Houses are only getting more expensive, and as more physicians debate how much house they can afford in the early stages of their career and express a desire to develop passive revenue streams through real estate, the concept of house hacking has come up more frequently in our physician communities. Essentially, this real estate strategy involves buying a property, living in one part of it, and renting out part of the property. By doing this, you are able to significantly reduce (or potentially even eliminate!) the costs associated with your mortgage and many living expenses. While it may not be ideal for everyone, it offers first time home buyers the opportunity to buy a house earlier, get a bigger house than they may otherwise be able to afford, or free up room in their budgets for other expenses or savings. It also allows you to take some tax deductions related to your business and rental activity, and jumpstart your real estate investments. Below, we’ll cover the basics, who should consider it, pros and cons, tax considerations, and how to get started if you decide it’s right for you.
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What is House Hacking?
House hacking involves buying a home, living in one part of it, and renting out the rest. For those at early stages of their careers, it can be a creative way to buy your first home as well as get started with real estate investing, as it allows you to both help finance your home and get some of the benefits of real estate investing.
It can be done with a single family home, a duplex, or a multi-unit property. Additionally, you can do a long term rental arrangement, or you could use a portion of (or all of) your house for short term rentals for vacation stays. This is especially plausible for those families who can easily spend the weekend with family or friends if they get a lucrative offer to rent their house for a few days.
What are the Pros / Advantages of House Hacking?
Allows you to buy a bigger house or buy a house earlier than anticipated
Especially in higher cost of living areas, many physicians struggle with the concept of being house poor by spending too much money on a house. We have some guidelines for how much house you can afford, and when we post these on the physician communities, many quickly point out that it is hard to fathom finding a reasonable house that fits these criteria in high cost of living areas at the beginning of your career. By renting out a portion of your house, you can have someone else help shoulder some of the ongoing costs of home ownership, thus allowing you to afford a house you may not otherwise be able to provided that you can come up with the necessary down payment or qualify for a physician loan.
Lower your monthly expenses through house hacking and free up room in your budget
By renting out a percentage of your property to someone else, you lower the effective cost of your mortgage and housing costs to you, and free up some room in your budget. This can allow you to check off a lot of the basics of physician personal finance much earlier in your career, including maxing out your retirement accounts, funding your HSAs and 529s early for maximal tax advantaged growth, maintaining a healthy emergency fund, and paying off those student loans faster. Or, if you’re already able to do all those things, it can allow you to spend less on housing and have more money for things that alleviate physician burnout, like going out to eat more, spending more time on an expensive hobby, or taking more bucket list vacations.
Get started with real estate investing and establish passive income
Many physicians are interested in the benefits of real estate investing, but are very nervous about where to start. They worry about what it’s like to manage tenants, do maintenance, etc. House hacking offers the opportunity to get a taste of what it would be like to have a long term rental property without having to manage something from afar (or a short term rental property, for that matter, as some will elect to rent out part of their houses for vacation stays).
As your savings grow or as you enter another stage in life where you may no longer want to share a portion of your home, you can transition this property to a cash-flowing rental property while you buy your own single family home (or you can just stop renting out part of the home and keep this one to yourself once you can more comfortably afford it).
Pay off your mortgage quicker or eventually lower monthly payments
Maybe you just want to accelerate your pathway towards financial independence and financial freedom. With the extra money coming in that you can direct towards the mortgage, you may elect to actually pay above your required monthly mortgage payments to pay down the mortgage faster. As you do this, you can then consider recasting the mortgage to make your monthly payments lower and more affordable as you scale back from clinical work or refinancing the mortgage when the loan amount shifts from a jumbo mortgage to regular mortgage range.
In general, this approach will lower the risk of buying that bigger house, and you can use it at earlier stages of your career. For example, it may be a great strategy for a young physician family without children, with the goal of paying down the mortgage faster, and then no longer renting it when you add children to your family.
Tax deductions from shared expenses or related to rental activity
Since you are running a business, you’ll be able to take advantage of tax deductions related to the rental activity. Read more about this in the section on house hacking and taxes below.
What are the Cons / Disadvantages of House Hacking?
People living in your home
This is the most obvious con. Many of us consider our home our personal space, and don’t want to have other people with access to their home in any form, even if there are separate entrances and separate living spaces.
Having your tenants know so much about you
In general, most people who invest in real estate try to implement some asset protection strategies or use a property management company so that the tenants maintain some distance and don’t know as much about their personal situation. Obviously, this is much harder to do when they’re living on your property.
Having to choose a property that lends itself to house hacking
Not all properties are going to be amenable to house hacking. If there’s only one entry point, one kitchen, or one master bedroom, or you’re not excited about the idea of sharing other common spaces or parking, this will create challenges. While many physicians choose to buy duplexes or other multi-unit properties with the goal of eventually moving out and renting that space as well, if your goal is to buy a property that you will eventually occupy yourself, you may have a hard time finding one where you can transform the space. When people buy single family homes for this purpose, they often buy one with an in-law suite or separate living space above a garage or in a pool house that may be intended for a nanny. Consider carefully the costs of renovation and/or having to undo the renovations later if you want to use that house just for yourself when considering this strategy.
The other thing to keep in mind is local zoning or HOA regulations, as these may preclude you from house hacking.
Different Ways to House Hack
Rent out a room or rooms, or an Accessory Dwelling Unit (ADU)
If you have extra bedrooms in your house, you can just rent out individual rooms. This will likely require you to share common areas in your living space like your kitchen, which many people may not be okay with. If it’s a known tenant who’s family or a friend, you may find this more palatable.
Alternatively, if you have an accessory dwelling unit on your property (like a dedicated in law or grandparents suite or a space above a detached garage or in the pool house), this can be an easy conversion to a rental unit. This usually won’t require as significant renovations, and will preclude some privacy issues associated with having someone inside your main home.
Regardless, make sure you establish house rules for noise, guests, and otherwise to impact your daily life as minimally as possible. Also make sure you check local HOA regulations.
Rent out the other half of your duplex or the other units in a multi-unit property
Duplexes are popping up more and more in urban areas where housing lots are not available. Many real estate developers will buy up a bigger plot of land with a smaller single family home and put up a duplex or even a triplex or fourplex. Additionally, there are many properties in urban areas where each floor of a building is an individual unit.
The nice thing about this approach is that you have more privacy since every unit is intended to exist on its own. This will also command more rent per unit, and allow you to eventually move away and rent out your unit as well. It can be a great way to scale a real estate portfolio but use the same management team for all of the units.
The main challenge with this approach is the higher initial investment required to purchase a multi-unit property. Additionally, managing multiple units can be more time-consuming and complex, especially if you’re new to being a landlord. It’s important to consider the additional responsibilities and upfront costs when deciding if this type of house hacking is right for you.
Short term rentals
This can be a particularly lucrative house hacking strategy, while still allowing you to maintain your privacy when you want it. Posting your house or portions of it for rent on short term rental platforms like VRBO or Airbnb in areas where tourists or corporate entities are often looking for stays can result in significant income, as you can generally charge much higher rates per night.
You will of course have to be willing to do the things associated with having a short term rental, like marketing the property, arranging stays and communicating with guests, and cleaning the property after use. Your HOA and local regulations will also need to be amenable to this.
Learn more about short term rentals.
How to Get Started with House Hacking
If you’re considering utilizing this strategy, there are several steps to be aware of when getting started.
Run your numbers and figure out financing
It’ll be important to do the math here on multiple levels. First, you need to know what kind of down payment you can afford or how large of a 0% down physician mortgage you qualify for to figure out how you can afford to spend on the property.
There are also more creative ways to finance this as you also qualify as an owner-occupant, so you can also look at options outside of conventional mortgage loans. These include homebuyer-assistance programs like the Federal Housing Administration (FHA) loan for multifamily properties with up to four units. This can have a very low down payment (<5%).
Next you’ll want to figure out what properties in your area can rent for, and compare that with your monthly budget for mortgage yourself. You can find this information by talking to a Realtor or by searching sites such as Zillow to see what properties in your desired areas with similar characteristics are renting for. Add those two together and plug them into the How Much House You Can Afford guidelines.
Find a property appropriate for house hacking that also fits your needs
Any time you purchase an investment property, there’s a lot of criteria you need to consider, such as the demand for rentals in the area, whether a property cashflows, access to public transportation and other amenities like a shopping center, and more. You’ll have to think of these when picking your location. This becomes especially important if you’re eventually going to move out and rent the whole property.
However, since you’re also going to be living in the property, you’re going to have a lot more considerations about which properties fit the house hacking model. This means you will also need:
A house that is amenable to a separate living space or that can easily be converted to one. If this is a duplex or multi-unit property, this is more straightforward. But if not, you’ll need a home that has either an accessory dwelling unit (ADU) such as an in law or grandparents or nanny suite, a finished basement, a floorplan with areas that can be partitioned off or lots of extra bedrooms, and/or places that can be converted to fit your needs where you can add bathrooms or mini kitchens or a common living space.
HOA rules and local regulations that allow you to house hack.
An area where you would also like to live. Many physicians buy rental properties in areas where they themselves wouldn’t necessarily want to live, but in this case, you need it to work for your family’s needs as well. Factors such as proximity to your jobs and access to good school districts may heavily weigh in on this.
Run the final numbers to make sure house hacking still makes sense
Once you’ve found the actual property that you want, circle back to your projections and do the numbers more concretely with direct comps on rental prices and by plugging the numbers into your affordability calculators for your budget and housing needs. Make sure that you include the costs of insurance, maintenance, property taxes, utilities, etc., as well as leave a buffer for times that the property may not be rented.
Find a mortgage lender and close on your property
You’re ready to move forward! If you need help finding a mortgage, we have a comprehensive list of mortgage lenders and agents that are used to working with physicians that have experience in these areas.
Explore mortgage lenders for physicians.
Find a tenant (or tenants)
Now it’s time to find tenants. You can get these through your personal networks, your local hospital system if there’s an academic medical center nearby, or by advertising through a site like Zillow or using a realtor. Make sure you interview the tenants very carefully, as remember, you (and your family if applicable) are going to be sharing a living space or common areas with them. This is not something where you want to take your real estate agent’s word for compatibility or rent to someone without meeting them in person, as any tenant conflicts or issues will likely come to you first.
House Hacking and Taxes
This is a complex topic, and you’ll want to discuss it with your accountant as well as reference changing IRS guidelines and rules regularly. You will typically report income and expenses related to house hacking on the Schedule E form on your taxes as supplemental income and losses. Depreciation, if you take it, will also be reported here.
Keep personal and business expenses separate
It goes without saying that you cannot deduct personal expenses for your home, but as you are running a business by renting a portion of your house, you will have some tax-deductible expenses. This can get very confusing when you are co-mingling your living situation with your rental property.
The first thing to do is determine what percentage of the property is occupied by you and what percentage is occupied by the tenant(s), which will factor into which tax deductions you can take and how much. This is often done by square footage.
Any maintenance or repair costs on the rented areas of your property or the common areas can be fully or partially deducted, depending on how much is allocated to you versus the renters.
You can also deduct a proportionate percentage of your insurance premiums, mortgage payments, and other expenses (see the section on potential deductions with house hacking below). Talking to your accountant will make sure you stay above board on this.
Potential deductions with house hacking
Keeping in mind the disclaimer about how much can be deducted based on the percentage for personal and rental use, these are potential deductions you may be eligible for:
Mortgage interest
Home Insurance
Property Taxes
Repairs and maintenance
Furniture, Appliances, and other items necessary to make the spaces livable or attractive for rental
Utilities and Services such as security systems, window treatments, internet, etc.
As charging your tenants for utilities separately may be challenging or impractical in this case, you may elect to pay for the utilities and deduct a portion
Advertising or Realtor Fees
HOA Fees
Depreciation (talk to your accountant about the pros and cons of doing this)
Keep careful records of all related expenses and income
Because there’s a lot of grey areas or potential for abuse here, you’ll want to keep careful and accurate records to support your claims if you are audited.
This includes records, receipts, and documentation for repairs, maintenance, furniture, appliances, and improvements that you make. If you use your car or computers, etc. to perform duties related to maintenance or the business, track the mileage and times that you spent on rental related activities.
Also record all security deposits, rent payments, and other income that you may receive from tenants with dates and copies of the receipts.
Also keep records of what you’re paying out of your pocket for the house, like insurance payments, property taxes, HVAC maintenance services, internet, security systems, etc.
If you’re taking depreciation, create a schedule with the advice of your accountant/tax professional.
Be aware of long term consequences on capital gains and depreciation at the time of sale
Normally when you sell a rental property, you have to pay capital gains taxes. Additionally, if you depreciated the property for the tax benefits, you’ll have to deal with the depreciation recapture taxes. Talk to your accountant about how this may apply to you depending on how long you intend to live in the house and/or hold the property.
Conclusion
House hacking is a unique strategy used by some early career physicians on our communities to be able to buy their first house or get started with real estate investing. While some continue this strategy well into their attending lives, we more typically see doctors eventually getting other renters for that space or selling those properties as they eventually transition to a single family home, or ceasing to rent out their houses as their family or financial situation evolves. If you do use this strategy, make sure you’re aware of the pitfalls and navigate them carefully, but also enjoy the benefits of lower housing costs and a faster path to financial freedom!
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