Planning to rent out a home? Be prepared.
Everyone likes a little extra income, and the "sharing" economy has made that easier than ever. For those with a second property, options like Airbnb and VRBO have become very popular as means of procuring rental revenues. However, renting a home through one of these services can include tax implications of which many are unaware. If you are operating as a landlord for short-term rentals, here are some things you should know.
What qualifies as rental property?
The IRS has a great deal of information on classifying rental properties in Topic Number 415. https://www.irs.gov/taxtopics/tc415
To be considered a rental property, the home in question cannot qualify as a residence. A residence is one in which personal use equals the greater of either 14 days or "10% of the total days you rent it to others at a fair rental price". So what does "personal use" mean, in this case? Personal use can be one of four scenarios.
1. When you or another individual who has an interest in the property (i.e., a business partner or co-owner) uses the property (unless that individual pays you a fair market price for rental). So, if your business partner's family uses the property for a vacation, that's personal use.
2. When a family member uses it without paying a fair price. If you let your niece rent it at half the usual rate while she's in town for the weekend, that's personal use.
3. "Anyone under an agreement that lets you use some other dwelling unit" Consider the rom-com "The Holiday", where Kate Winslet and Cameron Diaz swap houses with each other for a vacation. If you were to do something similar, those days spent at your house would county as personal use, since you were trading them for your own lodgings during that time.
4. Anyone at less than a fair rental price. This is self-explanatory, but also somewhat nebulous. Your best option is to have documentation supporting your pricing strategy, and apply it consistently.
Likewise, any expenses deducted must be deducted proportionally to the amount of time the home served as a rental. (So, if 5% of the year was personal use, only 95% of the appropriate expenses may be deducted.) If the property, in fact, does not meet the criteria to be considered a rental, you cannot deduct expenses on it. However, you also do not have to report rental income, in that case.
What can be deducted?
Expenses that are necessary for "managing, conserving and maintaining your rental property" can be deducted. These could include plumbing repairs, or cleaning services. You can also deduct expenses related to the business of renting out the property, such as any host fees from Airbnb, or advertising and legal fees related to the property.
You can also deduct any expenses which the tenant paid and which you then had to reimburse the tenant for. (For example, if the air conditioner breaks on the weekend, the tenant pays to fix it quickly, and you then reimburse the tenant, you can deduct that repair expense.)
You cannot deduct costs of improvements, those costs incurred in the act of restoring the property, or adapting it for a different use. You can, however, recover some of those costs on Form 4562 where you would report depreciation expenses.
Occupancy Tax
Many states and municipalities require landlords to collect and remit occupancy tax on short-term rentals. (It's a bit like a sales tax, but for hotels.) You will need to closely examine your local laws, as they can vary greatly on tax rates, what constitutes short-term rental, how frequently it must be remitted, etc. To further complicate the matter, occupancy tax may be collected by states, counties, AND cities.
Additional Taxes
If you were to sell your property, after it has been designated as a rental, you will need to report the income from the sale as capital gains, and pay capital gains tax on that accordingly. If you are a high-income earner, you may also be responsible for net investment income tax. (See IRS Topic Number 559.) https://www.irs.gov/taxtopics/tc559
1099s
As always, be sure that you are collecting W-9s from service vendors and following all applicable requirements for filing 1099s at year-end.
We work with a number of property owners, on these very issues every day.
Your Accountant's Weird Habits - Explained
If you have a pet in your family, maybe you've seen those articles purporting to explain why your dog spins in a circle before lying down, or why your cat would rather drink from the faucet than a water dish. To many people, there is a creature even more alien and perplexing than any animal: the finance professional.
Your bookkeeper or tax professional might say or do things that don't make a lot of sense to you. Some of their actions might seem flat-out contradictory. But, as with any exotic species, there is a reason behind all of it.
I want to break down a few of the most commonly complained-about behaviors, along with the explanations behind them (with the assistance of cat pictures).
First annoying habit: My accountant keeps nagging me to get organized.
Your bookkeeper wants you to have a system for tracking open customer balances, or wants you to keep all your expense reports in one place. It's frustrating, because the whole reason you're paying them is for them to "keep up with that stuff".
So why do they do it?
For starters, good bookkeeping relies on complete information. (A balance sheet showing $1M in the bank doesn't mean much if there's a $995K liability that got left off.) Unless you have an in-house accounting staff, your bookkeeper is relying on you to get that information to them. A good organizational system ensures that all of the information is getting to who needs it.
Furthermore, most accountants charge based on time expended, and though good accounting can be had at a good value, it's still not cheap. Paying your accounting service to dig through files and hunt down info is a waste of their time and your money.
Speaking of "time", my accountant freaks out if I don't get certain information to them right away. What's the rush?
Certain items, particularly related to tax filings, can incur massive penalties if late. Your accountant needs the information in advance of those deadlines, to record it and check for accuracy. (Inaccurate filings can also, of course, result in penalties.)
If your accountant is pestering you to get information to them quickly, it's because they are trying to keep you out of trouble and save you money.
Since we're already talking about taxes...Why does my accountant try to make me spend money I don't want to spend? For instance, why do I have to treat certain workers as W-2 employees, instead of paying them as contractors?
Because worker classification is a big deal. Not paying employees correctly can result in audits, fines, and even lawsuits. Your accountant is being a stickler about the rules because they don't want you to get sued.
Still talking taxes...Why does my accountant say I can't take this cool deduction I found? I saw online that I can expense my home office/car payment/pet kinkajou/etc.
Present blog excluded, internet advice is no substitute for real, professional guidance. Though you'll seeing many articles claiming that you can write off an entire car payment, or take a "home office" deduction, the actual guidelines surrounding those items have specific criteria which must be met. Unfortunately, small businesses, particularly those which are sole proprietorships, are frequent targets for audits. Taking excessive, unqualified deductions puts you at an even greater risk. If you trust your tax professional, trust that they will advise you of deductions for which you do qualify. (If you are not happy with your current tax professional, we can recommend some.)
So I have to spend extra on employees, but can't take any of the fun deductions. And now I'm being told that I need to watch my spending on meals, and look at ROI for things like advertising. Is my bookkeeper just a kill-joy?
No, they just don't want you to go broke. Going bankrupt isn't just bad for you; it also means you can't pay your vendors (like your bookkeeper). So they have a vested interest in keeping you solvent.
Because, no matter what your business, one thing we all have in common is that we like to get paid.
