With the advent of online sites such as Airbnb, VRBO, and HomeAway, many individuals have taken to renting out their first or second home through these online rental sites, which match property owners with prospective renters. If you are doing that or are planning to do so, there are some special tax rules you need to know.
These special (and sometimes complex) taxation rules are based upon the length of time you rent your property out and with varying tax outcomes. In some situations, the rental income may be tax-free. In other situations, your rental income and expenses may need to be treated as a business, as opposed to a rental activity. The following is a general synopsis of the rules governing short-term rentals (those rented for average rental periods of 30 days or less).
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.
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:
A. 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.
B. The owner (or someone on the owner’s behalf) provides extraordinary personal services without regard to the property’s average period of customer use.
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, will be reported on Schedule C instead of Schedule E, the IRS form used to report longer-term real estate rentals. 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, you report your rental income and expenses on Schedule C.” Substantial services do not include furnishing heat and light, cleaning public areas, collecting trash, and such.
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.
Profits and Losses on Schedule C – Profit from a rental activity is not subject to self-employment tax, but a profitable rental activity that is reported as a business on Schedule C is subject to this tax. A loss from this type of activity is still treated as a passive activity loss unless the taxpayer meets the material participation test – generally, providing 500 or more hours of personal services during the year or qualifying as a real estate professional. Losses from passive activities are deductible only up to the passive income amount, but unused losses can be carried forward to future years. A special allowance for real-estate rental activities with active participation permits a loss against nonpassive income of up to $25,000 – but phases out when one’s modified adjusted gross income is between $100K and $150K. However, this allowance does NOT apply when the activity is reported on Schedule C.
These rules can be complicated; please call us to determine how they apply to your particular circumstances and what actions you can take to minimize the tax liability and maximize the tax benefits from your rental activities.