We must first define what a short-term rental is in terms of taxation before we can proceed. Many investors are under the assumption that just by listing their homes on a short-term rental site such as VRBO or Airbnb, their properties qualify as short-term rentals. That is a miscalculation.
When it comes to tax reasons, the location of a rental property is less important than the number of days that a property is available for rent, as well as the kind of services that are provided in conjunction with the rental.
A short-term rental property is generally defined as one where the average number of rental days per guest is seven or fewer per year, and the property is regarded as a short-term rental for tax reasons.
Even though a property is listed as a short-term rental, if the average visitor stay is more than seven days, the property will most likely be considered the same as a long-term rental, despite the fact that it is sold as a short-term rental. Rentals, when hotel-style services are provided (such as a bed and breakfast), are normally classified as short-term rentals under the tax code.
One thing to keep in mind is that short-term rentals, like long-term rentals, are normally taxed at the investor’s marginal income tax rate, which is often the highest rate available. As a result, if you are an investor with W-2 and other income in the 35 percent tax bracket, all taxable rental income is put on top and subject to the same tax rate as your W-2 and other income.
Taxation of short-term rentals: Strategies for lowering taxes
Because short-term rentals can generate significant cash flow, it is critical to ensure that you are using the proper short-term rental techniques throughout the year in order to decrease your tax liability on this kind of revenue.
Make the most of your tax deductions
The first step in lowering your taxes on your short-term rentals is to maximize your tax deductions as much as possible. As an investor, you may find yourself making numerous travels to your short-term rental homes to set up, stage, or even manage the properties. Make sure to keep track of your travel expenses so that you may deduct them from your rental revenue when tax time comes around.
Travel to short-term rentals may be deducted from rental revenue in the same way that travels for any other sort of real estate investment can be deducted. The key is to make certain that you have documents to support the basis for your travel arrangements. Let’s take a look at an example of how effective this approach may be.
Consider the following scenario: James owns a couple of short-term rentals in a lakeside village that is just two hours distant from his house. The huge truck he acquired was largely used to repair, stage, and manage the short-term rentals. He also utilized it for other purposes.
Because the vehicle was used largely for commercial purposes and weighed more than 6, 000 lbs, James was entitled to deduct the whole purchase price of the truck from his taxable earnings.
In addition to lowering his short-term rental taxes and saving about $10,000 in taxes, James was able to deduct close to $30k off the purchase of that vehicle. Because depreciation is calculated based on the vehicle’s purchase price, James was able to get a considerable tax deduction despite the fact that he financed a portion of the truck purchase.
Make a change in your income.
Another strategy for maximizing tax savings on short-term rental revenue is to use income shifting. Consider compensating family members or friends who are assisting you with your short-term rentals in order to transfer revenue and save on taxation.
In addition to James’ niece and nephew, James also had a nephew who was still in college and was interested in going into real estate. James enlisted the assistance of his nephew to assist with the restoration and repairs necessary to get the short-term rentals up and running.
The $8,000 James sent to his nephew was tax-deductible, resulting in an additional $2,400 in tax savings for James. Short-term rental tactics that have historically been employed for long-term rentals are almost identical to those accessible to short-term rental investors in terms of tax savings.
Take advantage of the depreciation allowance
With short-term rentals, an investor may face greater start-up expenses than with long-term rentals. It is possible that you may need to acquire furnishings, fixtures, and appliances at some point.
Most of these things, whether purchased as brand-new or used, may now be eligible for bonus depreciation, regardless of whether they are purchased as brand-new or used. This implies that, rather than depreciating the cost of these products over a number of years, you may be able to claim the whole depreciation in the first year of ownership.
Example: If James spends $6,000 to outfit his short-term lake rental with appliances, furnishings, and a kayak, he may claim a $6,000 deduction in the first year of ownership. It is critical to maintaining detailed records of all of the products you purchase with your money.
Towels, bedding, and toilet paper are all examples of costs that might be deducted from your taxes. Those tiny sums may build up to significant tax savings over the course of a year.
Keep track of your expenditures
Keeping track of expenditures for short-term rentals is no different from keeping track of expenses for any other rental property. If you have a number of short-term rentals, keep note of your revenue and costs for each one. We’ve previously spoken about vacation, furniture, and adjusting one’s revenue stream.
Don’t forget about other possible tax deductions, such as business dinners, a qualified home office, or associated educational costs. Because short-term rentals may be quite lucrative, it is critical to ensure that you record all of your costs in order to deduct the taxes related to that revenue when filing your taxes.
Learn about the tax advantages
Investments in short-term rentals may also be eligible for a variety of tax advantages. In certain cases, the tax advantages of investing in long-term rental properties may be superior to those of traditional long-term rental properties.
For those who work in the long-term rental industry, you are undoubtedly already aware of some of the limits that apply to higher-income investors under the passive activity loss regulations.
In summary, if your adjusted gross income is more than $150,000, any rental losses from long-term rental properties will likely only be able to offset revenue from other passive sources.
It is not possible to utilize excess losses to offset taxes on your W-2 income if there is an excess loss. Instead, the losses are carried forward to future years, when they may be used to offset future passive income.
As you can see, there might be considerable tax advantages to investing in short-term rentals in some situations. It’s crucial to note that laws and regulations governing short-term real estate investment may change fast, so keep this in mind.
Before making an investment in a short-term rental, it might be beneficial to do an analysis of the transaction to see how it would perform if it were a long-term or mid-term rental. To protect your property’s performance if the city enacts additional short-term rental limits or modifications, make sure you have alternative investment plans in place to guarantee the property continues to perform successfully.
Once you’ve determined that short-term rental investment is right for you, consult with your tax expert and prepare ahead of time throughout the year to ensure that you maintain as much of your great income flow as possible!
Meet Krishnaprasath Krishnamoorthy, a finance content writer with a wealth of knowledge and experience in the insurance, mortgage, taxation, law, and real estate industries. With 15 years of experience and qualifications in insurance, mortgage, law, and investments, Krishnaprasath Krishnamoorthy has a deep understanding of the complex financial and legal issues that impact individuals and businesses alike.