Even as fears about COVID-19 are starting to subside, the short-term rental sector that thrived during the pandemic is still growing. Owners of rental properties are generally aware that the money from the rental activity may be subject to income tax; but, when substantial guest amenities are included with the rental, owners may be unaware that the rental income may also be liable to self-employment tax. The following points should be taken into consideration if you are thinking of investing in short-term rental properties.
Short-term rentals typically allow you to generate a better monthly rental income than a rental with a 12-month contract. In addition, with a short-term rental, an investor can easily raise the rent price to reflect the market rate, boosting gross rental income. Depending on the local market’s conditions and demand, a short-term property may provide 2-3 times more monthly rent than a long-term rental property. Due to this, real estate investors are drawn to short-term rentals.
A short-term rental can be treated as a business activity. If you provide substantial services to your guests, then the short-term rental income is considered active income, not passive income. When you are actively working in a business, your income is reported on a Schedule C and is subject to an additional self-employment tax of 15.3%.
Generally, you will file Schedule C for your short-term vacation rental if:
- the average period of customer use of the property is 7 days or less and you provide substantial services. You figure the average period of customer use by dividing the total number of days in all rental periods by the number of rentals during the tax year; or
- the average period of customer use of the property is 30 days or less and you provide substantial personal services with the rentals.
Substantial services include things like housekeeping while the apartment is occupied. You may be regarded as a passive owner for tax purposes if you merely clean the apartment in-between visits. Even if you perform the maintenance personally, it is not considered a substantial service.
The following are a few examples of “substantial” services:
- Daily cleaning of the rental when the same visitors are staying there.
- Daily bed linen and other linen changes while the same visitors are staying on the property.
- Concierge services.
- Organizing visitor excursions and trips.
- Serving food and providing entertainment (like providing breakfast each morning).
- Arranging transportation.
- Offering other “hotel-like” services
Long Term Rentals
Other real estate investors that want to generate more predictable passive income do so through long-term rentals. Passive income can be made from a rental activity where the person is not actively involved in day-to-day business operations. One of the biggest advantages of having passive income is that you won’t be required to pay self-employment tax on the rental income. The income is reported on Schedule E.
However, you are subject to passive activity rules, which allow taxpayers to deduct up to $25,000 in passive losses against ordinary income (if MAGI is $100,000 or less). Taxpayers are given this special allowance as long as they don’t materially participate in rental activity but only actively participate. Approving new tenants, setting rental terms, approving expenditures, and other similar actions are examples of management decisions that count as active participation.
Mixed-Use Rental Property
When the rental property is not personally used by you or your family during the year, all associated expenses are fully deductible. However, there may be limitations on the rental expenses you can write off if you rent out a home that you also use as a personal residence. The IRS will designate a dwelling unit as a personal residence if you use it for personal purposes for more than 14 days during the tax year or for more than 10% of the total days you rent the property to guests at a fair market price (whichever is greater).
Generally, you must split your total expenses between personal and rental use based on the number of days spent for each purpose if you use the dwelling for both personal and rental purposes. If your total rental expenses exceed your total rental income it can’t be deducted but may be carried over to the following year.
Maintain thorough records for tax purposes and treat your rental property like a business. This can help you avoid tax problems and make it much simpler to prorate or separate personal from business expenses. Additionally, doing this will guarantee that your tax savings are accurate.
State Income Tax
If you have rental income from a rental property outside of your home state, you might be required to file a nonresident state income tax return in the other state. Although not all states impose income taxes, those that do will need you to declare any income you earn there and pay your fair amount of taxes. In order to prevent double taxation, the majority of states offer a tax credit for taxes paid in another state. State-specific requirements will differ; the main thing to remember is that you’ll need to consider the location of your rental property rather than your home residence.
Owners of rental properties may be required to pay a lodging tax in some states or localities. The lodging tax may also go by the terms stay tax, occupancy tax, room tax, sales tax, transient occupancy tax, tourist tax, or hotel tax, depending on the location. Any potential lodging taxes owed are separate from your income tax liability for earnings from short-term rentals. The majority of states have statewide lodging taxes, and many of those states also permit cities and counties to impose additional taxes. You must check with your state, city, and county to determine if any local lodging taxes are owed that your rental platform does not collect. The location of your property will determine whether you must pay your lodging taxes monthly or quarterly. Many localities require you to submit on a regular basis after you register, even if there is no rental revenue to report or any tax owed at the time.
Tax-Free Rental Income
It’s possible that you won’t owe any tax on the rental income if you personally utilized the rental property and only infrequently rented it out. You must have rented the property for 14 days or less during the year at fair market value. The rental income will not be reported on Schedule C or Schedule E.
In 2021, all US businesses that process payments, including Airbnb, were required by the US Internal Revenue Service (IRS) to disclose the earnings of any US customers who made over $20,000 and completed more than 200 transactions over a calendar year.
Starting January 1, 2022, the companies will send you a Form 1099-K if your annual earnings exceed $600 in a calendar year with no transaction minimum. The new rule will give the IRS data needed to verify what you report.
How we can help
Since there are still numerous gray areas of law where short-term rentals are concerned, it is important to stay up to date and consult with your dedicated tax professional. They’ll assist you in taking proactive measures to lessen your tax liability. Additionally, they will ensure that your record-keeping practices keep you compliant.
Tax Planning Services
Eco-Tax offers affordable tax planning and preparation packages. When working with Eco-Tax, you will be paired with an experienced CPA (certified public accountant) or EA (licensed enrolled agent) tax consultant who are experts in both your industry and your state. Your dedicated tax consultant will be your trusted advisor providing you support year-round.
Get in touch at 866.968.4848 or complete our online free consultation form.