Understanding Nightly Rentals #3



If you’ve been following along, we’ve discussed the regulatory side and an introduction to the tax side of doing short-term rentals. Today we will discuss how to hold title and save on the self-employment taxes we mentioned last month.

First, hopefully you now understand that the rent you make from short-term rentals is taxed differently as active income. That means it’s taxed more like your flip projects that you run through an s-elected LLC. (We’ve done other blogs on s-election and tax savings! Go back and review some of those if you don’t understand how the s-election saves on taxes on ordinary income.) While is it totally fine to own your flip in an s-elected LLC, it is NOT good to own a rental property in an s-elected LLC. This is because there is a “sale of asset” tax that can apply when you transfer or sell an asset you’ve held for a long time. You don’t want to pay this tax!

So, just like any other rental property, you should “own” the property in an LLC that is taxes as either a single member or partnership. And if available to you in your state, a Series LLC. This will be the same LLC that you own all your other rental properties in. So that’s good news! You will own your short-term rental the same way you own all your rentals.

But what about the tax savings on this ordinary income that short-term rentals generate? Here’s the trick:

  1. Set up a separate property management LLC (PM LLC). You could use your flipping LLC as well, but I recommend a separate, dedicated company.
  2. Make sure you own your rental in a series LLC or property holding LLC (Hold LLC). This is the LLC that provides your liability protection as well.
  3. Then, your Hold LLC leases the property on a long-term lease to the PM LLC. This should be at least a year but can be numerous years.
  4. Your PM LLC then rents out the property on a short-term basis, collects rent, does the cleaning and management and etc. This is all ordinary income!
  5. Your PM LLC then pays the monthly rent to your Hold LLC. This converts the ordinary income to passive income.
  6. Your long-term monthly rent to the PM LLC should be at market rates or a little higher. Don’t make this rent the same as what the PM LLC makes in short-term rents (which should be a lot higher). If it’s too high, that will look bad to the IRS.
  7. If you are making good money with short-term rentals, you’ll probably make more each month in the PM LLC than the monthly rent it pays to the Hold LLC. This is ordinary income. So, if this is a large enough number you can do an “s-election” on it for the tax savings that s-corps provide on ordinary income.
  8. You should confer with your CPA or tax advisor. The s-election tax savings can vary greatly among individuals and how much you are actually making. But with the rent pass through to your Hold LLC, you’ve already converted a lot of the short-term rents into passive income. And remember, there could be hotel taxes that you need to pay

Hopefully this makes sense. You now know how to own and rent a short-term rental property, get asset protection and tax savings.

In the next article, we’re going to tax this topic and explain it again with lease sandwiches and arbitrage!

Jeffrey S. Breglio, Esq.
Breglio Law Office and REI Mastery U
(801) 560-2180


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