While short-term home rental may be a relatively easy source of income to offset the cost of owning more than one home, homeowners considering this as an investment strategy would do well to understand the ups and downs of short-term home rental and taxes.
Since the 1950s, relatively few homeowners have recouped a portion of the cost of owning more than one home through short-term vacation rentals. The 1990s saw an increase in the popularity of short-term home rentals, but they were often in the care of a property manager, not the owner. In the early 2000s, the creation of VRBO (Vacation Rental by Owner), Booking.com, and eventually Airbnb made the home sharing and rental business more accessible to the everyday homeowner.
Short-term vs. Long-term Rental
If you own a vacation home, you may consider renting it to help pay the mortgage. Short-term rentals often generate a higher monthly income than a traditional 12-month lease. However, longer-term rentals require less hands-on management and may require the tenant to pay for some maintenance. Homeowners considering short-term rental should check on local hotel regulations and compliance.
One of the more critical IRS rules is the “14-Day Rule” in the IRS’ Topic #415 – Renting Residential and Vacation Property. In short, no federal income tax is owed if the house is not rented for more than 14 days a calendar year or if you use it for at least 10% of the number of days it is rented.
Whether you decide on long or short-term, detailed records regarding your rental property and associated expenses are crucial. Good records will help you explain any item if questioned and aid in arriving at the correct tax with minimum effort. Before you decide on the rental terms for your property, it’s also advisable to consult a tax specialist to ensure you will meet your income and tax goals.
Passive vs. Active Income
The IRS classifies real estate rental income as either passive or active income. This classification is significant because it impacts the amount of taxes and when an investor must pay. This designation of active versus passive determines whether your rental income and expenses are reported on Schedule C or E of form 1040 and whether you may owe self-employment taxes.
- Schedule E (Supplemental Income and Loss) is used for rental income and is considered passive income.
- Suppose you are a real estate professional or provide your tenants substantial (hotel-like) services. Your rental income will be classified as active, and Schedule C (Profit or Loss from Business) will be required.
- When you provide substantial services, you may be subject to self-employment taxes.
Depending on your tax and income goals, rental income may be an effective way to pay a second mortgage and reduce your tax liability while increasing your cash flow. The tax specialists at Myrick CPA can help you gather the information needed to make the best-informed decision and see your income and tax goals through to fruition. So contact Myrick CPA today to make an appointment and get started on your rental income investments.