Home Insurance when Renting to a Family Member
If you own a second or third home and a family member is looking for a place to stay... well... you know the rest. Given high home prices and lagging wage growth, nearly one-third of adults between the ages of 18-34 are living with their parents. It makes sense that renting to a loved one is a situation that many homeowners, parents, aunts, uncles, and grandparents are currently facing.
Once you’ve decided to rent to a family member, you need to get the right home insurance coverage so you aren’t out any money if a claim occurs.
But with so many types of home insurance options to choose from, which policy should you get?
HO3 vs DP3
The main types of homeowners insurance policies are Homeowners (HO3) and Dwelling Fire (DP3). To decide which one is best for your rental, it helps to understand the difference between the two.
HO3 policies are the policies of choice for most homeowners. HO3 covers the main structure, including the structures that are attached and those not attached to the home, personal items in the home, and the cost of renting another property when the home is not usable. It also covers you if you are sued for an accident and if someone gets hurt on your property. You can get away buying the HO3 if you are not charging rent, only family members live there, and you visit the home somewhat regularly. Or if you also live in the unit full time, you can still charge rent and get a DP3. However, your tenant, must get a HO4 to cover their personal property and liability.
The DP3 is known as the landlord policy is an insurance policy that covers a residential building that is used as a rental. Standard DP3 policies only cover the home structure and your liability. If you choose this type of coverage for a rental, your tenant needs to get an HO4 policy for renters to insure their personal property and cover their personal liability. If you are charging rent, most home insurance carriers will REQUIRE you to get a DP3. (they will not offer the HO3)
Charging a Relative Rent vs Letting Them Live There for Free (Taxes)
It can be tempting to let a family live at your property rent-free, and sometimes it can be the right decision. However, in almost all cases, you should charge rent. Not only that, you should avoid giving your relative too large of a discount on what they pay. Expecting someone to contribute is not too much to ask. In fact, in the U.K., over half of adult children living at home contribute to the household mortgage and expenses. Some might say the UK is a more "mature" economy and this will become more commonplace in the US.
Why not let your family live rent-free? Taxes. For starters, if you don’t collect rent or charge too far below fair-market value (up to 20 percent is typically allowed), your home will be considered a personal residence rather than a rental. While that is a great from an insurance perspective (the HO3 is back on the table, and gives more coverage than DP3), it can have a huge negative consequence come tax day.
If you don’t charge any rent, you cannot claim your property as a rental. If you charge way under fair-market value, it can be even worse. Not only will you have to claim the rent as income, but you likely won’t be able to claim deductions for the upkeep of the property; deductions that you would get if it was considered a rental. In short, you are best off charging family members somewhere close to what you would charge anyone else for rent.
Disclosure: The above is not tax advice. Consult a licensed tax accountant for advice on tax-related decisions.
Mixing family and business is complicated no matter what. Ideally, you charge your family members close to market rents, purchase a DP3 insurance policy, and ask your family members to carry their own HO4 renters policy for all belongings in the household and their personal liability. If charging rent is not an option, it is better to get the HO3 policy which includes more coverage as long as you visit the residence somewhat regularly. Oftentimes the cost of the HO3 can even be cheaper than the DP3.
Hope that helps!
At your service,