Tax Planning for Airbnbs: Real Estate Industry Update

As vacations make a comeback, Airbnbs and other vacation rental investments are once again on the rise. But how does that affect your tax picture?

James Moore real estate and tax partner John VanDuzer recently spoke with Kyle Paxton, a tax manager with our firm who is also on the real estate team. Together they discussed tax treatments, deductions, deprecation and passive loss rules for these properties on an episode of the Real Estate Industry Update.

Do I have to pay taxes on my rental income?

In most cases, yes. However for some setups, the process is fairly simple.

“If you hold an Airbnb in your name personally, or within an LLC with only one owner, those are going to be reported on your individual tax return,” said Paxton. “There’s no separate filing from a federal tax perspective. Just report it on your 1040 on the appropriate schedule.”

There’s even better news if your rental is your personal residence. If you live there throughout the year and you rent your space for fewer than 14 days/year, you don’t have to report the income at all. This is a common occurrence with people who live near venues that host major sporting events. Fans often look for Airbnbs and other short-term rentals instead of higher priced hotels. If you live in an apartment near a football stadium hosting the Super Bowl, for example, you could make a tidy tax-free sum.

If you don’t fall under these limits, however, you will have to report the income and pay taxes. As we mentioned above, in some cases it’s just entered on your 1040. Where this gets complicated, however, is if you offer what the IRS classifies as substantial services.

“If you’re performing cleaning duties while your tenants are there, or concierge-type services—tours and things like that—you start breaching into substantial services,” said Paxton.

When you offer these services, you’re moving into the realm of hotels and bed and breakfasts. That means it’s considered a trade or business on your tax return, and those requirements are much more complex.

One more note for those renting their property out for most of the year. If you use it personally for more than 14 days/year, you may face limits on the deductions you can take for expenses.

Speaking of deductions (and depreciation)…

Although most who own an Airbnb or other vacation rental must report their income, it also means they get to deduct some of their expenses. Anything connected to the work you do for it can be treated as an expense and therefore deducted on your return. Some of these expenses are more obvious, like property taxes, utilities and maintenance activities like painting. But it can cover more than you think.

“If you’re having to visit this property a lot throughout the year to maintain it, you start getting into vehicle mileage,” Paxton explained. “The list goes on and on of the things you can deduct.”

The key, he said, is having a good system to track all of your expenses. Save your invoices and receipts, and keep a mileage log if you’re visiting the property regularly. Not only does this establish documentation in case you’re faced with an IRS audit, it provides a one-stop place for your CPA to review your expenses and find deductions. “Digging into these things, and trying to help people identify those expenses, is really where our value add starts coming in,” said Paxton.

Sometimes, however, those expenses have to be depreciated. This means that instead of deducting the entire expense at once, you have to charge it out over a number of years. To determine whether an expenditure can be expensed or will need to be depreciated , remember the acronym RABI—restoration, adaptation, betterment or improvement. If your expenditure falls under one of those adjectives, it’s a capital item that has to be depreciated.

“Painting is a repair. So, if you paint the whole building and it costs $10,000, you can expense that as a repair,” said VanDuzer. “A roof is a building system. If you replace the whole roof and you spend $10,000, that’s a capital item.”

Thankfully, plenty of depreciation rules in effect right now make owning Airbnb or other rental properties beneficial.  Paxton cited the example of adding a pool to your property.

“You spend a bunch of money on it, and you’re improving the property significantly. Generally, under the tax law, you get a depreciation deduction over 15 years for that land improvement,” he said. “The good news is, right now for land improvements, you can take bonus depreciation. And that is a provision that allows you to take 100% of the cost as a tax deduction in year one. And depending on what tax bracket you fall into on your individual return, that can be a huge cost recovery—possibly over 30% of your investment.”

Don’t forget passive activity loss rules.

If you’re not actively involved in the operations of your Airbnb, you could be subject to passive activity loss rules. This means you won’t be able to deduct any losses you take from your tax return without having offsetting passive income. However, these losses aren’t completely lost; they remain suspended until they’re used or the property is ultimately sold.

If you’re providing the substantial services we discussed earlier, here is where you benefit. While these services lead to a more complicated tax return, they also could mean you’re materially participating in your business. So you won’t be subject to passive activity loss limitations. It also means you can offset other non-passive income with income from this real estate activity.

To fit the requirement of material participation, you have to pass one of seven tests stipulated by the IRS. Qualifying for this gets complicated, so it’s best to discuss this and other Airbnb tax concerns with your real estate CPA.

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