How Are Short Term Rentals Taxed?

Aug 10, 2022

Real estate is tricky and is usually treated much different than a typical business. This is just one Blog Post and Podcast Episode in an entire guide we put together on real estate taxes.

If you have not checked out our other content around real estate taxes, do so now by visiting: The Ultimate Guide to Real Estate Taxes

Here we are going to be talking about short term rentals and how the taxation of them may be different than your normal rental property.

Before we get started on that though, lets remember that if you rent your personal residence for 14 days or less throughout the year that is not taxable income to you. This is an excellent tax planning strategy that we utilize and discuss in another Blog and Podcast of ours, What Is The 14 Day Home Rental Strategy (aka The Augusta Rule)?

What Does The IRS Consider a Short Term Rental?

Generally stating, the IRS looks at a short term rental as one that has average rental days of 7 or less. This is an easy calculation.

Total Rental Days / # of Times Rented

For example, if you rented out your property 25 times during the year for a total of 150 days your average rental would be 6 days (150/25).

What Are The Different Tax Treatments for Short Term Rentals?

When the average rental period is 7 days or less there are two different tax treatments that come into play. This depends on if you provide "substantial services" or not for the rental property.

  • Provide "Substantial Services": Report as a business on a Schedule C
  • Do Not Provide "Substantial Services": Report as a rental property on Schedule E

There are Pros and Cons to each scenario that we will discuss later. However, we first want to outline what "Substantial Services" means.

Basically providing a "substantial service" means that you are treating it similar to a hotel. You are going above and beyond just a simple occupancy rental. Think of things like cleaning the unit during the stay, providing new sheets, making the beds, cleaning dishes, maid type services, other "hotel" or bed and breakfast like services.

If all you are doing is cleaning common areas of the building, collecting trash, etc that would not be considered "substantial services".

What Are The Pros and Cons Of Having Short Term Rental On Schedule C?

If you average rental is 7 days or less and you provide "substantial services", you would need to report it as a business on Schedule C.

  • The bad thing about this is that if it produces a profit that would be subject to self employment taxes.
    • However, you would also be able to use the 20% 199A tax deduction assuming other qualifications are met.
  • The good thing about this is that if it produces a loss you can use that to offset other business income (or ordinary income if you do not have other business income) if you materially participate.
  • An S Corporation may make sense if you fall in this area and the property is producing a significant profit. You want to be careful here though and ensure you are doing the right thing as this is one of the only areas an S Corp may make sense with a "rental" property.

What Are The Pros and Cons Of Having Short Term Rental On Schedule E?

If you average rental is 7 days or less and you do not provide "substantial services", you would report it on a Schedule E. One thing to note is that even though it is a "rental property", since it is short-term the IRS does not classify it as rental activity and thus it is not considered passive.

  • The good thing about this is that it is not subject to self employment taxes.
  • Since it is not a "passive activity" it does not qualify for the typical passive loss rules. This means it:
    • Does not qualify for the $25k active real estate investor rental loss break.
    • Does not produce material participation hours to be used to become a real estate professional.
    • Cannot be grouped with other long-term rentals.
  • However, the great thing about them is that if you are able to prove that you "materially participate" in the activity, you are able to claim any losses against non-passive income (business, W2, etc). To "materially participate" there are 7 tests you can meet but the most common we see are:
    • You participated in the activity for more than 500 hours.
    • Your participation was substantially all the participation in the activity of all individuals for the tax year, including non-owner participation.
    • You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including non-owners) for the year.

The final piece is important. Most rental activity loss you cannot apply against your regular ordinary income EXCEPT for short term rentals, as long as you materially participate. Be sure to factor this into your planning strategy.

Finally one thing to think about is that if you also use this property for personal use, other rules may come into play that you want to look into.

Again, this is just one Blog Post and Podcast Episode in an entire guide we put together on real estate taxes.

If you have not checked out our other content around real estate taxes, do so now by visiting: The Ultimate Guide to Real Estate Taxes

We also have a full section in our Tax Minimization Program specific to strategies around rental properties!

 

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