Black Market Renting – A Risky Strategy That Can Cost You

By Douglas Katz – 10/10/2023

Renting out your property can be a great way to earn extra income, but it’s crucial to do it the right way.  Some property owners attempt to skirt local and broader regulations by renting their properties illegally or in the black market. This is especially on the rise with the recent deluge of regulations and restrictions for short-term property rentals, but it is nothing new.  Where I live near Chicago, for example, I have seen in my twenty plus year career a lot of deals with illegal garden units. A lot of people see dollar signs but don’t think of fines or worse that can lay in wait.  In this article, we’ll explore the comprehensive risks associated with such practices and delve into the potential adverse outcomes that property owners may face.

Skirting Local Regulations and Fess

Skirting local regulations by renting your property illegally can expose you to significant risks. Local regulations exist to ensure the safety and well-being of both tenants and the community. They also offset liability for the municipality for potential lawsuits regarding existence or enforcement of regulations.

Municipalities also need to generate revenue to serve their residents.  Not paying the additional fees and charges associated with an investment property robs them of a source of revenue and this is rarely taken kindly. Unlike some other fees, the fees associated with rentals are usually unequivocally supported by the residents.

Ignoring these rules, fees and regulations can lead to a range of dire consequences, including financial losses and legal troubles.

  • Financial Consequences: Violating local regulations can result in substantial financial penalties. These fines can vary widely depending on your location and the specific regulations you’ve violated. In some cases, fines may accumulate daily until you comply with the rules, potentially causing severe financial strain.
  • Legal Liabilities: Renting your property illegally can lead to legal liabilities, including lawsuits from tenants. If tenants suffer harm or injuries due to unsafe conditions or code violations in your property, you may be held responsible for medical bills, pain and suffering, and legal fees.
Real Estate Tax Exemptions

Like ignoring regulations and fees, misclassifying your property’s use can puts you in peril with the municipality and other local governments.  Like the regulations, this is also a sin that angers your neighbors who see their property taxes steadily increase and see misusing the exemption as a source of the increases.  This can have significant tax-related repercussions, including penalties, back taxes, and unexpected consequences:

  • Penalties and Back Taxes: Misclassifying your property, such as claiming it as your primary residence while renting it out illegally, can result in penalties and back taxes. The taxing authorities may require you to pay the additional taxes you owe, along with fines and interest.
  • Political Implications:  Misclassifying property use can lead to unexpected consequences, such as the exposure of tax fraud during political campaigns or investigations. This may seem far fetched, but we have all seen it happen. This can harm your reputation and result in legal and financial repercussions.
Adverse Outcomes of Ignoring Safety Regulations

Ignoring safety regulations when renting out your property is not just risky; it can have life-altering consequences. Safety regulations exist to protect tenants and their families from harm, and disregarding them can result in tragedy.

  • Life-Threatening Situations: Failure to comply with safety regulations, such as not providing functional smoke detectors, can create life-threatening situations. In the event of a fire or other emergencies, tenants may not have the early warning they need to escape safely, potentially leading to injuries or even fatalities.
  • Criminal Charges: If safety violations in your property lead to harm or loss of life, you could face criminal charges, including manslaughter or negligence. Convictions in such cases can result in imprisonment and a permanent criminal record.
Short-Term Rentals and Changing Regulations

Renting out your property on short-term rental platforms like Airbnb has gained popularity, but it comes with its own set of risks, especially when regulations are evolving.

  • Financial Penalties: Many cities have implemented strict regulations on short-term rentals. If you violate these rules, you may face significant financial penalties, which can range from hundreds to thousands of dollars. Continuous violations could lead to escalating fines or even property seizure.
  • Legal Actions by Neighbors: Disgruntled neighbors or community associations may take legal action against you for disrupting the neighborhood’s peace and quiet, lowering property values, or violating homeowner association rules. This can result in costly legal battles and damage to your property’s reputation.
Insurance Policies and Coverage

Insurance is based on the assumption that the facts and data under which the policy was written did not change.  Changing the use from personal use to rental use changes the risk dynamics and coverage needs in a many ways.  When renting your property illegally, you run the risk of significant insurance-related consequences:

  • Loss of Insurance Coverage: Operating an illegal rental can result in the loss of your insurance coverage. If your insurance provider discovers that you’ve been renting your property illegally, they may void your policy. In such cases, if you experience property damage or other insurable events, your insurance company may deny your claim, leaving you solely responsible for repair or replacement costs.
  • Insufficient Coverage for Liability: Even if your insurance remains valid, it may not provide sufficient coverage for liability needs. If a tenant or visitor is injured on your property due to safety violations, your insurance policy might not cover the full extent of the legal expenses and damages awarded in a lawsuit. This could result in a severe financial burden that could jeopardize your financial stability.
  • Lawsuit Risks: Ignoring safety regulations can increase the likelihood of lawsuits from injured parties. If you lose a lawsuit and your insurance coverage falls short, you may face significant personal financial consequences, including the potential loss of assets.

Like an insurance policy, a mortgage is a document written based on the facts of the deal when you bought or last refinanced the property.  Many people confuse it with the note, which details the financial terms of the money that you borrowed.  The mortgage details the other aspects of the agreement and many prohibit changing the use.  Even those that do may require a set period of time under which the property is used as a personal residence before renting.  Renting your property illegally can also have repercussions regarding your mortgage:

  • Violation of Mortgage Terms: Most mortgages are drawn up with specific terms regarding the use of the property. For example, some mortgages are designed for personal use only and prohibit renting the property as an investment. Violating these terms by renting your property illegally can result in serious consequences. In some cases, your lender may have the right to call for immediate repayment of the entire loan balance, a process known as acceleration.
  • Restrictions on Title Changes: Mortgage agreements typically include clauses that restrict changing the title of the property without the approval of the mortgagee (the lender). Renting your property illegally may expose you to risks if your lender reviews your property’s use. During times of financial volatility or when mortgage companies seek to reduce their exposure, they may scrutinize property titles and use to their advantage, potentially causing issues or financial strain for property owners.
  • Added Cost: In the event that a lender determines that you did not meet the minimum time as a personal residence before renting, they can adjust the terms to meet the true planned use.  They cannot do this in a vacuum and without your consent, but when faced with the requirement to pay in full or consent to an adjustment, many people have no choice but to agree to the investment property pricing under which the loan should have been written in the first place.
Homeowners Associations

Homeowners associations can be notoriously restrictive and difficult to deal with.  Many have by-laws that limit or prohibit use of a property as a rental.  Some may have additional costs and requirements for use as a rental in the same way that a municipality would.  Renting your property illegally can also put you at odds with homeowners associations (HOAs), which have their own bylaws and rules governing property usage:

  • Bylaw Violations: Many HOAs have bylaws that prohibit or restrict renting out properties for certain periods or require approval for rental activities. Renting your property illegally can result in bylaw violations, subjecting you to penalties determined by the HOA. These penalties can range from fines to restrictions on using common facilities, and in severe cases, they may even force you to sell the property.
  • Friction with Neighbors: While by-laws can be a pain in the rear, they do exist to protect the owners or to maintain a particular vibe.  People complain about them but they usually support their general enforcement.  Thumbing your nose at these rules will make you a persona non grata in short order.
Do the Risks Outweigh the Reward

In the world of making money from property, it’s important to remember that trying to make more money by breaking the rules can lead to really big problems. It’s like trying to get more candy than you’re supposed to—you might end up with none at all.

We’ve talked about how trying to rent your place illegally or not following the rules can cause big troubles. Your insurance might not help if something bad happens, and you could end up owing a lot of money. Your mortgage, which is like a special loan for your house, could become a big problem too. You might even have to sell your property. Homeowners associations and taxes can be tricky too, and if you do things the wrong way, it can be really expensive.

So, when you’re thinking about making money from your property, remember that it’s important to be fair and follow the rules. Trying to get more money quickly can lead to big problems that can hurt you in the long run. It’s better to play it safe and make money the right way, even if it takes a bit longer.

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