How to Rent Your Home and Buy Another: Mortgage, Landlord, and Tax Rules

To rent your home and buy another, you need to clear four hurdles in order: confirm your current mortgage lets you convert the property to a rental, qualify for the new loan while carrying the old one, set up the rental to meet federal and local landlord rules, and plan for the tax changes that follow. Each step has specific requirements, and skipping any of them can cost you the deal or expose you to real legal risk.

Check Your Current Mortgage’s Occupancy Clause First

Most conventional mortgages require you to move into the property within 60 days of closing and live there as your primary residence for at least one year. If you haven’t reached that one-year mark, renting the home out without written consent from your lender can be treated as occupancy fraud.

Occupancy fraud is a federal crime. Anyone who knowingly makes a false statement to influence a mortgage lender, including misrepresenting how a property will be used, faces fines up to $1,000,000 and up to 30 years in prison.¹ Even without criminal prosecution, a lender that discovers the misrepresentation can accelerate the loan, demanding immediate repayment of the entire balance. Foreclosure can follow even if you’ve never missed a payment.

Genuine life changes create room for an exception. A job transfer, military deployment, divorce, or family health emergency may allow conversion before the one-year mark, but you should notify your lender in writing and keep a copy. Fannie Mae treats active-duty military members temporarily absent due to service as owner-occupants.² Disclosing a real change in circumstances protects you; concealing your true intent does not.

Qualifying for the Second Mortgage

Every mortgage lender is required to make a good-faith determination that you can repay the loan, weighing your income, existing debts, monthly payments on both properties, and credit history.³ Carrying two mortgages sharpens that scrutiny.

Debt-to-Income Ratio

The centerpiece is your debt-to-income (DTI) ratio: the percentage of your gross monthly income eaten up by all debt payments combined, including principal, interest, taxes, and insurance on both homes plus car loans, student loans, and credit cards. Fannie Mae caps DTI at 50 percent for loans run through its automated underwriting system. Manually underwritten loans have a stricter 36 percent baseline that can stretch to 45 percent for borrowers with higher credit scores and cash reserves.⁴ Adding the full payment on the departing residence to your existing debts often pushes borrowers to the edge of these limits, which is why the rental income offset matters so much.

Cash Reserves

Lenders want to see liquid assets, such as savings, investments, or retirement funds, as a safety net. When your current home becomes an investment property, Fannie Mae requires six months of mortgage payments (including taxes and insurance) in reserves for that property. If you own additional financed properties beyond your new home and the rental, you’ll need reserves equal to 2 percent of the combined outstanding loan balances on those other properties.⁵ A one-unit primary residence purchase has no minimum reserve requirement on its own, but the investment property requirement can represent a significant cash obligation.

Equity in the Home You’re Keeping

Fannie Mae does not require a specific equity percentage in the departing residence. Equity still matters in practical terms: the less you owe relative to value, the lower your monthly payment on that property, which directly improves your DTI and eases qualification for the new loan. A professional appraisal helps the new lender assess the overall risk.

How Rental Income Is Counted

Expected rent from the departing residence can offset the mortgage payment on that property. Fannie Mae and Freddie Mac apply a 75 percent rule: only three-quarters of the gross monthly rent counts as qualifying income, with the remaining 25 percent held back for vacancy and maintenance.⁶

The lender then subtracts the full monthly payment on that home (principal, interest, taxes, insurance, and any HOA dues) from the 75 percent figure. A positive result adds to qualifying income; a negative result becomes a monthly debt.⁷ If the lease is $2,000 per month, the lender credits $1,500. If the full payment is $1,400, you net $100 in your favor. If the payment is $1,800, you carry a $300 monthly liability.

How much of that income you actually get to use depends on your landlord history. With documented property management experience and a housing payment on your new primary residence, the rental income faces no extra restrictions. Without that experience, the rental income can only offset the departing property’s own payment, not boost your overall qualifying income. If you won’t have a primary housing expense at all, such as when you plan to live rent-free with family, no rental income from the departing home can be counted.⁶

The Rent Verification Appraisal

To confirm the rent you’re charging is realistic, your lender will typically require a professional appraiser to complete Fannie Mae Form 1007, the Single-Family Comparable Rent Schedule, whenever you’re using rental income to qualify and the departing residence is a one-unit property.⁸ The appraiser looks at comparable rentals to determine fair market rent.⁹ The lender uses the lower of the appraiser’s estimate or your actual lease amount in the 75 percent math. Set rent at $2,200 with a $2,000 market estimate, and the calculation runs on $2,000.

Setting Up the Rental

Once you convert the property, obligations that never applied while you lived there kick in. Getting them right protects your investment and your loan approval, because the lender will review your lease during underwriting.

The Lease Agreement

You need a written lease that identifies the tenants, the property address, the monthly rent, the lease term, and which party pays for utilities, lawn care, and other specific costs. Standardized lease forms from real estate associations cover most required clauses, but confirm the agreement complies with your local landlord-tenant laws. The signed lease is the primary document your new mortgage lender uses to verify expected rental income.

Landlord Insurance

A standard homeowner’s policy doesn’t cover a property you’re renting out. You’ll need to switch to a landlord policy (sometimes called a dwelling fire or rental property policy). It covers the structure, provides liability protection if a tenant or visitor is injured, and can compensate you for lost rent if the property becomes uninhabitable. Failing to make the switch can lead to denied claims or canceled coverage.

Security Deposits

Most jurisdictions regulate how much you can collect as a security deposit, how you must hold it, and when you must return it. Many require the funds to sit in a separate account rather than mixed with your personal money. Deadlines for returning unused portions after a tenant vacates vary but are strictly enforced, and violations can lead to penalties or lawsuits. Check your local and state statutes before collecting anything.

Rental Registration

Some cities and counties require landlords to register rental properties and pay an annual fee before leasing to tenants. Fees vary widely. Registration may trigger an initial property inspection. Contact your local housing or code enforcement office to find out whether your area has a requirement.

Federal Landlord Rules That Apply Everywhere

Two federal laws apply to almost every landlord. Violating either one can lead to fines, lawsuits, and the loss of your ability to rent the property.

Fair Housing Act

Federal law prohibits discrimination against tenants or prospective tenants based on race, color, religion, sex, national origin, familial status, or disability. The prohibition covers every stage of the rental process: advertising, screening, setting lease terms, and providing services. You cannot advertise a preference for tenants without children, for example, or refuse to rent to someone because of their national origin. You are also required to allow tenants with disabilities to make reasonable modifications at their own expense and to make reasonable accommodations in your rules or policies when needed for a person with a disability to fully use the home.¹⁰ Many states and cities add protected classes beyond the federal list.

Lead Paint Disclosure

If your home was built before 1978, federal law requires you to provide every new tenant with specific lead-paint information before they sign a lease. You must give the tenant a copy of the EPA pamphlet “Protect Your Family from Lead in Your Home,” disclose any known lead-based paint or hazards in the property, and share any existing inspection reports.¹¹ The lease must include a signed lead warning statement, and you must keep a copy of these signed disclosures for at least three years after the lease begins.¹² The law does not require you to test for or remove lead paint. It only requires you to disclose what you know.

Tax Changes When Your Home Becomes a Rental

Converting your home to a rental changes its tax treatment in several ways. Understanding the changes in advance helps you plan for both the yearly benefits and the potential hit when you sell.

Reporting Rental Income and Expenses

You report rental income and deductible expenses on Schedule E of your federal return. Deductible expenses include mortgage interest, property taxes, insurance premiums, repairs, management fees, and advertising.¹³ Mortgage interest on a rental is deducted as a business expense on Schedule E and is not subject to the $750,000 acquisition debt cap that applies to personal residences.¹⁴ Costs that improve the property rather than maintain it, such as a new roof or a kitchen remodel, must be capitalized and depreciated rather than deducted in the year you pay them.

Depreciation

You are required to depreciate the building (not the land) over 27.5 years under the standard MACRS method, whether or not the property is actually losing value.¹⁵ Your depreciable basis is generally the lower of your adjusted purchase price or the property’s fair market value on the date you convert it, minus the value of the land. Depreciation reduces your taxable rental income each year, but it creates a future tax bill when you sell.

Depreciation Recapture at Sale

When you sell a property you’ve depreciated, the IRS recaptures the depreciation deductions you claimed (or should have claimed) by taxing that portion of the gain at a maximum rate of 25 percent, regardless of your regular income tax bracket.¹⁶ Remaining gain is taxed at the standard long-term capital gains rate. Recapture applies even if you skipped depreciation deductions in some years, because the IRS treats the depreciation as “allowed or allowable.”

The Capital Gains Exclusion Clock

Homeowners who sell a primary residence can exclude up to $250,000 in capital gains from federal income tax ($500,000 for married couples filing jointly), provided they owned and used the home as their principal residence for at least two of the five years before the sale.¹⁷ When you convert your home to a rental, the clock keeps ticking. Sell within three years of moving out, and you can still meet the two-out-of-five test and claim the exclusion on the portion of gain not attributed to depreciation.

Wait too long and you lose the exclusion entirely. Any gain allocated to “periods of nonqualified use,” meaning time after 2008 when the property was not your principal residence, is not eligible for the exclusion.¹⁷ The gain allocated to nonqualified use is calculated from the ratio of nonqualified-use time to total ownership time. The longer you rent the property before selling, the smaller the excludable portion becomes.

Mortgage Interest on the New Home

For your new primary residence, mortgage interest is deductible as an itemized deduction on Schedule A. If you took out the loan after December 15, 2017, the interest is deductible on up to $750,000 of acquisition debt ($375,000 if married filing separately).¹⁴ That limit applies only to the personal residence debt. Interest on the rental property mortgage runs separately through Schedule E.

1
Office of the Law Revision Counsel. 18 U.S. Code 1014 – Loan and Credit Applications Generally
2
Fannie Mae. Occupancy Types
3
eCFR. 12 CFR 1026.43 – Minimum Standards for Transactions Secured by a Dwelling
4
Fannie Mae. B3-6-02, Debt-to-Income Ratios
5
Fannie Mae. Minimum Reserve Requirements
6
Fannie Mae. B3-3.1-08, Rental Income
7
Fannie Mae. Income from Rental Property in DU
8
Fannie Mae. Appraisal Report Forms and Exhibits
9
Fannie Mae. Single-Family Comparable Rent Schedule – Form 1007
10
Office of the Law Revision Counsel. 42 USC 3604 – Discrimination in the Sale or Rental of Housing
11
Office of the Law Revision Counsel. 42 U.S. Code 4852d – Disclosure of Information Concerning Lead Upon Transfer of Residential Property
12
U.S. EPA. Lead-Based Paint Disclosure Rule Fact Sheet
13
Internal Revenue Service. Instructions for Schedule E (Form 1040)
14
Internal Revenue Service. Real Estate Taxes, Mortgage Interest, Points, Other Property Expenses
15
Internal Revenue Service. Publication 527 – Residential Rental Property
16
Internal Revenue Service. Property (Basis, Sale of Home, Etc.)
17
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain from Sale of Principal Residence