Rental units can be a great way to build an income stream. You’ll find that rental income is typically less active than a day job. But it will still require some planning and effort to get the ball rolling.
As you start to build your real estate portfolio, it is important to understand exactly what rental income is and how it can affect your finances. Here’s what you need to know.
What type of income is rental?
According to the IRS, rental income is any income that you receive for the use or occupation of property. Essentially, if you are renting out space to a tenant of any kind, that income would qualify as rental income.
You might be renting out space on a short-term or long-term basis to commercial or residential tenants. But as long as you are receiving a payment for the tenant to use the space, you’ll need to claim this as rental income.
Is rental income passive income?
Rental income is often thought of as a passive investment. Although some rental income arrangements are passive, not all rental income is completely passive. In most cases, there will be some form of interaction with the property that creates a little bit of active work.
If you are actively managing your properties, then rental income will not feel passive at all. You might find it more passive than a regular day job. In fact, you will likely have busy periods of turning over the unit between tenants.
If you want a more passive rental income experience, then you can hire a property manager. With a competent property manager in place, you can take a more hands-off approach to the property. However, you should still expect to do some upfront work to find the right property manager for your situation. Check out what questions you should ask before you hire a property manager to minimize any future headaches.
Is rental income an asset?
Rental income is not an asset. Instead, rental income is income that you can produce with the help of an asset. However, the income you receive from a rental unit is not an asset by itself.
Do you have to report rental income to the IRS?
If you are bringing a rental income, then you will need to report this to the IRS at tax time. The income you receive from a rental will impact your total tax liabilities for the year.
In many cases, you’ll be able to deduct the expenses of maintaining a rental property. This can help to lower your overall tax burden. Of course, everyone’s tax situation is different. With that, you should seek the guidance of a tax professional when considering your tax planning strategies.
How to generate rental income
If you are interested in generating real income, then you can take steps to start today. Here’s what you’ll need to do.
First, you’ll need to find the space that you can rent out.
In some cases, you might be able to pursue house hacking by renting out space in your current home. If you own your home, take a look around to see if there are any suitable areas for a tenant. You might be able to set up a separate space for more privacy or simply rent out extra bedrooms. House hacking can be a viable way to start producing a rental income immediately.
If house hacking isn’t possible in your current situation, then you will need to find a property to rent out. You could look for any property that is able to produce a rental income. Take some time to learn about the rental market in your target area before diving in. You may want to expand your search to include locations with a better return on investment.
After you’ve located a property that will work for you, it’s time to close. Luckily, there are numerous financing opportunities to help you get started. This is especially true if you are seeking out a property that you plan to house hack. As an owner-occupant, you can unlock very attractive financing. But there are still opportunities for investors if you are willing to look. For example, owner financing could be a good option.
You’ve closed on the property – now what? You may need to spend some time updating the space. However, this will depend on the property.
Once the updates are complete, you can look for tenants to fill the space. You can seek out tenants in various ways, including Facebook Marketplace, Craigslist, word of mouth, a property manager, and more.
Don’t be afraid to get creative when looking for tenants. You might decide to pursue short-term rental strategies through Airbnb or VRBO instead of a long-term arrangement depending on your inclination and the opportunities in your area.
Before you allow a potential long-term tenant to sign a lease, make sure they are able to meet your criteria. You may want to run a credit check and verify their income to ensure they’ll be able to afford rent. You don’t want to end up with a tenant who cannot keep up with their monthly rent payments.
Once you have tenants in place, hopefully, collecting rent is a breeze. A bad tenant can make this part difficult. But you can set up self-managed systems to easily accept rent payments. Or consider working with a property manager to avoid the hassle of collecting rent.
Maintain the property
Although this is not technically required to build a rental income stream, it is vital to maintain the property if you want the rental income to continue flowing. Tenants expect a clean and safe place to live. Take the time to ensure that the property is well maintained.
A strong desire to provide a nice home for your tenants will likely lead to better returns over time. After all, many of us would be willing to pay more in rent for a well-maintained place over the years.
The bottom line
Rental income can be a boon to your income. With this increase in somewhat passive income, you’ll find that you have more financial freedom. Over time, you can build a real estate portfolio that generates more and more rental income.
Luckily, anyone can get started in real estate. Not sure how to dive in? Check out our guide to real estate investing for beginners.