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March 21, 2023

Tax Considerations for Short-Term Rental Property Owners

Short-term rentals remain a popular avenue for additional income. Due to outdated Treasury regulations, which were put into place by the IRS long before Airbnb or Vrbo, there are several different ways that taxes can be determined, particularly if you don’t qualify as a real estate professional. Providing substantial services and material participation can have a substantial impact on how taxes for short-term rental properties are calculated and which tax deductions apply.  

Key Takeaways: 

  • A tax “loophole” for short-term rental properties can create more opportunities for above-the-line deductions on your tax return and can also result in self-employment taxes being due when net income is positive. 
  • Three factors directly impact how short-term rental properties are taxed: the average stay of the tenant, if substantial services were provided and whether the taxpayer provided material participation.
  • Finding a balance between providing services that will appeal to potential tenants and avoiding substantial services can be difficult, especially as the latter can create additional tax burdens.

To determine whether the income produced by a short-term rental is active business income versus passive rental income, several factors must be considered. The average stay of a tenant, the level of services provided to the tenant and whether the property owner provided material participation have a significant impact on how taxes are calculated and how the property is classified. 

Is My Short-term Rental Income Active Business Income or Passive Rental? 

The tax treatment of the income and losses from your short-term rental activity is determined based on whether substantial services are provided. Substantial services, as described by the IRS, include the following and other “hotel-like” services: 

  • Cleaning the property daily while the same guest occupies it 
  • Changing linens daily while the same guest occupies the property 
  • Conducting outings or guest tours 
  • Providing entertainment and meals 
  • Providing transportation 

If you perform substantial services as a short-term rental-property owner, you must report the operations as business income.  This could result in more opportunities for above-the-line deductions on your tax return in a year of net loss from the property.  However, any net income would be subject to Self-Employment tax.  

If substantial services are not provided and your average tenant stay remains below the seven-day average, the net income/loss will follow the passive rental tax laws. Services such as heating and air conditioning, water and gas, internet and Wi-Fi, cleaning of common areas, customary repairs and maintenance, trash collection and paying HOA dues are considered insubstantial and will not affect the character of the income.

If you have questions about which filing option is right for you and your short-term rental operation, speak with your CPA or tax planning advisor.

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