Short-Term Rental Tax: What Property Owners Need to Know

As the home sharing economy grows, more and more people are earning extra money by renting out their homes, apartments, or spare rooms for short stays. Its rising popularity is in large part due to the advent of apps and websites like VRBO and Airbnb, which make it easy to list a place for rent and find renters.

Renting out your place can boost your income, but it comes with important tax responsibilities. To operate a short-term rental business successfully, you must understand and comply with all the tax requirements set by your local area and state, as a failure to do so can result in costly penalties and fees.

In this article, we'll discuss the tax considerations that anyone running a short-term rental business needs to know. We'll help you understand how to comply with all the relevant rules and regulations, allowing you to earn extra income while staying on the good side of tax authorities.

What does the IRS consider a short-term rental?

The IRS considers a short-term rental to be a property rented for fewer than 15 days in total during the year. If you rent out your property for less than 15 days, the income from these days is not required to be reported for income tax purposes.

However, if you are running a short-term rental business and rent your property multiple times during the year, exceeding 14 total rental days, the IRS considers the property a rental. In this case, you'll have rental income and expenses and will report your profit and loss on your Schedule E tax return.

Does the IRS consider your vacation rental a business?

Another consideration for short-term rental owners is the concept of material participation, which plays a significant role in determining whether your rental activities are considered a trade or business for tax purposes. The distinction can impact your ability to deduct rental expenses from other income.

The IRS defines material participation through several tests. If you meet any one of these tests, your rental activities are treated like a regular business, allowing you to deduct certain expenses against your other income.

Here are the 7 IRS tests for material participation:

1. 500-hour test: You participate in the activity for over 500 hours during the tax year.
2. Substantial participation test: Your participation constitutes substantially all of the total participation in the activity for the tax year, including both owners and non-owners.
3. 100-hour plus no less participation test: You must participate in the activity for over 100 hours during the tax year, and no other individual, including non-owners, must participate more than you.
4. Significant participation activities test: An activity qualifies as a "significant participation activity" if you participate for more than 100 hours and your combined participation in all significant participation activities exceeds 500 hours during the year.
5. Prior participation test: You materially participated in the activity for any five of the last ten tax years, which need not be consecutive.
6. Personal service activity test: If the activity is a personal service, you materially participated in it for any three of the prior tax years, whether consecutive or not.
7. Facts and circumstances test: Based on all facts and circumstances, you participate in the activity regularly, continuously, and substantially throughout the tax year.

Understanding short-term rental tax liability

Here are the areas you need to know about regarding taxes and vacation rental properties:

Income reporting

You must report rental income on your tax return, regardless of the amount or the number of days you rented out the property. If you receive payments through a rental platform (e.g., Airbnb, VRBO), they will typically send you a Form 1099-K, which reports the gross income you received.

When reporting your short-term rental income, you have two options depending on the nature of your rental activity: Schedule E or Schedule C.

Schedule E

If your short-term rental business primarily involves renting out your property and providing only minimal services, you should use Schedule E of your Form 1040 to report your rental income and expenses. This is the most common scenario for short-term rental owners who do not materially participate in the rental activity.

Schedule C

If your short-term rental activity qualifies as a business due to material participation, you may need to report your rental income and expenses on Schedule C of your Form 1040. This is especially true if you provide substantial services to your guests, like concierge services or other amenities.

Providing substantial services includes offerings like:

• Cleaning during occupancy.
• Guided tours and activities.
• Catered meals and entertainment.
• Transportation services.
• Other hotel-like amenities.

Using Schedule C means your net income will be subject to self-employment tax in addition to ordinary income tax. However, you may also be able to deduct more business-related expenses on Schedule C compared to Schedule E.

Short-term rental property tax deductions

You can deduct specific expenses related to operating a rental property. If you rent out a portion of your primary residence, you're eligible to deduct expenses directly associated with that rental space.

You also may qualify to deduct depreciation on the property. Depreciation allows you to gradually recover the cost of the property over its useful life, providing another potential tax benefit.

Types of common deductions include:

• Cleaning and maintenance costs: You can deduct the costs of cleaning your rental property, such as hiring a cleaning service or buying cleaning supplies.
• Property and PMI insurance: The premiums you pay for property insurance and private mortgage insurance (PMI) are generally deductible as expenses.
• Service charges: You can deduct any fees or commissions you pay to third-party platforms or rental management companies as a business expense.
• Utility bills: The cost of electricity, gas, water, and internet are also deductible as rental expenses.
• Repair expenses: You can deduct the cost of repairs and improvements to your rental property as long as they're considered ordinary and necessary for your business operation.
• Mortgage interest: If you're paying off a loan for your rental property, you can deduct the interest you pay on that loan as a rental expense.
• Advertising fees: The money you spend on advertising your short-term rental, such as vacation rental listing site fees or marketing costs, can be deducted as a business expense.
• Depreciation: You can also deduct depreciation for the wear and tear on your rental property as time goes on.
• Property taxes: You can deduct property taxes paid on your rental property as an allowable expense, reducing your taxable rental income.

Self-employment taxes

If your rental activity qualifies as a business, you may be subject to self-employment tax on your rental income. If you materially participate in your rental activity (based on the seven tests mentioned earlier), the IRS may consider it a business rather than a passive investment. In this case, your rental income would be subject to this tax, which consists of Social Security and Medicare taxes.

Here's how it works:

• If your rental activity qualifies as a business and you earn net income (profit) from it, you will need to pay self-employment tax on that income.
• The tax rate for self-employment is 15.3%, which goes towards Social Security and Medicare.
• If your rental activity is considered a business, you can deduct half of your self-employment tax on your income tax return as an adjustment to income.
• If your rental activity is considered a passive investment (i.e., you do not materially participate), then your rental income is not subject to this tax. However, passive rental income is still subject to ordinary income tax.

It's important to note that the rules surrounding material participation and self-employment can be complex, so check with a tax professional to determine how these rules apply to your specific situation.

Record keeping

As a short-term rental owner, it's important to establish good record-keeping practices to streamline your financial management and tax preparation. Here are some tips to help you stay organized:

Use financial accounting software

Financial accounting software like Azibo can simplify the process of tracking your rental income and expenses. These tools make it easier to comply with tax laws because you can easily:

• Categorize transactions.
• Generate financial reports.
• Prepare documents for tax filing.
• Create invoices and receipts.

Set up separate bank accounts

It's a good idea to maintain separate bank accounts for your personal and business expenses. Key benefits of separate accounts that can help you at tax time include:

• Simplified record keeping: Separate accounts make it easier to track rental income and expenses without having to sift through personal transactions.
• Clearer tax preparation: When all rental-related transactions are in a dedicated account, preparing for tax filing becomes more straightforward.
• Audit protection: Having separate accounts demonstrates that you treat your rental activity as a business and can help support your deductions in case of an audit or other tax issues.

State and local taxes

In addition to federal income taxes, short-term rental owners may be subject to various state and local taxes. Some rental platforms may collect and remit certain taxes on your behalf, but you should still verify which taxes are covered and which ones you're still responsible for. Common local tax liability areas include:

• Sales tax: Some states and localities require short-term rental owners to collect and remit sales tax on their rental income.
• Applicable occupancy tax or hotel tax: Many cities and counties impose occupancy taxes or hotel taxes on short-term rentals, similar to those paid by hotels and motels.
• Income tax: Depending on your state, you may need to pay state income taxes on your short-term rental income.

Short-term rental tax treatment

The tax rules for your vacation rental might seem overwhelming, but with the right knowledge, you can turn your business into a tax-savvy, profit-generating machine.

Don't let the tax man rain on your short-term rental parade. Stay one step ahead by keeping detailed records, understanding the deductions you can claim, and enlisting the help of a real estate professional tax expert who can guide you through the process. A good CPA will help you find ways to make the most of every tax-saving opportunity.

By mastering the art of short-term rental taxes, you'll boost your bottom line and gain the peace of mind that comes with knowing you're running a compliant and successful business. So, go ahead and embrace the tax challenges head-on — your bank account (and your stress levels) will thank you for it!

IRS short-term rental FAQs

Does Airbnb report income to the IRS?

Yes, Airbnb typically reports income to the IRS. They usually provide hosts with a Form 1099-K, which reports the gross income received from rentals.

How much do you have to make on Airbnb to file taxes?

If you earn over $600 in a calendar year through Airbnb, you should receive a Form 1099-K, which reports your gross income. However, regardless of whether you receive this form, you are still required to report all rental income on your tax return.

What is considered a short-term rental in CA?

In California, a short-term rental is a property rented for periods of 30 days or fewer. However, specific regulations and definitions may vary depending on local ordinances and jurisdictions.