The competitive short-term rental marketplace has made taxpayers consider renting their home, rooms or even their backyard! Online sites Airbnb, Vrbo, HomeAway and Craigslist all help facilitate renting property and space. Most offer varying degrees of services and all will charge a fee to access their marketplace. However, whatever method you use to rent your property, room or other space will result in thorny issues on your tax return.
The tax treatment varies based on how long you rent the property during the year as well as the type of activity it is considered in the eyes of the IRS. Once considered a taxable activity, there are two ways your activity can be classified as a traditional passive rental (renting a home) or as a service (renting a home along with your time to provide additional services).
First, the good news.
If you rent your property for less than 14 days and live in the property for more than 15 days in a year, there is no income tax reporting requirement. This is also loosely referred to as the “Augusta” rule, named for members of Augusta National that rent their properties during The Masters weekend for top dollar.
Taxable Activity – Passive Rental
If, however, you rent out your property for more than 14 days, you need to consider what is provided with the rental, which in turn will determine how it is reported on your tax return.
Traditionally, most rentals are viewed as passive activities that are reported on Schedule E. Think of this as renting your property in the mountains during ski season. The renter would be responsible for simple upkeep. You only provide the property to the renter. In this case, the income will be reported on Schedule E. You will be able to deduct expenses related to this rental, such as cleaning, commissions, and repairs (these are direct expenses). Expenses such as mortgages, real estate taxes and depreciation (considered indirect expenses) must be prorated based on the period the property was rented versus used personally. The net income of this activity will be subject to your marginal tax rate and any losses will be offset against other passive income or carried forward if no other passive income exists.
Taxable Activity – Active Rental
If you provide services in conjunction with the rental, such as daily cleanings, offering breakfast, or other activities that would make it akin to operating a hotel, the rental would be considered a business and reported on Schedule C. The IRS considers the type of service; if the services rendered are substantial to the occupants, then it would be considered more of a business instead of passively renting the property. As in the above example, you still will be allowed the expenses to reduce your income, but the net income would be subject to self-employment (SE) tax. The SE tax is 15.3%, which is broken down as 12.4% for Social Security and 2.9% for Medicare. Keep in mind that this is in addition to regular income taxes, but you will be able to take one-half of the SE tax as a deduction to reduce your net profit. If you have a net loss from this activity, then you will be able to offset it against your other income, whether passive or not.
The IRS assesses short-term rentals based on the facts and circumstances of each case. As each case is unique and one size doesn’t fit all, Cray Kaiser can help you determine the classification along with structuring it favorably for tax purposes. Please contact us today at 630-953-4900.