to turn their home into a source of income.

 "If I could go back and redo one financial thing from when I was in my twenties I would have house hacked." -Cynthia Meyer

This week on Real Life Planning Podcast:


What is house hacking? [00:00:49]


What are the two types of house hacking? [00:02:14]


What are the benefits of house hacking? [00:4:04]


What are the risks? [00:07:10]


what tax considerations should I know if I house hack? [00:08:35]

Takeaway Quotes:

“So house hacking… is in the broadest sense making money from a home that you already own in order to subsidize the cost of owning that property.” -Cynthia Meyer

"House hacking gives you a chance to decide if you really like the real estate thing… It's a good way to take that leap into real estate investing in a lower risk situation and decide if it is a business that you want to continue to scale and grow over time." -Cynthia Meyer

Connect with Cynthia Meyer:

About the Real Life Planning Podcast

Host Cynthia Meyer welcomes fascinating guests to share real life stories of how they are realizing their financial potential. Each episode explores practical, realistic steps to create results.

TRANSCRIPT for Episode 36

[00:00:11] Welcome friends. Today I want to talk about some planning issues around house hacking. So house hacking, if you're familiar with the term, is in the broadest sense making money from a home that you already own in order to subsidize the cost of owning that property. It's a really powerful way to get started as a real estate investor, but there are also other uses including generating income- multi generational living retirement income or subsidized retirement income.

[00:00:47] So I want to dig into that a little bit today and talk about some of the initial things that I hope you'll think about if you're considering doing a house hack. So recently, Zillow did some research and they found that there's a really a rising interest in house hacking among younger homebuyers.

[00:01:07] So this came out in November, I think, of 2023 and it basically found that 51 percent of Gen Z and 55 percent of millennials put a pretty high importance on the opportunity of renting out a portion of their home for rental income while living in the home and if you asked that same cohort 56 percent of Gen Z and 64 percent of millennial respondents in the survey said that they also placed a high importance on the opportunity to rent out their entire home in the future. So we've got a whole two generations here- I like to call this the HGTV effect, right? It's that they're looking at real estate as a growth asset. Other research from Bankrate and NerdWallet has shown that these types of homebuyers are looking at their home as an investment.

[00:02:03] Something that isn't just a place to live, but a place that may potentially generate income for them.

[00:02:09] So, let's talk about the two different types of house hacking and then we can dig into some of the issues a little bit. So the first type of house hacking, I like to call it house hacking 1. 0. This is the traditional house hack. By the way, (What's the origin of the term "house hack?") it wasn't always called house hacking and people have been doing this for generations. But that term house hacking was coined by Brandon Turner, one of the original teachers at BiggerPockets and house hacking is just a perfect way to describe how people are thinking about it now- hacking your house for additional income.

[00:02:43]So house hacking 1.1 is buying a multifamily property, living in one unit, renting out the others, buying a single family property, renting out rooms to other people. Buying a single family property and creating or renovating an accessory dwelling unit that's called an ADU, very big on the West Coast, by the way and renting to others. So those are the traditional ways of house hacking.

[00:03:07] So, house hacking 2.0 includes other ways to take as basic concept, right? Which you have an asset that you're using for living and how can you find ways to create income from it? And so other ways of  (VLOG TITLE) house hacking 2.0 include vacation house hacking, renting out your residence on Airbnb or Evolve or another vacation platform. Renting a room in your residence on Airbnb which was the original purpose of Airbnb when they first got started. Renting out your garage space or your parking space for somebody else to park their car or their RV or their boat. Renting out storage space on places like neighbor. com. Renting your home or your garden for events. Some people rent their- if they have a beautiful home, they rent it for photo shoots or parties or meetings. You can rent your office too on places like Peerspace. Some people even rent their pool or renting a part of your home for outdoor and adventure travelers, like renting space for people to camp or park their RVs. These are all additional ways of house hacking that are inspired by the original spirit of taking tenants on your property. 

[00:04:21] So what are some of the benefits of house hacking regardless how you're doing it? The first obviously is that you are subsidizing the ownership of a property by generating rent from it. So that could mean in one situation, it could mean that the rent from the other unit or units in the property actually pay for the cost of owning the property. So my sister, for example, owns a duplex, a two flat and the rent from the one floor of her building pretty much pays the entire cost of her owning the property. Now, she was lucky to benefit from a really low interest rate when she first took the loan. It's a little harder to do today but a lot of people have used that strategy, right? Move into a duplex or triplex or fourplex and the rent from the other units pays pretty much all of the costs of the mortgage interest and taxes on the property.

[00:05:20] The other thing that house hacking can do is you can get started as a real estate investor and a homeowner at the same time. You're jumping the gate if you will by using that same amount of capital as the down payment on an investment that has two purposes. A house hacker may buy a house hack, for example, and then eventually move out of their owner's unit and maybe go buy another house hack. We have some wonderful series about house hacking with Lauren Bellis. I'll put those in the show notes. And that's exactly what she did is she's a serial house hacker. She moves in, she renovates, and then moves on to her next project. 

[00:06:01] The other thing is that the income from house hacking can be used to apply towards other goals. So it could help you save for the down payment on the next rental property by freeing up additional cashflow in your monthly budget. That way you've got the down payment for the next real estate investment. So there's lots of ways to use that capital.

[00:06:22] The other thing I would say is that house hacking gives you a chance to decide if you really like the real estate thing. Do you like being a landlord? It's not for everybody and some people house hack and they love it and they go on to build nice real estate portfolios for themselves. And some people get a taste of it and they think, you know what? This is not for me. This is not a business that I want to pursue. And so they've had that firsthand experience of being a landlord and they've decided it's not for them. It's a good way to take that leap into real estate investing in a lower risk situation and decide if it is a business that you want to continue to scale and grow over time. 

[00:07:02] Let's talk a little bit- let's start with the risks because a lot of real estate investing content, it starts with the rewards which I think can be considerable. As a real estate investor myself, I've certainly benefited from them. But as a fiduciary financial planner, I want to make sure we're talking about some of the risks here of house hacking. And the first is vacancies and non payment. So whether you have tenants in an additional unit or you have roommates in your house, or you have a tenant in your ADU, sometimes people don't pay. There are landlord tenant laws that cover how you can handle that situation when you have a non paying tenant and there may be long periods of time where you're going to pay all of the costs of a more expensive property than you might normally afford if it was just you living in it and you're going to have to pay for all that. Cash management and managing liquidity- making sure there are enough cash reserves are so important. 

[00:08:02] The next thing is that, it could be more house than you could afford. So when thinking about how to get into your first house hack, it may be something to think about not necessarily biting off more than you could chew. So if you do get into that situation where there is a long vacancy or non payment period that you can still afford all the carrying costs of the property without the tenant's rent. 

[00:08:27] Obviously, you have to know all the landlord, tenant, and short term rental laws if you're planning to rent out an Airbnb, for example and you have to know those just the same way as if you were buying in a standalone investment property.

[00:08:39] You may need you may need a certificate of occupancy or a landlord license or a short term rental license. So you have to know all of the legal guidelines and make sure that you follow them. And you want to make sure your tents have leases, for example, if you're renting mid to long term.

[00:08:54] Risk management in that regard, right? Know the rules and follow them.

[00:08:59] The other thing that we can think about here is the insurance situation.  So if you have a multi unit property you're going to get a policy called an owner occupied dwelling insurance. But if you're like my oldest daughter, for example, and you when you bought a house, you first rented to roommates, you would do a homeowner's policy. So you want to, before you buy your house hack, obviously you want to discuss this with your insurance agent and get a quote in the appropriate policy. So somebody that owns a fourplex, for example, doesn't get a regular homeowner's policy. They have to have a policy that is a hybrid of their personal home and landlord insurance. Most house hackers are going to want to have some umbrella liability insurance that would protect them in the case of civil litigation. It's an extra layer of coverage above their landlord policy. It's often a good idea, I personally like this to encourage tenants to have a rental insurance. Landlord insurance does not cover the contents of the tenant's unit. So it's a good idea for tenants to have rental insurance; super inexpensive, easy to get. So in case of a flood or a fire or something like that, then they can get reimbursed for their stuff because your insurance is not going to reimburse them for it.

[00:10:16] If you are renting your home on Airbnb, for example, or evolve you do need a short-term rental rider on your homeowner's policy. And. There aren't a lot of carriers who offer short term rental providers on homeowners and policy. So you may have to shop around for insurance or get a standalone short term rental policy.

[00:10:35] And of course you want to make sure that you think of your home, your house hack, look at it from the eyes of the tenant and what could possibly go wrong. So obviously things like smoke alarms, you'd probably do that anyway, right? But making sure that there are fences and signs and the lighting is good. There's a fence around the pool if you had one. So you have to look at it from the perspective of, "Hey, I'm a business owner. I'm a real estate business owner. How can I mitigate the various risks of people coming on to the property?" 

[00:11:09]I think it's good to talk a little bit about short term rentals because there are some additional risks of having a short term rental. The first I think is that the law can change relatively quickly. So there may be regulations in your market on short term rentals. You may need a license, you may not need a license. There may be no short term rentals allowed, in which case you can't do it, right? But knowing the rules and then understanding that those rules could change in an instant. Your property always has to make sense as a long term rental, right? As a long term rental house hack even if you're planning to do a short term rental unit on the property.

[00:11:50] Another thing I want to share is that if you're house hacking, get some professional tax advice when you go to prepare your tax returns. You may have been DIYing it yourself but now you're a real estate business owner; you should take this seriously. The money that you spend to have some professional help from a tax advisor who's real estate savvy can be really helpful to you as you build and scale your real estate business.

[00:12:16] So super important that you just don't try and wing it here, right? Please get some professional tax advice because there are lots of opportunities for house hackers down the road when you sell the property. As well as just understanding what you can and cannot deduct. I'm not going to give you any tax advice today. 

[00:12:36] I don't give tax advice, but I want to share some educational principles with you.

[00:12:40] The first thing is that the expenses in your house hack are proportionate. And some of those expenses can be deducted or not deducted depending on which side of the fence they fall. Are they personal? Or they rent a property used in a business. So let's take the example of a duplex and each side of the duplex is exactly the same and you live in one half and your tenant lives, tenant, or tenants live in the other half.

[00:13:08] So on the part of the home that represents your owner's unit, you can take half your property taxes up to the salt limit, the $10,000 salt limit on your itemized deductions. You can take half the mortgage interest and your itemized deductions, if you itemize. So half of that unit, the finances of it are going to be treated as if it was your standalone home.

[00:13:35] The other half of the unit, which is your rental property component of the unit, you can deduct a proportionate amount; in this case, it's 50 percent of the expenses of the property. So again, another half of the property taxes, half the property insurance, which isn't deductible on the personal side. Half the maintenance or any maintenance that specifically applies to that rental unit itself. So you can see how this could get complicated. And this is why I really want to encourage you to use a professional tax advisor, use a tax preparer who's real estate savvy when you're house hacking. 

[00:14:09] Let's say you move out of the owner's unit and into a new property and you rent your owner's unit and now it becomes part of the rental property. All of a sudden, 100 percent of the expenses would be deductible. 

[00:14:20] Or what happens when you sell the property? How much can you take in what's called section 121? That's the capital gains tax exclusion for the sale of a primary residence. How much can you 1031 exchange? How does that tax deferred 1031 exchange- how does that all work? As you can see. It gets a lot more complicated. That's why you need tax advice.

[00:14:40] I want to finish up with the idea of figuring out like what's rental income and what's not. The IRS defines rental income as any payment you receive for the use or an occupation of property. Basically, that's rent from tenants who are in separate units, rent from roommates when you own the house, rent from your midterm tenants, renting out your parking space, renting out storage on your property renting out the the gazebo for a wedding, that sort of thing. So that's rent from real property.

[00:15:11] It's good to talk to your tax advisor again about how to treat things like renting out if you rent out your car on Truro, or you rent out an RV that you own, but it's parked in the yard. If you rent out your boat, et cetera, like some of that, it can be considered business income, not rental income, right? So you want to make sure that you're handling that the right way.

[00:15:33] For short term rentals, seven days or less, where the owner provides like substantial hosting services, like it's a bed and breakfast, for example. When you're renting your property on Airbnb, that might also be considered business income. So again, you have to you have to get some tax advice about this. 

[00:15:51] Homesharing, by the way, is not considered income. So those are situations like you're contributing to expenses to a home that you share with an unmarried partner, for example, or your mom lives with you and she gives you some money towards the household expenses. That's considered homesharing. That's not considered rental income in general.

[00:16:09] When you're house hacking it's always good to run the numbers. So whenever I have a client who's coming to me saying, okay, we're going to get started as real estate investors and homeowners at the same time, we'll run all of the numbers of the property for a year and we'll look at a best case scenario. We're also going to look at the worst case scenario, right? How much is that client going to be all in terms of monthly expenses if the tenant doesn't pay the rent or for some reason they can't rent it out, or their short term rental bookings are lower than expenses, or their rates go down or whatever. Don't just look at the best situation. Look at the worst possible situation so you can go into your house hack wide eyed and prepared. 

[00:16:50] When my oldest daughter, my stepdaughter was buying a property during the pandemic and we were chatting about this, I told her that if I could go back and redo one financial thing from when I was in my twenties is that I would have house hacked. I was living in an expensive neighborhood at the time, and it didn't seem like I could get together enough of a down payment to buy a home. If I could go back in time and change one thing differently, in terms of finances, like that's what I would do. I would go house hack. But the journey that I've had eventually led us to become real estate investors and that's worked out pretty well for us, and that's why I'm talking to you today.

[00:17:27] All right. Thank you friends. Talk to you next time.

If you like this video podcast, consider joining Real Life Planning’s Question of the Week where CERTIFIED FINANCIAL PLANNER™ and rental property business owner Cynthia Meyer answers the most common questions about real estate financial planning direct to your inbox each week. 

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