How to Account for Your Income from Short-Term Rentals

The short-term rental market is booming in D.C. and Maryland, providing many homeowners with an excellent source of extra income. But with this income comes the responsibility of understanding the tax implications, regardless of whether you rent out a single room or an entire property.

Tax treatment for rental income varies based on how long guests stay and how involved you are in managing your property. Rental income is often considered passive, but certain short-term rentals can be classified as business income. Accurately determining which category your short-term rental income falls under can impact everything from tax obligations and deductions to your financial planning goals. 

Federal Tax Treatment of Short-Term Rentals

Most rental income is classified as passive under IRS rules. However, an exception applies for short-term rentals where the average guest stay is seven days or less.

If your rental qualifies under this rule, the IRS treats it as a business activity rather than traditional rental income. That means:

• Your income may be classified as nonpassive if you meet certain participation tests.
• Self-employment tax may apply if the IRS determines your rental activity is an active business.

Whether your rental is passive or nonpassive affects how deductions and losses can be used to lower taxable income.

Passive vs. Active Income: Why It Matters

Passive Income Rules

• Most long-term rental properties are considered passive investments, meaning losses can only be deducted against other passive income.
• If a short-term rental does not meet IRS material participation standards, it is generally treated as passive.

Nonpassive Income Considerations

• Material participation means you are actively involved in managing the rental. The IRS defines this as:
  • Spending 500+ hours per year on rental operations.
  • Performing more work than anyone else involved in the property's management.
  • Meeting one of the seven IRS tests for material participation.

If you meet material participation requirements, the rental is not considered passive and may be subject to self-employment taxes.

Active Participation Exception

• Even if material participation rules are not met, landlords who actively manage their properties may qualify for an active participation exception.
• This exception allows up to $25,000 in rental losses to be deducted against other nonpassive income, though income limits apply.

Since tax treatment varies by situation, consulting with a CPA is usually the best and most effective way to determine the proper classification for your rental.

D.C. and Maryland Tax Requirements for Short-Term Rentals

Short-term rentals are subject to local tax regulations in addition to federal tax laws.

Washington, D.C.:

• Rental income is classified as business income, requiring hosts to register with the Office of Tax and Revenue (OTR).
• Hosts must file Form FR-500 on MyTax.DC.gov to comply with city tax regulations.

Maryland:

• The state charges a 6% sales tax on short-term rentals.
• Some counties impose additional lodging taxes, which rental owners must collect and remit.
• Some rental platforms, like Airbnb, may handle tax collection, but hosts should verify local requirements.

Understanding local tax laws is essential to avoid penalties and ensure proper compliance.

Why Professional Tax Planning Matters

Short-term rentals can generate great income, but they can also create complex tax situations. An experienced, knowledgeable CPA can help:

• Determine if your rental income qualifies as passive or nonpassive.
• Identify eligible deductions for property taxes
• Ensure compliance with federal, state, and local tax laws.
• Minimize tax liability through strategic planning.

The tax rules for short-term rentals aren't one-size-fits-all, and no two property owners' circumstances are identical. Proper planning tailored to your unique needs ensures your rental income is reported correctly and all available tax benefits are effectively used. Short-term rentals can be a great source of extra income, but understanding how that income is taxed is essential. Classifying rental income correctly can significantly affect how much tax you pay and what deductions you can claim.

Do you need expert guidance regarding short-term rentals? Contact Myrick CPA to ensure your short-term rental income is handled correctly to ensure you're maximizing your tax benefits.