Airbnb & Short Term Rental Properties

Silicon Valley Real Estate | JLee Realty

Many property owners have been attracted to the higher rent that can be charged for a short-term rental. Additionally, it is easier to have short term rental income not be classified as a passive income, creating opportunities for more tax deductions. With companies such as Airbnb making it easier for property owners to find prospective renters, short term rentals have grown in popularity. The popularity of hosting Airbnb rentals has lead many cities and counties to update their regulations and taxes.

An Airbnb rental is not always a short-term rental. Some owners of rental properties have found that Airbnb can be a good way to find tenants for longer leases. Students and visiting faculty often use Airbnb to find a home where they can stay for longer periods. The tax regulations distinguish between short-term rentals and long-term rentals. The taxing authorities do not distinguish between the companies that help connect renters to the property owner.

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Airbnb & Vacation Home Short-Term Rental Properties in Silicon Valley

California law treats tenants with rentals of 30 days or less differently from those with a lease term exceeding 30 days. Many laws protecting tenants do not apply to short-term rentals.

Standard rental agreements generally do not consider: multiple payments before the renter occupies the property, check-in times, check-out times, late check-out penalties, nonrefundable cleaning charges, cancellation policies, etc.

Cities and counties typically tax short-term rentals whether the use of the property is offered by a hotel or by an Airbnb rental. Local taxes on short-term rental fees are called a transient occupancy tax (TOT). The TOT in most Silicon Valley cities ranges from about 10% to 15%.

City Transient Occupancy Tax Rates (subject to change)

County Tax Rates (unincorporated areas)

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Common Transient Occupancy Tax Requirements.

There are several regulations regarding transient occupancy taxes (TOT).

  • Tax applies to all charges related to the room: room rate, cleaning fees, etc.
  • Federal and state employees on official business are generally exempt.
  • The tax is typically due either monthly or quarterly.
  • There are penalties for late payment.

Property Rental Income Is Typically Passive Income

IRS Form i8582: "A rental activity is a passive activity even if you materially participated in the activity (unless it’s a rental real estate activity in which you materially participated and you were a real estate professional)."

Deducting a loss, such as depreciation, from income is one of the attractions of real estate rental activity. However rental income by default is passive income in the eyes of the IRS. If you have a passive loss, it can only be used to reduce other passive income, not W-2 income nor active business income. Passive activity loss rules apply to every business. If you do not materially participate in the business, your activity is passive.

If you are a real estate professional and you materially participate, your rental income does not have to be considered passive income. To be considered a real estate professional you have to work more than half of your working time and at least 750 hours in a real estate professional capacity (intended to exclude other professionals from converting passive investment losses into non-passive). You need to keep daily records of your activities.

A 7-day rental does not produce active participation hours towards the 750 hours per year needed for you to be classified as a real estate professional. Thus it will not help convert long term rental activity out of passive loss rules.

Typically passive rental income is reported on Schedule E. You do not have to pay self-employment taxes on passive income (the self-employment tax rate is 15.3%).

Airbnb And Vacation Home 7 Day Rental Period Income Tax Rules

If your average rental period is 7 days or less, your activity does not fall under standard IRS rental regulations.

"If you rent a property to customers with an average stay of 7 days or less, on average, this is a short-term rental. If that's true, you don't have a "rental" activity under Section 469. This means you don't have to qualify as a real estate professional to recategorize that activity from passive to active. You do still have to materially participate."

Thus one of the attractions of Airbnb and other 7 day rentals, is that any losses, such as depreciation, can potentially be used to offset other income.

Income from a 7 day rental is typically subject to self-employment tax. If your short-term rental income Schedule C shows a net income, it is likely that your qualified business income can have a Section 199A (qualified business income - QBI) tax deduction. If your short-term rental has a tax-deductible loss, you can combine that loss with your other self-employment income to reduce your earnings that are subject to the self-employment tax.

Your rental income will be taxed at your ordinary income rate.

Income Taxes For Rental Period of 30 Days Or Less

If your average rental period is 30 days or less, your rental activity could be considered a business if you provide substantial services. However services such as cleaning public entrances, exits, stairways, and lobbies, collecting trash, and so forth are considered occupancy services and do not create a business. If you clean the unit, supply clean linens, wash the dishes, and provide maid services, these can classify your rental as operating a business.

For income tax purposes, your short term rental is considered separate from any long term rental activity you have.

Vacation Home Rental Rules

If you own a home that you rent out for part of the year and live in for part of the year, you will be subject to tax rules that are generally referred to as vacation-home rules. You will need to prorate your expenses between the rental and personal use.

If you only rent out your home for 14 days or less each year, you are not required to report the rental income but you can not deduct any of the rental expenses.

If you rent out your home for 15 days or more, rental expenses can typically be deducted that include: mortgage interest, property taxes, utilities, maintenance expenses, insurance premiums, and depreciation. To determine how much can be allocated against the rental income, divide the number of days your home was rented out by the total number of days the property was lived in. For example if you rent out your property for a total of 100 days and you occupied the property for 100 days, you can deduct 50% of the expenses from your rental income.

If you use your property for the greater of 14 days, or 10% of the number of days the home was rented, the IRS treats the property as a personal residence and does not allow a rental loss to be deducted. You can still deduct rental expenses up to amount of rental income. Property taxes and mortgage interest are often deductible for your personal residence. As a personal residence with rental income you would likely use tax forms: A, E, or C. It is important that you document the days rented, complete days you worked on maintenance or repairs, and the days you used the home. For the IRS to classify the home to be a residence it must have a sleeping space, bathroom, and cooking facilities.

It is important to note that the 14 days, or 10% limit applies to the total use from all co-owners. Each co-owner does not get 14 days or 10%.

Personal Use Of A Rental Property

Personal use occurs when the property is used by:

  • Anyone with an interest in the property.
    • An exception is if the home is rented to another owner as his main home under a shared equity financing agreement.
  • A member of the family of anyone who has an interest in the property unless the property is their main residence and they pay the fair market rental price.
    • Family members include: brothers, sisters, half-brothers, half-sisters, spouses, lineal ancestors like parents or grandparents, lineal descendants like children or grandchildren.
  • Anyone paying less than the fair rental price (including a charity).
    • An exception is an employee who uses the home as lodging at the owner/employer's convenience.
  • Any person who uses the home under a home-exchange agreement with the owner.
    • An example would be a paying tenant who lets you remain in the home: personal use when deciding if the dwelling is a residence, rental use when prorating expenses.
    • When prorating expenses you can only count the days for which you receive fair market rent when calculating the ratio.
  • If a property is never rented out nor occupied by the owner and is held for its expected appreciation, the use is considered personal use.

Personal use does NOT occur for full time days of maintenance by an owner.

The IRS safe harbor guidelines for determining if a mixed use property can qualify as property held for productive use in a trade or business are published in Rev.Proc. 2008-16 (see SECTION 4 APPLICATION).

Renting Out A Room In Your Home

If you rent out a room in your home, the tax rules apply the same way as if you were renting out the entire home. The difference is that you must allocate expenses between the portion you are renting out and the part you live in. You can use any reasonable method of allocating the expenses. The two most common ways are using the number of rooms or the square footage. It may be reasonable to divide expenses based on how many people are using the item (for instance water).

The Tax Cuts and Jobs Act (scheduled to last through 2025) allows the owners of any business other than a regular C corporation to deduct up to 20% of their net business income from their income taxes (income level dependent). Renting a room to short-term guests can qualify as a business especially if you earn a profit each year. However it is common for Silicon Valley cities to put restrictions on short-term rentals in residential neighborhoods.

Section 199A The IRS Trade Or Business Safe Harbor

The IRS has published a "safe harbor" that tells you how your rental activity can be classified as a business. A short summary is:

  • You maintained separate books and records to show the expenses incurred on that property
  • You performed 250 hours of real estate related work annually.
  • You attach a statement to your return indicating you are electing the safe harbor.

Home Equity Loan Interest Deduction

Currently you can deduct interest on a home equity loan only if you use the funds "to buy, build, or substantially improve the home that secures the loan." If you take out an equity loan on your first home to purchase your second home, the interest can not be deducted on a personal residence.

Property Tax Deduction

State and local tax deductions are limited to a total of $10,000 for as many personal residences as you own. If your short-term rental activity is classified as a business, the property taxes on the short-term rental property can be used to reduce your business income.

1031 Exchange With A Short Term Rental Property

Business and investment properties are eligible for swapping in a 1031 exchange. If you rent out a property for at least 14 days and you occupy it for no more than the lesser of 14 days or 10% of the days the property was actually rented out, it may qualify for use in a 1031 exchange. The property must have been rented out at the fair market rate. Your time spent in a rental property working to repair or improve the property does not count as part of the 14 day limit.

A rental property obtained in a 1031 exchange can qualify for a partial Section 121 ($250,000/$500,000) exclusion. If the property acquired is held for the first two years as a rental, then held for three more years as your primary residence, 3/5 of the gain can be allowed for the Section 121 exchange. However, the Housing and Economic Recovery Act of 2008 prevents the gain attributable to the time before personal use from being excluded from taxes.

Using a property that you purchased, fixed up, then wish to sell as a short-term rental will not immediately qualify for a 1031 exchange. You must be able to show that the property was purchased as an investment, rather than something that was bought simply to sell at a higher price.

Short Term Rental Business Vs. Passive Rental Activity

If your short term rental is operated in a way to classify it as a business, losses are not restricted to passive investments. If you have significant income from other activities, losses from operating a short term rental business can provide deductions. There are six ways that your short term rental property can be kept from being classified as passive rental activity:

  1. The average rental period is seven days or less.
  2. The average rental period is 30 days or less, and you provide significant personal services. These could be providing daily cleaning or meals like a hotel does.
  3. Extraordinary personal services even though the average rental period is longer than 30 days.
  4. Renting the property is incidental to a non rental activity.
  5. The property is made available during defined business hours for nonexclusive use by various customers.
  6. Provision for using the property by a partnership, S corporation, or joint venture which the taxpayer owns an interest in.

Material Participation Can Turn Your Short Term Rental Losses Into Non-passive Losses.

Materially participating can enable you to deduct the full amount of your losses. Meet any one of the seven criteria below to satisfy the material participation standard:

  1. Spend more than 500 hours on the short term rental business.
  2. Do substantially everything for the short term rental business.
  3. Spend more than 100 hours on the activity and no one one person spends more time than you do.
  4. Spend more than 100 hours of significant participation in the short term rental and more than 500 hours in all significant participation activities.
  5. Participating in the business for five of the 10 previous taxable years.
  6. Personal service activity (non income-producing) for three of the previous taxable years.
  7. Regular, continuous, provable participation in the business for more than 100 hours.

Most short term real estate investors use one of the first three to qualify for material participation.

Seek Professional Advice

The information presented is a partial summary of many of the issues surrounding Airbnb and Vacation Home rentals. There are additional issues that are not discussed and the regulations are constantly changing. Please seek the advice of a tax professional who can consider all relevant aspects of your situation.

A recommendation based on personal experience: David Andrews, CPA at Wong Ewers LLP (