As the sharing economy continues to grow, more people are capitalizing on the opportunity to rent their homes, other real property, or even extra rooms to travelers through Airbnb or similar services (sometimes called "peer-to-peer accommodation") for extra income. It's a win-win in many cases—travelers experience places they visit as a local resident would, and the owner makes money that would otherwise go to a hotel or motel (although the latter probably isn't too happy about it).
What is important for CPAs' clients to know, however, is that the income from short-term rentals can come with tax implications. Many people may not think of themselves as self-employed just for offering their home as a rental or vacation spot—but they are. In light of that, it has become even more important to educate and advise clients on how rental income can affect their tax return.
In some cases, clients offering their property as a short-term rental may be able to reduce their tax liability and keep their federal income tax on that income to a minimum—and, in some cases, eliminate it entirely.
Here are some things CPAs need to know as clients come to them with short-term rental income.
WHAT'S TAXABLE?
Income from rental of personal property is usually taxable, but there may be expenses that can be deducted to offset some of the tax liability. The income hosts receive is considered to be from either a business or a rental. In either case, unless the less-than-15-day rule, below, applies, they are allowed to deduct expenses, including utilities, repairs, supplies, and cleaning services. For a dwelling unit used during the tax year by the taxpayer as a residence, deductions attributable to rental use are limited, however, to gross income from rentals over the sum of (1) the rental portion of deductible home mortgage interest, qualified mortgage insurance premiums, real estate taxes, and deductible casualty and theft losses, plus (2) the rental portion of expenses directly related to operating or maintaining the dwelling unit (such as repairs, insurance, and utilities). The rental portion is determined by the ratio of the number of days the unit is rented at fair rental to the total number of days in the tax year the unit is used for any purpose.
Sec. 280A provides a rule that is crucial for anyone considering renting out a dwelling unit, including the taxpayer's primary residence or vacation home. Under this rule, hosts do not have to pay tax on income they earn from actually renting the unit for fewer than 15 days during the year if they also use the unit themselves as a residence. Hosts are considered to use the unit as a residence if they use it for personal purposes during the tax year for more than the greater of (1) 14 days or (2) 10% of the total days during the year they rent it to others at a fair rental. A unit is not rented at fair rental for any day it is used for personal purposes, which include use for any part of a day by the taxpayer, another person who holds an interest in the unit, or a family member (defined under Sec. 267(c)(4)) of the taxpayer or other person with an interest in the unit. While taxpayers who rent out a unit (for which they meet the residence test) for less than 15 days a year do not have to recognize income from the rental, they also cannot deduct expenses incurred in renting out the unit.
If clients rent their home or other unit for 15 days or more during the year, they will need to report this activity when filing their individual income tax return (unless the activity is operated as a partnership, S corporation, or other entity and reported on that entity's return), either on a Schedule C, Profit or Loss From Business, as trade or business income subject to self-employment tax, or on Schedule E, Supplemental Income and Loss, as rental income, not subject to self-employment tax but possibly subject to net investment income tax. Generally, income from short-term rentals will be trade or business income where the taxpayer provides substantial services in connection with the rentals, such as regular cleaning and changing linens, or the rental is part of the taxpayer's trade or business as a real estate dealer.
Clients can deduct some of the expenses of their property to offset the income earned in both cases. For example, clients can deduct commissions, expenses incurred, and the ratable portion of utilities, insurance, taxes, and mortgage interest, subject to the limitations noted above. As trusted tax advisers, CPAs can help clients better understand which deductions they can and cannot take.
KEEPING RECORDS OF RENTAL PERIODS
If clients rent out their unit for fewer than 15 days in the tax year, urge them to keep track of both rental days and the days of personal use. If they rent for longer than that, they should detail the dates precisely so that, with their tax preparer, they can separate personal from business expenses. Keeping good records will help document their rental activity as a short-term vacation rental and make things easier when calculating their taxes.
PROVING A SHORT-TERM RENTAL
Again, the rule is simple: Taxpayers do not have to report rental income if they stay within the less-than-15-day rule. However, because of reporting laws, companies such as Airbnb, HomeAway, and VRBO may report to the IRS all income hosts receive from short-term rentals, even if they rented the unit for less than two weeks. If this happens and the income is not included on the host's tax return, the IRS could contact the taxpayer for verification.
Ideally, if clients follow your advice and keep thorough records, these documents will reflect the details of the rental activity and, if it falls within the less-than-15-day rule's exception, will substantiate that status.
REPORTING RENTAL INCOME
One of the benefits of using a service such as Airbnb to earn extra rental income is that the company makes the process of short-term renting simple for hosts. The company handles all bookings and collects the payments. This makes reporting rental income easy for hosts in the United States because they will receive a Form 1099-K, Payment Card and Third Party Network Transactions, or 1099-MISC, Miscellaneous Income, after the end of the year that totals the gross income from renting their property through the service. This information is also sent to the IRS, so don't forget to help clients report it on their income tax return.
Who doesn't want to earn extra income? It is important, however, to be armed with information and knowledge of the tax rules to maximize the opportunity.
Mike D'Avolio (Mike_D'Avolio@intuit.com) is a senior tax analyst at Intuit ProConnect in Plano, Texas.
To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at pbonner@aicpa.org or 919-402-4434.
