What to know if you rent out your house (© Bartomeu Amengual/age fotostock))

Q: I will be transferred to a new city soon for my job, but housing prices have dropped so much since we bought our house that we can’t afford to sell it. Our only real option is to rent it out and wait for the market to recover. What do I need to know about insurance and taxes?

A: First on your to-do list: Replace your homeowners insurance policy with rental-home insurance. It covers the building and provides liability protection but doesn’t cover possessions. In some cases, it can cost less than a regular homeowners policy, but don't be surprised if it's more expensive. The fact that the owner is not occupying and caring for the property can drive up the price, says June Walbert, of insurer USAA. She also recommends including a section in the lease requiring your tenants to buy renters insurance, which will cover their liability and belongings.

BingIs rent-to-own a good idea?

When you file your tax return, you’ll generally report rental income and expenses on Schedule E. You’ll be able to deduct your mortgage interest on the rental property, as well as insurance premiums, real estate taxes, advertising costs to rent the house, rental management fees, utilities you pay, travel to and from the property and legal and accounting costs.

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And you can deduct depreciation -- basically the purchase price of the house (but not the land) divided by 27.5 each year -- and the cost of repairs. You can’t deduct home improvements that add value to the property, but you add the cost of improvements when figuring depreciation. If your expenses exceed your rental income, you can deduct up to $25,000 of the loss against other kinds of income. (That loss allowance declines if your income is more than $100,000.)

Keep a close eye on the calendar, recommends Mark Luscombe, of CCH Tax and Accounting. If you rent for more than three years, you’ll lose the opportunity to claim any tax-free profit from the eventual sale. To qualify for up to $500,000 in profit tax-free when you sell a home, you generally must have lived in it for two of the five years leading up to the sale. For more details, see IRS Publication 527, Residential Rental Property.

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