Last week we talked about short-term rentals and the need to confirm the licensing and zoning issues that may apply. Here we are going to talk about the taxation of short-term rentals. What follows is a summary of some tax issues. This is NOT meant as tax advice. Please consult your own tax professionals.
Rented for Fewer than 15 Days During the Year – When a property is rented for fewer than 15 days during the tax year, the rental income is not reportable, and the expenses associated with that rental are not deductible. Interest and property taxes are not prorated, and the full amounts of the qualified mortgage interest and property taxes are reported as itemized deductions (as usual) on the taxpayer’s Schedule A. This would only apply if you rented out your residence or a vacation property on occasion.
The 7-Day and 30-Day Rules – Rentals are generally passive activities. However, an activity is not treated as a rental if either of these statements applies:
- The average customer use of the property is for 7 days or fewer—or for 30 days or fewer if the owner (or someone on the owner’s behalf) provides significant personal services (like cleaning). This is the important one.
- The owner (or someone on the owner’s behalf) provides extraordinary personal services without regard to the property’s average period of customer use. This probably wouldn’t apply as you won’t be providing these kinds of services on a long-term rental.
If the activity is not treated as a rental, then it will be treated as a trade or business, and the income and expenses, including prorated interest and taxes. IRS Publication 527 states: “If you provide substantial services that are primarily for your tenant’s convenience, such as regular cleaning, changing linen, or maid service.” Substantial services do not include the furnishing of heat and light, the cleaning of public areas, the collecting of trash, and such. So, the “rent” you receive from typical short-term rentals is considered “ordinary” income (just like flips!), and you’d want run the income through an “S-elected” entity.
Exception to the 30-Day Rule – If the personal services provided are similar to those that generally are provided in connection with long-term rentals of high-grade commercial or residential real property (such as public area cleaning and trash collection), and if the rental also includes maid and linen services that cost less than 10% of the rental fee, then the personal services are neither significant nor extraordinary for the purposes of the 30-day rule. I note this exception, even though probably not applicable to a typical short-term rental as we use them. But, if you have a larger complex that you choose to short-term rent, it might.
This is a big difference in how short-term rentals vary from your typical rental. Because you are collecting “rent,” many investors assume it’s passive income like the rest. But it’s not! Running a short-term rental business is being in the business of running a “hotel” and is taxed like your flip projects.
That taxation means your rental income from a short-term rental is subject to the self-employment tax of 15.3%. And that’s right off the top. You then will pay state and federal income taxes. This is why you run your flips through an S-elected entity, like an LLC. Because that S-election can save you on the employment tax.
In the next blog, I will teach you how to hold title to a short-term rental and how to save money on the self-employment tax.
Jeffrey S. Breglio, Esq.
Breglio Law Office and REI Mastery U
www.reimasteryu.com
jeff@bregliolaw.com
(801) 560-2180