Understanding Short-Term Rentals #3



In the last blog, we learned that the rent from short-term rentals is considered ordinary income (like flips) and not passive income (like long-term rentals). That’s a big deal because ordinary income is subject to the self-employment tax of 15.3%. In this article, I’m going to teach you how to hold title to the short-term rental and how to save on the employment tax.

First, you want to hold title (who “owns” the property as listed on the county land records) in an asset-holding LLC, like a “series” LLC. If you’re unfamiliar, go back and read the blog, “The Series LLC” from September 18, 2020. This LLC is taxed either as a sole-proprietorship (single member) or a partnership (multi-member). It is NOT taxed as an S-corp. (no S-election!!)! This is important. And ALL your rental properties should be owned like this!

So, there is no difference in how you hold title or own your short-term rental. Own it just like all your other rental properties. But, because this rent is taxed differently than the rent you collect on long-term rentals, you going to structure the “renting” part differently.

The first thing you will need to do is set up a “property management” LLC. This is NOT the LLC that owns the rental! This is set up to do nothing more than manage the short-term rental (you can also use it manage your long-term rentals and deflect liability!). Then, your LLC that owns the short-term rental will lease it to the property management company on a long-term lease (can even be more many years!). The property management LLC then does the short-term leasing and property management.

The property management LLC will then pay the property-owning LLC its monthly rent. The rest it will keep to cover costs and expenses. Now, you’ve turned part of the short-term rents into a long-term rent situation. The rent that the owning LLC collects is passive (like all long-term rentals) and not subject to the self-employment taxes. For example, if the property management LLC makes $2000 a month in short term rentals and pays the owning LLC $1500, then you’ve turned $1500 of ordinary income into passive income, saving you self-employment taxes!

Now, optimally, you’d want the long-term monthly rent to be as close to what you make in the short-term month rates to convert most of the rent received to passive. But your long-term rental rate should be reasonable market rates. And the property management LLC does need to cover costs and receive a reasonable return for the work that it does. So, the management company does need to make some money. If that is going to be substantial, you can do an S-election on the management company and save even more in taxes. For more information on the S-elected LLC and how it saves on taxes, see the blog, “The Tax Savings LLC” from July 30, 2020.

Short-term rentals are fantastic as they can provide much greater returns on rental properties. So, if your location allows short-term rentals, and you structure it as we’ve discussed, you’ll make more money and save on taxes! In the next blog, we’re going to cover another surprise tax on these kinds of rental properties.

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

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