Note: This article is meant for general information and does not provide tax advice to the reader.
Short-term rentals, vacation rentals. People often will use these terms interchangeably, thinking they mean the same thing. While similar in that they both are rental income, short-term rentals and vacation rentals are different entities in the U.S. tax code. Knowing the difference can help you derive the most benefit from your real estate investment and save you from costly mistakes.
A short-term rental is when a house is rented for a short duration, usually less than 30 days. Short-term rentals are offered to guests through online platforms such as Airbnb and VRBO. In comparison, a vacation home is a property that primarily is used by the owner for personal enjoyment and is rented to others for a limited number of days each year.
Different kinds of rental income. Like a long-term rental, income from a short-term rental is taxable and must be reported on your federal tax return. However, a long-term rental, such as when you have a tenant with a signed lease, is considered passive income where you have no active or direct involvement. This income is reported on a Schedule E. Passive income is not subject to Social Security or Medicare taxes and losses generally are not able to offset other current income.
Running a short-term rental. In comparison, running a short-term rental could be considered operating a business. If you are actively managing a short-term rental and are providing what is considered to be concierge services, then this is an active business. This would include cleaning and linen services while renters are at the property or other interactive services such as would be provided by a hotel.
Income from this business would be reported on a Schedule C and is subject to Social Security and Medicare taxes. Business expenses specific to operating the short-term rental can be deducted to reduce your tax liability. These could include property management fees, advertising, cleaning costs, maintenance, property taxes, and mortgage interest.
Then again, short-term rental income is not always active income. If you have a short-term rental but you aren’t actively involved, this could be considered passive rather than active income. The best way to determine the status of your short-term rental is to discuss this with your tax advisor as part of your tax planning process.
About vacation homes. According to the U.S. tax code, vacation homes are different than short-term rentals. That difference is based on how many days the owner uses the rental home personally. The IRS rule is if you use the home more than 10% of the time or more than 15 days in a year, the house is considered a vacation home. Even if you rent the house for the rest of the year as a short-term rental, if you stayed longer than 15 days, it’s a vacation home.
With a short-term rental, the mortgage interest, taxes, and other expenses can be counted towards the rental income or loss. If it's a vacation rental expenses have to be allocated, so mortgage interest and property taxes are now indirect expenses and are allocated based on the percentage of personal use versus short-term rental use. Plus, losses for a vacation home are basically not allowed. The only deduction that could roll over to the next year is the depreciation.
The IRS 10% rule and taxes. The consequences of not fully understanding the 10% tax rule could be an unexpectedly higher tax bill based on a full year of rental income with only a portion of expenses allowed as deductions. If you have a popular short-term rental, your tax bill could be considerably higher if you personally used the house just a few days longer than the 10% rule allows—whether you did that intentionally or unintentionally.
Short-term rentals have become more common as an investment vehicle. In addition to understanding local market regulations and restrictions, you should also be aware of the tax implications and benefits. Consult with your tax advisor prior to making this real estate investment and plan ahead to determine the best approach to your tax strategy.
To learn more about real estate investing and business tax advisory services by Marlene Van Sickle CPA go here. If you would like to discuss your short-term rental and tax planning, contact us at info@vansicklecpa.com.
To learn more about real estate tax planning in general, see our posting--Real Estate Investing: What to know about your taxes before, during and after buying rental property
IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations governing tax practice, you are hereby advised that any written tax advice contained herein was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of (1) avoiding penalties under the Internal Revenue Code or applicable state and local provisions or (2) promoting, marketing, or recommending to another party any tax-related matters addressed herein.