Book: Every Airbnb Host’s Tax Guide

“Every Airbnb Host’s Tax Guide” by Stephen Fishman, J. D.

See also: https://www.nolo.com/legal-encyclopedia/tax-issues-when-renting-out-room-your-house.html
See also: https://legaltemplates.net/resources/real-estate/renting-a-room-in-a-house/
See also: https://www.nolo.com/legal-encyclopedia/small-taxpayer-safe-harbor-for-repairs-improvements.html

“Any rental expenses paid for by guests are rental income; for example, payments a guest makes to you for repairs, utilities, or other rental costs. These costs are then deductible by you as rental expenses.”
“You are entitled to deduct virtually all the expenses you incur when
you rent out your property, just like any other residential landlord. This
includes such items as advertising costs, attorneys’ and accounting fees,
listing fees and commissions, travel expenses, mortgage interest, utilities,
supplies, travel expenses, car expenses, repairs and maintenance, furniture
and personal property costs, and depreciation of your real property.”
“Any expenses you incur just for your short-term rental activity—
for example, Airbnb listing fees—are fully deductible.”
“Deductions such as depreciation and
repairs must be prorated according to the amount of time you rent your
property during the year compared with the time you use it personally;
and, if you don’t rent your entire property, by the amount of space that
is rented. For example, if you rent your entire home 10% of the year,
you’ll be able to deduct only 10% of the depreciation you’d be able to
claim for a full-time rental.”
“Be aware, however, that when you set up your account with an online
platform like Airbnb, VRBO, or FlipKey, you must provide a completed
IRS W-9, Request for Taxpayer Identification Number and Certification.
This verifies your identity and address for tax purposes. If you don’t
complete a W-9, the company is required to withhold 28% of your
rental income and pay it to the IRS. This is called backup withholding.”
“If you pay estimated tax, the payments are due four times per year:
April 15, June 15, September 15, and January 15. To avoid having to
pay an underpayment penalty, your total withholding and estimated
tax payments must equal the lesser of either (1) 90% of your tax liability
for the current year, or (2) 100% of what you paid the previous year (or
110% if you’re a high-income taxpayer—adjusted gross income of more
than $150,000; or $75,000 for married couples filing separate returns).”
“The easiest way to calculate your quarterly estimated tax payments
is to subtract your total expected income tax withholding for the current
year from the total income tax you paid last year. The balance is the
total amount of estimated tax you must pay this year. But, if you’re a
high-income taxpayer, add 10% to the total.”
“First of all, if you sell the home at a profit, you will be required to
recapture all the depreciation deductions you took (or should have taken)
during the years you rented the home.”
“You must report the total amount of depreciation on IRS Form
4797 and pay a flat 25% tax on it (however, if your top income tax rate
is below 25%, the lower rate applies). This can have a significant tax
impact. For example, if you rented your home part time through Airbnb
for five years and took $10,000 in total depreciation deductions, you’ll
owe $2,500 in tax when you sell the home.”
“If you
own and occupy the home as your principal residence for at least any
two of the five years before you sell it you don’t have to pay income tax
on up to $250,000 of the gain from the sale if you’re single, or up to
$500,000 if you’re married and file jointly. (But you must still pay the
25% tax on your depreciation recapture.) Your two years of ownership
and use can occur anytime during the five years before you sell—and
you don’t have to be living in the home when you sell it.”
“For more details on the home sale tax exclusion, see IRS Publication
523, Selling Your Home.”
“A good example is supplying daily maid service—this is a service provided by hotels and bed and breakfast businesses, not residential landlords. Other examples
include providing:
• meals or snacks
• laundry services
• books, games, and videos
• concierge services
• tours and outings
• transportation
• amenities like linens, irons, hangers, shampoo, and soap, or
• other hotel-like services.
However, providing such services is not enough in itself to turn your
rental activity into a hotel business. The services must be “substantial”—
that is, their value must constitute a “material part of the payments made
by the tenant.” (IRS Rev. Rul. 1983-139.) The IRS provides no precise
guidelines on exactly how much services must be worth to be substantial,
but examples in IRS Regulations indicate they must be worth at least
10% to 15% of the total rent paid by the guests. (IRS Reg. §§ 1.1402(a)-
4(c)(3), 1.469-1T(e)(3)(viii), Ex. 4.)”
“In addition to regular income taxes, higher-income hosts may be subject
to the Net Investment Income (NII) tax.”
“The NII tax is a separate 3.8% income tax on unearned income—that
is, income other than from a job or business in which you actively
participate. Those subject to it—primarily higher-income taxpayers—
must pay it in addition to their regular income taxes. The tax is included
on Form 1040. You report the amount you’re required to pay by
completing IRS Form 8960, Net Investment Income Tax—Individuals,
Estates, and Trusts, and attaching it to your return.”
“Even if your AGI exceeds the $200,000/$250,000 threshold, you’ll
be subject to the NII tax only if you have net investment income. Net
investment income consists of:
• net rental income (rents minus expenses)
• income from investments, including interest, dividends, and
annuities
• income from any business in which you don’t materially
participate, including real estate limited partnerships and other
real estate investment businesses, and
• net capital gains (gains less capital losses) you earn upon the sale
of property that is not part of an active business, including rental
property, stocks and bonds, and mutual funds.”
“The NII tax is a flat 3.8% tax that must paid on the lesser of (1) the
taxpayer’s net investment income, or (2) the amount that the taxpayer’s
AGI exceeds the applicable threshold: $200,000 for single taxpayers, and
$250,000 for married filing jointly.”
“Depending on where your property is located, your short-term rental
activity can be subject to occupancy taxes levied by your city, county,
or other local government, or state. These taxes go by different names—
for example:
• occupancy tax
• transient occupancy/rental/lodging tax
• sales tax
• hotel tax
• lodging tax
• room tax
• gross receipts tax
• bed tax
• transaction privilege tax, or
• tourist tax.”
“You can find summaries of the local short-term rental taxes charged
in many areas, along with helpful links, on the Airbnb website at the
following url: http://www.airbnb.com/help/article/653/in-what-areas-is-
occupancy-tax-collection-and-remittance-by-airbnb-available”
“Useful summaries are also available on the Avalara website at https://
mylodgetax.avalara.com/taxcenter/usa.”
“In some locations, Airbnb has entered into agreements with the
local governments involved to collect and remit the applicable local
taxes on behalf of hosts. In some areas—San Francisco and Portland,
for example—it does this automatically; in other areas you must request
this. You can find a list of these locations at airbnb.com. However, if
Airbnb or any other rental platform you use won’t collect local taxes for
you, it is your responsibility to do it yourself. If you fail to do so, you’ll
be responsible for paying the tax and you could also be fined by your
local tax authority. If this seems like too much work, there are private
companies you can hire to collect and remit local taxes for you. Among
these are Avalara (https://mylodgetax.avalara.com), which has partnered
with VRBO and HomeAway to provide this service.”
“Starting in 2018 through 2025, homeowners may deduct up to $10,000 in property tax each year on a main and second home. The mortgage interest deduction for homes purchased during this time period is limited to home acquisition debt up to
$750,000.”
“However, if you do receive a Form 1099 reporting such income
(with a copy automatically sent to the IRS), you should take steps to
avoid questions from the IRS. The IRS has provided no guidance on
how to deal with this problem, but one approach is to file Schedule E
with your return and list the rental income on Line 3 as Rents received.
Then, on Line 19 (Other) list the income as an expense and add the
following note in the space provided on Line 19: ‘Rent on Line 3 is
exempt from tax under Section 280A(g)—residence rented less than 15
days.’ You then list zero in Line 26 Total rental real estate and royalty
income or (loss). This should satisfy IRS computers since the income
shown on the 1099 will be listed on your return.”
“Operating expenses are the day-to-day expenses you incur for your
short-term rental activity. They include things like mortgage interest if
you own your home, rent if you’re a renter, insurance, utilities, Airbnb
or other similar fees and commissions, advertising costs, supplies,
travel expenses, and car expenses.”
“Long-term assets are things you use for your rental activity that have
a useful life of more than one year. Your main long-term asset is your
home or building you rent out. However, long-term assets also include
such things as furniture, appliances, vehicles, and equipment.”
“Residential rental buildings (and structural components) are depreciated
over 27.5 years. Commercial buildings are depreciated over 39 years.
Long-term personal property assets are depreciated over a much shorter
period—for example, furniture and appliances are depreciated over five
years.”
“Starting in 2018 through 2025, short-term hosts may qualify for a special pass-through tax deduction. This enables them to deduct from their income taxes up to 20% of their net income from their rental activity.”
“If you rent a room or rooms in your home while you continue to live there, you’ll have to further allocate your expenses according to the amount of space in your home that you rent out. Moreover, if there are any repairs or expenses that only relate to personal areas of the home, you won’t be able to deduct those at all. Any expenses that are just for your short-term rental activity— Airbnb fees, for example—can be deducted in full.”
“Thus, if you rent out your home, vacation home, a room in your home, or any other property though Airbnb or a similar online rental platform, you’re engaged in a business for tax purposes if your activity is undertaken to earn a profit and carried on regularly, systematically, and continuously. For example, someone who has an extra bedroom in their house that they actively list on Airbnb or another online rental platform and rent at market rates to multiple guests during the year would likely be engaged in business, particularly if a profit is earned on the rentals. This is true whether they manage their short-term rentals themselves or hire a management company to do so for them.”
“As a result of the new law, during 2018 through 2025, you cannot deduct any of the
expenses you incur from a hobby from your income taxes. But you’re still required to report and pay tax on all the income you earn!”
“If you earn a profit from your rentals in three out of five consecutive years, the IRS must presume that you have a profit motive. Any legitimate profit—no matter how small—qualifies; you don’t have to earn a particular amount or percentage. The presumption that you are engaged in a for-profit activity applies to your third profitable year and extends to all later years within the five-year period beginning with your first profitable year. However, you don’t have to earn profits every year to be profit-motivated. Many people who want to earn profits from real estate rentals have negative cash flows.”
“To show the IRS that you’re profit motivated, you should take the following steps:
• Keep good business records (see Chapter 13).
• Keep track of the time you spend on your rental activity.
• Keep a separate checking account for your rental activity.
• Take steps to increase your short-term rental income—for example, redo your online rental listing with better photos, offer more amenities to your guests, and make your property available for rent more often.
• Educate yourself about earning profits from short-term rentals by attending educational seminars and other programs.
• Prepare a business plan showing how much money you expect to earn or lose over the next several years.”
“LLCs are by far the most popular type of entity for owning rental property. LLCs with more than one owner are ordinarily treated the same as partnerships for tax purposes. LLCs with one owner are ‘disregarded entities’—the owner reports profits, losses, and deductions from rental activities on his or her individual Schedule E.”
“Each year, the LLC must file IRS Form 1065, U.S. Return of Partnership Income, and provide each owner with an IRS Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., listing the owners’ shares of the LLC’s income and expenses. The owners must then file IRS Schedule E with their individual income tax returns, showing their share of income or losses from the LLC’s activities.”
“The basic rule is that you can deduct
in a single year any expense that is:
• ordinary and necessary
• current
• directly related to your rental activity, and
• reasonable in amount. (IRC § 162.)”
“A good example of a current expense is the cost of utilities like electricity, gas, and water you provide your short-term guests. Anything you purchase that will benefit your rental activity for more than one year is not a current expense—for example, purchasing a new refrigerator for your vacation home. You can usually deduct the
cost of personal property like a refrigerator in a single year using bonus depreciation or the de minimis safe harbor (see Chapter 7).”
“The fees charged by short-term rental platforms, such as Airbnb, Home-
Away, or FlipKey, are all fully deductible operating expenses.”
“These rental platforms also typically charge ‘service fees’ to guests—for
example, Airbnb charges guests a 6%–12% service fee. Obviously, these
fees are not deductible by hosts since they don’t pay them.”
“Many local (and some state governments) require short-term hosts to
pay for business licenses and special registration fees. For example, San
Francisco requires short-term hosts to pay a $250 registration fee every
two years. These fees are fully deductible operating expenses.”
“Ongoing website hosting, maintenance, and updating costs are a currently
deductible operating expense. Money you spend to get people to view
your website, such as SEO (search engine optimization) campaigns, is
also currently deductible. However, the cost of initially developing your
website may constitute a capital expense, not a currently deductible
business operating expense. If so, the cost may have to be deducted over
three years. Any other advertising you do is also deductible.”
“For example, you can deduct the cost of driving to the airport to pick up
or drop off your short-term guests. You can also deduct driving to meet
with repair people, attorneys, accountants, property managers, and other
people who help in your short-term rental activity.”
“Travel from your main home to your vacation home (or other
property away from your own home) can be deductible if done for rental
purposes—for example, to do cleanup, maintenance, repairs, guest
check in, hauling supplies, or other rental-related tasks. However, this is
true only if you have an office in your main home that qualifies as the
principal place of business for your rental activity (see ‘Home Office
Deduction’ below). Otherwise, such trips are nondeductible personal
commuting, even if there is a rental purpose for the trip. Moreover,
you may not currently deduct driving expenses incurred while making
improvements to your home or other property you use in your short-
term rental activity. Instead, the cost of such driving must be added to
the basis (cost) of the improvement and depreciated over several years
(see Chapter 6).”
“You must use the standard mileage rate in the first year you use a
car for your rental activity, or you are forever foreclosed from using that
method for that car.”
“Long distance travel is travel away from the area of your tax home (the
city or general area where you live) that requires you to stay at least
overnight at your destination before returning home. If the property you
rent to short-term guests is a vacation home or another home outside
the area of your tax home, you may have substantial long distance travel
expenses. Such expenses can be deductible. However, you can’t deduct
trips primarily for personal vacations.”
“Examples of rental purposes include:
• traveling to your property to deal with guests, maintenance,
or repairs
• traveling to building supply stores or other places to obtain
materials and supplies for your rental activity
• learning new skills to help in your rental activity, by attending
landlord-related classes, seminars, conventions, or trade shows, and
• traveling to see people who can help you operate your rental
activity, such as attorneys, accountants, or real estate managers.”
“Such destination expenses include:
• hotel or other lodging expenses for rental business days (if any)
• 50% of meal and beverage expenses
• laundry and dry cleaning expenses, and
• tips you pay on any of the other costs.”
“You may deduct 100% of your transportation expenses if you spend
more than half of your time on rental activities while at your destination.”
“You spend a day on
rental activities if you:
• spend more than four hours doing rental-related work—for
example, working on repairs or maintenance of the property or
dealing with your short-term guests
• spend more than four hours on travel for your rental activity
(travel time begins when you leave home and ends when you
reach your destination, or vice versa)
• drive at least 300 miles for your rental activity. You can average
your mileage. For example, if you drive 600 miles to your des-
tination in two days, you may claim two 300-mile days, even if
you drove 500 miles on one day and 100 miles on the other
• spend more than four hours on some combination of travel and
your rental activities
• stay at your destination between days you work on rental
activities, if it would have cost more to go home and return
than to remain where you are. This sandwich rule allows you to
count weekends as rental activity days, if you work at your travel
destination during the previous and following week”
“For example, you can deduct the cost of hiring an attorney to draft a
short-term rental agreement for you. You can also deduct the cost of
hiring a firm to process and pay any local lodging taxes due on your
rentals. You may deduct any accounting fees that you pay for your rental
activity as a deductible operating expense—for example, fees you pay an
accountant to set up or keep your books, prepare your tax return, or give
you tax advice for your rental activity.
You may also deduct the cost of having an accountant or other tax
professional complete the rental portion of your tax return—Schedule E
and other rental activity tax forms—but you cannot deduct the time
the preparer spends on the personal part of your return.”
“It’s common for short-term rental hosts to provide their guests with
various amenities such as linens, sheets, soaps, shampoo, toothpaste,
toothbrushes, razors, toilet paper, paper towels, games, guidebooks,
first aid kits, and other supplies, and even food. All such items are fully
deductible if they are purchased only for your guests’ use.”
“Gifts you provide to your short-term guests or others in the course of
your rental activity are deductible. However, the gift expense deduction
is limited to $25 per person per year. Any amount over the $25 limit is
not deductible.”
“Any other operating expenses you incur just for your rental activity
are also fully deductible provided they are ordinary, necessary, and
reasonable in amount—for example:
• any fees or service charges for PayPal or another online payment
service that you use for your rental activity
• cleaning fees you pay to have the apartment professionally
cleaned before and after your guests leave
• the cost of purchasing a lockbox or having duplicate keys made
• the cost of storing your belongings while guests stay in your
apartment
• the cost of any credit reports you obtain to screen potential guests
• dues and subscriptions for your rental activity, and
• education directly related to your rental activity, such as a
conference or seminar about how to make a profit from short-
term rentals.”
“Start-up expenses include:
• minor or incidental repairs to get a rental property ready to rent
• home office expenses
• insurance premiums
• costs to create and set up a website
• business licenses, permits, and other fees, and
• fees paid to lawyers, accountants, consultants, and others for
professional services.”
“Start-up expenses are not deductible in the same way as regular
operating expenses. First, they are only deductible if your rental activity
qualifies as a business for tax purposes. If so, you may deduct $5,000
in start-up expenses in the year you make your property available for
rent.”
“If you have a mortgage on the home, vacation home, or other property
you rent out short-term, you may deduct a portion of the interest as a
rental expense (but not repayment of the principal amount of the loan).
Any amount you can’t deduct as a rental expense should be deducted as
a personal itemized deduction.”
“Starting in 2018 through 2025, the personal itemized deduction for property taxes is capped at $10,000 per year. Amounts deducted as a short-term rental expense don’t count toward the annual limit. Thus, if you itemize your deductions, engaging
in a short-term rental activity could help you deduct more property tax on your main or second home.”
“All your utility costs are partly deductible operating expenses that must
be allocated according to your rental use. This includes electricity, water,
gas, garbage pick-up, cable TV, Internet service, and snow removal costs.
It also includes homeowner association or condominium dues.”
“However, any insurance coverage you purchase just for your rental
activity is fully deductible. For example, if you add an endorsement
to your homeowners’ policy to cover your short-term rentals, you can
deduct 100% of the cost. Likewise, you can fully deduct the cost of a
separate insurance policy for short-term rentals or full-blown landlord
insurance coverage.”
“For example, Airbnb has a
“host guarantee” in which it promises to pay up to $1 million to a host
for property damage. However, Airbnb makes clear on its website that
the guarantee is “not insurance,” and does not cover cash and securities,
collectibles, rare artwork, jewelry, pets, or personal liability. These
losses will likely not be covered by your homeowner’s insurance, which
ordinarily excludes coverage for short-term rentals. To the extent any of
them are not covered by insurance, you’ll have a casualty or theft loss
that could be deductible.”
“A casualty or theft loss is damage, destruction, or loss of property
due to a sudden, unexpected, or unusual event caused by an external
force. This includes, but is not limited to:
• vandalism, including vandalism to rental property by tenants
• theft
• earthquakes, fires, floods, landslides, sonic booms
• storms, including hurricanes and tornadoes
• government-ordered demolition or relocation of a building that is
unsafe to use because of a disaster, and
• terrorist attacks.
You should file a police report when a theft occurs or if your property
is vandalized.”
“Personal casualty losses are deducted as a
personal itemized deduction on IRS Schedule A, while casualty losses to
rental-use property are deducted on Schedule E. Additionally, personal
casualty losses are deductible only if, and to the extent, they exceed 10%
of the property owner’s adjusted gross income and the first $100 is not
deductible. Most importantly, however, during 2018 through 2025, the
personal deduction for casualty losses is available only if the loss was
caused by a federally declared disaster, such as a flood or hurricane.
Other casualty losses to personal use property—for example, uninsured
losses due to ordinary house fires—are not deductible. This rule does not
apply to rental or other business use property—uninsured losses to such
property are deductible as a rental or business expense whether or not
caused by a federally declared disaster.”
“Unless you rent your property for only 14 days or less for the year
(or less than 10% of the rental days), you must complete Form 4684,
Casualties and Thefts, treating all your casualty losses as personal losses.
Your deductible rental loss is the amount, if any, that exceeds 10% of
your adjusted gross income for the year (not including rental income).
You may deduct the rental use percentage of this amount as a rental
deduction on Schedule E. You may deduct any remaining portion of this
amount as a personal casualty loss on Schedule A to the extent it exceeds
10% of AGI less $100.”
“In contrast, when you deduct an expense through regular depreciation,
bonus depreciation, or Section 179 expensing, the expense can result in
extra tax when you sell the property. If you sell real property at a profit, you
must pay tax at a rate up to 25% on your total depreciation deductions.
If separately deducted personal property is involved, you pay tax on your
regular or bonus depreciation or Section 179 deductions at your ordinary
income tax rates (as much as 37%). This is called recapture, since deductions
you previously took are recaptured into your income and taxed.”
“However, things are different if you rent only one or more bedrooms
in your home, instead of the entire home. The IRS says that you can
deduct repairs that benefit the entire property, subject to the allocation
rules covered in Chapter 9. For example, you can deduct a portion of the
cost of painting the entire home or repairing the water heater or the roof.
You can also deduct repairs just for the bedroom or bedrooms (or other
rooms) you rent—for example, fixing a window in a rental bedroom.”
“For example, if you rent a bedroom in your home while you continue to live in the home, you would not be able to deduct a repair to the kitchen sink, even if your
guests were allowed to use the kitchen, because you also use the kitchen
for personal purposes.”
“Maintenance is undertaken
to prevent something from breaking down. A repair is done after a break-
down has occurred. For example, the cost of oiling the circulator pump in
a hot water heater is maintenance; the cost of fixing an unlubricated pump
that has failed is a repair. There is no practical tax difference between
maintenance and repairs—they are both currently deductible operating
expenses. However, because IRS Schedule E requires that you separately list
what you spent for each category, you must keep track of these expendi-
tures separately.”
“The safe harbor for small taxpayers (SHST) is the single most important
one. (IRS Reg. § 1.263(a)-3h.)”
“The SHST may be used only for buildings—including condos and co-ops
—with an unadjusted basis of $1 million or less. Unadjusted basis
usually means a building’s original cost (also called its cost basis), not
including the cost of the land. (See Chapter 7 for a detailed discussion
of how to determine a building’s basis.) To determine a building’s
unadjusted basis, you don’t subtract the annual amounts you deduct
for depreciation. But you add the value of any improvements you make
to the building while you own it and that you are depreciating along
with the rest of the building. If you own more than one property you
rent out—for example, you rent both your main home and a vacation
home—the $1 million limit is applied to each separately.”
“You may use the SHST only if the total amount paid during the year for
repairs, maintenance, improvements, and similar expenses for a building
does not exceed the lesser of $10,000 or 2% of the unadjusted basis of
the building.”
“IRS regulations don’t address how to calculate basis for purposes of
the SHST when you rent only a room or rooms in a home, instead of the
entire property. Presumably, your SHST basis should only cover the part
of the home you rent. You can calculate this based on the percentage of
the home that is rented. Compare the square footage of the entire home
with the square footage of the room or rooms you rent out.”
“The small taxpayer safe harbor must be claimed anew each year by filing
an election with your timely filed tax return, which is due by October 15
(if you obtain an extension of time to file). Thus, you can use the SHST
for amounts paid during 2018 by filing the election with your 2018 tax
return, which must be filed no later than October 15, 2019.”
“You can claim the SHST for some years and refrain from doing so
for other years—it’s entirely up to you. The SHST is also claimed on
a building-by-building basis. Thus, if you own more than one short-
term rental home or other building, you can claim the SHST for some
buildings and not use it for others.
There is no IRS form for this election. However, it is a very simple
document you can easily create yourself and attach to your return. You
can use the following format:
Section 1.263(a)-3(h) Safe Harbor Election for Small Taxpayers
Taxpayer’s name:
Taxpayer’s address:
Taxpayer’s identification number:
The taxpayer is hereby making the safe harbor election for small taxpayers
under Section 1.263(a)-3(h) for the following building property:
[ describe ]”
“The second potentially useful safe harbor for landlords is the routine
maintenance safe harbor. (IRS Reg. § 1.263(a)-3(i).) Expenses that qualify
as routine maintenance under this provision are deductible in a single
year.”
“However, building maintenance qualifies for the routine maintenance
safe harbor only if, when you placed the building or building system
into service, you reasonably expected to perform such maintenance
more than once every ten years. A nonexclusive list of examples of
maintenance for rental properties usually performed more than once
every ten years includes such items as:
• inspecting, cleaning, and repairing HVAC units
• clearing and replacing rain gutters
• inspecting and replacing sprinklers
• smoke detector inspection and replacement
• lighting inspection and replacement
• paint touch-up
• chimney inspection and cleaning
• furnace inspection, cleaning, and repair, and
• inspecting and replacing washing machine hoses.
The more-than-once-every-ten-years requirement would seem
to eliminate use of the routine maintenance safe harbor for building components that typically don’t need such frequent maintenance—for
example, roofs, windows, and wooden or tile flooring.”
“Rather, the routine maintenance safe
harbor is a method of accounting you adopt. Moreover, after you adopt
it, you must use it every year. You adopt the routine maintenance safe
harbor by currently deducting expenses that come within it on your
books and on your tax return. Its use is completely voluntary.”
“Any expense you deduct under the routine maintenance safe harbor
is counted toward your annual limit under the small taxpayer safe
harbor. For example, if your annual SHST limit is $5,000 and you
deduct $4,000 for maintenance under the routine maintenance safe
harbor, you’ll only be able to deduct an additional $1,000 under the
small taxpayer safe harbor. No amount is deductible under the small
taxpayer safe harbor if the annual limit is exceeded.”
“The third safe harbor is the de minimis safe harbor. (IRS Reg. §
1.263(a)-1(f ).) You may use this safe harbor to currently deduct any low-
cost items used in your rental activity, regardless of whether or not the
item would constitute a repair or an improvement under the regular
repair regulations.”
“The maximum amount that can be deducted under this safe harbor
is $2,500 per item. Like the SHST, this safe harbor is claimed by
filing an election with your annual tax return. You must also adopt an
accounting policy requiring such treatment.”
“As with the routine maintenance safe harbor, all expenses you
deduct using the de minimis safe harbor must be counted toward the
annual limit for using the safe harbor for small taxpayers (the lesser
of 2% of the rental’s cost or $10,000). For example, if your annual
SHST limit is $2,000, and you deduct $2,500 using the de minimis
safe harbor, you may not use the SHST that year. But if you deducted
only $1,000 using the de minimis safe harbor, you could deduct an
additional $1,000 using the SHST.”
“You can also read the voluminous repair regulations on the IRS website
at http://www.irs.gov/irb/2013-43_IRB/ar05.html; the IRS has also created
a detailed set of FAQs about them at http://www.irs.gov/businesses/small-
businesses-self-employed/tangible-property-final-regulations.”
“Restorations include replacing a substantial structural part of your
property, or rebuilding a substantial portion of your property to a like-
new condition after it has fallen into disrepair. IRS examples indicate
that substantial means replacing or rebuilding at least 30% of the
property involved.”
“If you are forced to do a repair because of damage caused by a guest, you
may deduct the cost from the guest’s security deposit or charge the guest
an extra fee for the repair. A security deposit does not constitute taxable
income. However, if you keep all or part of a security deposit because a
guest has caused damage, that amount is taxable income. When you fix
the damage, the amount spent on the repair is a deductible expense that
will offset the additional income.”
“Make sure your repairs are classified as such in all your books and
accounting records. This problem can easily crop up if you have a
bookkeeper or accountant do your books—who may list a repair
as a capital improvement. If an IRS auditor sees this, it will be
curtains for your repair deduction.”
“If you’re doing an extensive repair, take before-and-after photographs
to show the extent of the work and that the property has not been
made substantially more valuable.”
“Since you’re renting out your property part time, you must prorate
your deductions based on the percentage of the time the property is used
for rental versus personal use.”
“For example, if, before
listing your home as a short-term rental, you paid to repair the furnace,
the cost is not deductible or added to basis. The only exception to this
rule is where repairs qualify as start-up expenses for a brand new rental
business. This is a limited deduction of up to $5,000 you may take for
getting a new rental business up and going”
“Improvements include, but are not limited to, adding or
replacing all of the following:
• Additions . New bedroom, bathroom, deck, garage, porch, or patio
• Plumbing . Septic system, water heater, soft water system, filtration
system
• Heating and air-conditioning . Heating system, central air
conditioning, furnace, duct work, central humidifier
• Insulation. Attic, floors, walls, pipes, duct work
• Miscellaneous . Storm windows, door, new roof, central vacuum,
wiring upgrades, satellite dish, security system, and
• Land improvements. Fences, outdoor lighting, swimming pools,
driveways, paved parking areas and other pavements, sidewalks
and walkways, sprinkler systems, drainage facilities, and new land-
scaping if it will have to be replaced when the building is replaced.”
“If you rent a room or rooms in your home, instead of the entire
home, you may take a depreciation deduction for improvements that
benefit the entire home, such as a new roof or heating system. The
deduction must be prorated according to the percentage of the home
that is rented. You may also take depreciation for improvements just for
the room or rooms that are rented—for example, a new window for a
rental room. In this event, you prorate your deduction according to the
amount of time you rent the room.”
“You must keep separate accounts for depreciable additions or
improvements made after you place your rental property in service. You
add the cost of depreciable additions and improvements to the adjusted
basis of your property, which will reduce your tax liability when you sell
the property.”
“Building components that cost $2,500 or less may be deducted in a
single year with the de minimis safe harbor deduction. For example, a
bathroom sink is a building component. If you spend $2,000 to replace
a bathroom sink, the full amount of your depreciable basis can be
deducted that year with the de minimis safe harbor deduction instead of
being depreciated over five years. Your depreciable basis is the property’s
cost multiplied by the rental use percentage. Thus, if you rent your
home 25% of the time, you could deduct $500 of the cost of a $2,000
bathroom sink.”
“Starting in 2018, Section 179 can be used to fully deduct in one year up to
$1 million of the cost of the following improvements to nonresidential
real property placed in service after the property was first placed in service:
• roofs
• heating, ventilation, and air-conditioning property
• fire protection and alarm systems, and
• security systems. (IRC § 179(f).)
In addition, starting in 2018, Section 179 may be used to deduct
“qualified improvement property.” This consists of improvements to
the interior of nonresidential real property after it has been placed into
service in business. However, it does not include improvements related
to the enlargement of a building, an elevator or escalator, or the internal
structural framework of a building.”
“Note carefully that these provisions apply only to nonresidential
real property, not residential property and you must use the property
over 51% of the time for business. As discussed above (see ‘How Long
Is the Depreciation Period?’), a residence used for short-term rentals can
qualify as nonresidential property if the guests occupy it on a transient
basis. In this event, the property is depreciated over 39 years instead of
27.5 years. If you classify your property as nonresidential property you
can use Section 179 to deduct these improvements provided that you
rent out the property at least 51% of the time.”
“Arthur owns a vacation home that he starts to rent out
to short-term guests on March 1, 2017. He rents the property 75% of
the time and lives in it 25% of the year. Because his guests occupy the
home on a transient basis, he classified the home as nonresidential
property to be depreciated over a 39 year term. In 2018, he remodels
the home by taking out several of the interior (nonstructural) walls
to create a large open space. He can deduct 75% of the cost of the
remodel in 2018 by using Section 179.”
“The amount of any
profit on the sale attributable to the depreciation deductions you took in
prior years is taxed at a single 25% rate (however, if your top tax rate is
below 25%, the lower rate applies).”
“The following types of items inside your home, vacation home, or
other property you rent short-term are personal property:
• furniture
• refrigerators, stoves, dishwashers, microwaves, and other kitchen
appliances
• carpeting that is tacked down (but not glued down)
• drapes, curtains, and window blinds
• washers and dryers
• fire extinguishers and fire alarms
• plants inside your home
• portable window air conditioners and space heaters
• movable and removable partitions, and
• televisions.”
“If you rent a room or rooms in your home, instead of your entire home,
the IRS takes the position that you can only deduct personal property
located in the room or rooms you rent to short-term guests. For example,
if you rent a bedroom to short-term guests, you may deduct the cost of
purchasing new furniture for the bedroom or converting old furniture to
rental use.”
“If you purchase
property for your rental activity—that is, you don’t use it personally
first—you can usually deduct the cost in one year using one of the
following tax rules:
• the de minimis safe harbor
• material and supplies deduction
• 100% bonus depreciation, or
• Section 179 expensing.
If none of these rules apply, you’ll have to deduct the property over
several years (usually five) using regular depreciation. You’ll also have
to use regular depreciation to deduct the cost of personal property you
convert to rental use.”
“All expenses
deducted with the safe harbor are currently deducted as business operating
expenses. You may deduct them as “other” expenses on your Schedule E.
You can list the total amount as “de minimis safe harbor expenses.” Unlike
with bonus depreciation, you don’t need to list your safe harbor expenses
on IRS Form 4562, Depreciation and Amortization. Nor do you have to
create or maintain depreciation schedules for property items or include
them in your accounting records as assets. Also, bonus depreciation may
only be used to deduct personal property, not building components like a
bathroom sink that can be deducted with the safe harbor.”
“If you elect to use the de minimis safe harbor, you must also apply
it to all items you buy during the year for your rental activity with an
economic useful life of 12 months or less whose cost is within the de
minimis limit.”
“If the cost exceeds $2,500 per invoice (or item), no part
of the item’s cost may be deducted using the de minimis safe harbor. To
determine whether the cost of an item falls within the $2,500 limit, you
must apply the full invoice amount, even if you use the item only part
time for your rental activity and therefore would be allowed to deduct
only part of the full invoice amount.”
“To claim the de minimis safe harbor, you must file an election with your
tax return each year using the following format:
Section 1.263(a)-1(f) De Minimis Safe Harbor Election
Taxpayer’s name:
Taxpayer’s address:
Taxpayer’s identification number:
The taxpayer is hereby making the de minimis safe harbor election under
Section 1.263(a)-1(f).”
““Materials and supplies” are tangible property used or consumed in your
rental activity that fall within any of the following categories:
• any item of tangible personal property that cost $200 or less
• any item of personal property with an economic useful life of
12 months or less, or
• components acquired to maintain or repair tangible property—
that is, spare parts. (IRC § 1.162-3.)
The cost of such items may be deducted in the year the item is used
or consumed in your rental activity—which may be later than the year
purchased. To use this deduction, you are supposed to keep records of
when the items are used or consumed in your rental activity—something
few small landlords do in practice. For this reason, this deduction will
be useless for most hosts. Fortunately, they can use the de minimis safe
harbor discussed above instead to deduct materials and supplies.”
“Bonus depreciation may not be used for real property—thus it may
not be used for buildings and building improvements. However, you
may use it to fully deduct in one year the cost of new or used personal
property—for example:
• appliances
• furniture
• office furniture and equipment used in your home office
• removable flooring and carpeting
• cabinets and counters
• wall paneling, and
• decorative and track lighting.”
“Bonus depreciation is optional—you don’t have to take it if you
don’t want to. If you don’t want to take it, you must inform the IRS
as described below. But if you want to get the largest depreciation
deduction you can, you’ll want to take advantage of the bonus.
You can apply bonus depreciation for assets you use part of the time
in your short-term rental activity and use personally the rest of the time.
But you must adjust your depreciable basis accordingly. For example, if
you rent out a bedroom to short-term guests 25% of the year, you may
use bonus depreciation to fully deduct in one year 25% of the cost of a
bed you purchase for the room.”
“Bonus depreciation can’t be used for:
• land
• buildings or building structural components
• intangible property, such as patents, copyrights, and trademarks, or
• property outside the United States.”
“Personal property used by your
short-term guests is depreciated over five years. This includes appliances,
carpeting, and furniture. Computers and cars are also five-year property.
Office equipment is seven-year property. Thus, for example, if you buy a
new bed for your short-term rental activity and take bonus depreciation,
you must take bonus depreciation for all other personal property you
purchase that year for your activity, including refrigerators, chairs,
stoves, carpeting, and dishwashers.”
“Year Property Placed In Service: Bonus Depreciation Percentage
1/1/2015 through 9/27/2017 (new property only): 50%
9/27/2017 through 2022: 100%
2023: 80%
2024: 60%
2025: 40%
2026: 20%
2027 and later: 0%”
“Thus, if you personally use the property over 50% of
the time, you may not deduct it with Section 179. This eliminates the
majority of short-term hosts from being able to use Section 179.”
“Bonus depreciation and the de minimis safe harbor are subject to
none of these restrictions. For these reasons, there is little reason for
short-term hosts to use Section 179 to deduct personal property. The
provision may prove useful again for personal property after 2022, when
the bonus depreciation percentage is scheduled to be reduced below
100%.”
“Depreciation for
personal property works much the same as for real property. You
determine:
• the property’s basis—normally the cost of new or used property
you purchase for use in your rental activity after you list your
property for short-term rental or the fair market value of property
you convert to rental use—prorated, if applicable, by the
percentage of rental use
• the recovery period—normally five years for personal property, and
• the depreciation method—typically, you can use accelerated
depreciation which gives you a larger deduction the first few years
you own the asset and smaller deductions in later years.”
“You can easily calculate your annual depreciation deductions for
personal property you use in your rental activity by using accounting
and tax preparation software, online calculators, or by using the charts
in IRS Publication 946, How to Depreciate Property.”
“Luckily, virtually all
short-term hosts operate as pass-through businesses. Most short-term
hosts own their property individually, as a joint tenancy with their
spouse, or with one or more individuals as tenants in common. All these
ownership forms qualify as pass-through businesses.”
“A minority of short-term hosts own the property they rent through a
business entity, usually a limited liability company (LLC) or partnership.
These also qualify as pass-through businesses. S corporations also
qualify, but are rarely used for rental property. Regular C corporations
don’t qualify for the pass-through deduction; but, for a variety of tax
reasons, C corporations are almost never used for rental property.”
“QBI is the net income (profit) your
short-term rental business earns during the year. You determine this by
subtracting all your regular short-term rental deductions from your total
short-term rental income. Your net rental income or loss is listed in the
“Total rental real estate and royalty income (or loss)” line at the bottom
of Schedule E.
QBI does not include:
• short-term or long-term capital gain or loss—for example, the
capital gain (or loss) earned from selling your property
• dividend income or interest income
• guaranteed payments to partners in partnerships or LLC
members, or
• business income earned outside of the United States—such as
property outside the United States you rent to short-term guests.”
“You can benefit from the pass-through deduction only if your short-
term rental business earns a profit for the year. You get no deduction if
your rental business shows a net loss because your QBI will be zero.”
“If you have other nonrental businesses, QBI is determined separately
for each separate business you own. If one or more of your businesses
lose money, you deduct the loss from the QBI from your profitable
businesses. If you have a “qualified business loss”—that is, your net QBI
is zero or less—you get no pass-through deduction for the year. Any loss
is carried forward to the next year and the pass-through deduction for
that year (or the next future year with positive QBI) is reduced (but not
below zero) by 20% of the loss.”
“Your pass-through deduction can never exceed 20% of your taxable
income. This limitation won’t adversely impact most hosts because they
typically have income in addition to that earned through the short-term
rental activity.”
“If your taxable income is $157,500 to $207,500 (single) or $315,000 to
$415,000 (married filing jointly), the W-2 wages/property limitation
is phased in—that is, only part of your deduction is subject to the
limit and the rest is based on 20% of your QBI. The phase-in range is
$100,000 for marrieds, and $50,000 for singles.”
“If your taxable income is over $207,500 (single) or $415,000 (married
filing jointly), your maximum possible pass-through deduction is 20%
of your QBI, just like at the lower income levels. However, when your
income is this high, a W-2 wage/business property limitation takes
effect. Your deduction is limited to the greater of:
• 50% of your pro rata share of W-2 employee wages paid by your
rental business, or
• 25% of W-2 wages PLUS 2.5% of the acquisition cost of the
depreciable property used in your short-term rental business.”
“Aaron, a single taxpayer, purchased a three-bedroom
home in San Francisco 20 years ago that he rents out to short-term
guests 25% of the year. In 2018, he earned a profit of $15,000 from
his short-term rental business. He has no employees. His taxable
income is $250,000, so the W-2/property limitation applies in full
to his pass-through deduction. Since he has no employees, his
deduction is limited to 2.5% of the acquisition basis of his home. He
paid $300,000 for the home and allocates $60,000 of the cost to the
land. The acquisition basis in the home is $240,000 x 25% = $60,000.
Thus, his pass-through deduction is limited to $1,500 (2.5 % x $60,000
= $1,500). Had the W-2/property not applied, Aaron’s pass-through
deduction would have been 20% x $15,000 = $3,000. Thus, he lost half
his deduction.”
“For example, you can contribute to retirement accounts such as IRAs and 401(k)s—
your contributions are deducted from your taxable income subject to
annual limits (in 2018, business owners can contribute up to $55,000
to retirement plans). You could also give money to charity if you’re so
inclined (make sure you’re able to itemize your personal deductions).”
“These direct
expenses include:
• fees or other charges by rental platforms
• local or state licensing or registration fees
• advertising your rental
• credit checks for your guests
• any expenses you incur to photograph your property or create a
good listing for Airbnb or any other rental platform
• the cost of purchasing a lockbox or having duplicate keys made
• the cost of storing your belongings while guests are staying in
your home
• legal and professional fees for the rental activity (see Chapter 5)
• office expenses for your rental activity (see Chapter 5)
• mileage and travel expenses for your rental activity (see Chapter 5)
• additional insurance coverage you purchase for your rental
activity (see Chapter 5), and
• fees charged by a management company you hire to handle your
rental (see Chapter 5).”
“All your expenses other than direct expenses are only partially deductible
—they must be prorated between your rental and nonrental use of the
property. …
If you own the home or other
property, these expenses include:
• depreciation of the rental building and personal property in the
building (see Chapter 7)
• mortgage interest and private mortgage insurance (see Chapter 5)
• real property taxes (see Chapter 5), and
• casualty and theft losses (see Chapter 5).”
“You can also deduct personal property you
purchase and use for the rental activity, such as furnishings.
Whether you’re an owner or renter, you may deduct your prorated
operating expenses for the entire home, including:
• repairs (see Chapter 5)
• maintenance, cleaning, trash removal, condo/HOA fees, utilities,
Internet, and cable TV (see Chapter 5), and
• regular homeowner’s or renter’s insurance (see Chapter 5).”
“If you rent a room or rooms in your home (or part of a room), instead
of the entire home, you must allocate your partial deductions not only
by the amount of time the room or rooms were rented out to guests,
but by the amount of space in your home that was rented out as well.”
“Jack owns a two-bedroom condo in Honolulu. He rents one
bedroom to travelers through Airbnb, taking up 20% of the space in
his unit, for 100 days during the year and lives in the unit throughout
the year. His rental use is 100 days and his personal use is 365 days.
To allocate his expenses between rental and personal use, his rental days are treated as being 100, and personal days are 365. Thus his days
rented percentage is 100 ÷ 365 = 27%. His rental use percentage is 5%
(27% days rented x 20% area rented = 5%). Thus, he can deduct 5% of
his prorated expenses and 100% of his direct expenses.”
“Keep careful track of all guest stays at your home, including those
by relatives. A good way to prove to the IRS how long your guests—paying and
otherwise—stayed in your vacation home is to have them all sign and date a
visitors’ book. You can create one yourself or buy one from a stationery store.”
“Any day that you spend working substantially full time (at least eight
hours) repairing and maintaining your property is not counted as a
day of personal use. These days are not rental days either; instead, the
property is treated as not being used at all on those days. You don’t have
to count the day as a day of personal use even if family members use the
property for recreation on the same day. It’s a good idea to maintain and
keep documentation showing that you performed repairs or maintenance
on your rental, rather than using it for personal use.”
“Not-in-Use Days”: “Days the property is vacant”, “Days property offered for rent,
but not rented”, “Days used for maintenance and repairs”
“Let’s look at a comprehensive example to see how these rules operate.
Carlos owns a home that he used himself for 309 days during the year.
While he was out of town on business various times during the year, he
rented the entire home as follows:
• four days to his mother, who paid nothing
• 30 days through Airbnb to guests (tourists) who paid a fair
market rental
• 20 days when Carlos was out of town the property was vacant
because he couldn’t find any guests to stay there, and
• two days to a friend from the office who paid a below-fair-market
price.
Carlos’ own use is personal use. The four days his mother used
the house for free are also personal days. The 30 days he rented it to
strangers for a fair market price are rental days. The two days he let a
friend use it for a below-market rental are personal days. His totals for
the year are:
Rental days = 30
Personal days = 315
Not-in-use days = 20
(Carlos’ rental use percentage is 9% (30 ÷ 345 = .086).”
“You have another option for allocating the rental use percentage of your
mortgage interest and property tax—often referred to as the Bolton
method, based on the court case that established it. Instead of basing your
allocation on the total number of days the property is actually used and
not counting not-in-use days, you count all 365 days to figure your rental
use percentage for mortgage interest and property tax. This gives you
smaller rental expense for these costs. However, you may be able to deduct
the amount allocated to personal use as a personal itemized deduction. If
so, this can be to your advantage if you have a rental loss for the year and
are subject to the vacation home rules, which severely restrict your ability
to deduct rental losses.”
“If you own your rental activity as a single individual, you will file
Schedule E to report your rental income and expenses, subject to the
exceptions noted below. You also use Schedule E if you form a single-
member limited liability company (LLC) to operate your rental activity.
This is because a single-member LLC is a ‘disregarded entity’ for tax
purposes—it’s as if it doesn’t exist. Schedule E is also usually filed for
short-term rentals owned and operated by two or more people. If you
own the property with your spouse and you file a joint tax return, you
and your spouse can report your rental income and expenses on a single
Schedule E that you file with your joint Form 1040 tax return.
“Completing Schedule E is a relatively straightforward process. You fill
out only the first page, which is called Part I. (Part I is also used for
royalties, which have nothing to do with rental property.) Parts II–V on
the second page are only used by partnerships, S corporations, estates,
trusts, and real estate mortgage investment conduits (REMICs, a type of
real estate investment).”
“You separately list on the schedule your income and expenses for
each property you rent, whether full or part time. Schedule E is designed
to be used for up to three rental properties, labeled A, B, and C; there
are separate columns for each property. If you have more than three
rental properties, complete and attach as many Schedule Es as you need
for them all. But fill in Lines 23a through 26 on only one Schedule E.”
“Line A asks whether you made any payments during the year that
required you to file IRS Forms 1099. If you answer yes, you have to
answer in Line B whether you have already filed, ‘or will you file,’ the
forms. Obviously, you should answer ‘yes’ on Line B if you answered
‘yes’ on Line A. If you haven’t filed the required 1099 forms, you should
do so as soon as possible.”
“The one that
usually has to be filed by rental property owners is Form 1099-MISC.
You must file Form 1099-MISC if (1) your rental activity constitutes a
business for tax purposes, and (2) you hire an independent contractor to
perform services for your activity and pay him or her by cash or check
more than $600 during the year—for example, you hire a repairperson
or gardener.”
“Line 2: Dual-use properties
This portion of Schedule E is extremely important for short-term rental
hosts. You list here the actual number of days the property was occupied
by renters (fair rental days), and the number of days it was used by you
or your family for personal purposes (personal use days).”
“If you incurred a loss and personally used the property
more than 14 days or more than 10% of the rental days, you’ll be subject
to the vacation home tax rules. These prevent you from deducting your
losses, and require you to take your deductions in a prescribed order on
Schedule E.”
“Enter your total annual rental income in Line 3. This will primarily
consist of the rent your guests pay you. But it could also include:
• garage or other parking charges
• security deposits you retain to pay for repairs or other expenses
• the value of services tenants provide in lieu of rent, or
• payments guests make to you for repairs or other expenses.”
“A security deposit you receive from a guest is not rental income unless
you keep all or part of it when the guest leaves.”
“You list your expenses in Lines 5–20. When you rent your property part
time, many of your expenses must be prorated based on how much of
the time you rent the property—and, if you only rent a room or rooms,
how much of the property you rent. (See Chapter 9.) You only list the
prorated amounts in Schedule E.”
“Line 5: Advertising
This includes website expenses, photography costs, classified ads, and
other advertising expenses to rent your property.”
“Line 6: Auto and travel
This category includes both local and long-distance travel expenses.
(See Chapter 5.) If you have both types of expenses, you must add them
together. If you leased or rented the vehicle, show the lease payments on
Line 19. If you use the actual expense method to deduct your vehicle
expenses, show your depreciation expense in Line 18, but list all your
other expenses in Line 6.”
“Line 7: Cleaning and maintenance
This includes janitorial services, gardening, cleaning carpets, drapes, and
rugs. Do not include repairs here—repairs are done to fix property after
it’s broken; maintenance keeps your property in good working order so it
won’t break down.”
“Line 8: Commissions
These consist primarily of the fees you pay to online rental platforms like
Airbnb to list your property for short-term rental.”
“Line 9: Insurance
You may fully deduct any insurance coverage you purchase just for your
short-term rental activity, such as additional liability coverage for short-
term guests. The cost of other insurance coverage for your home, such
as homeowners’ or renters insurance, must be prorated based on the
percentage of rental use of the property (see Chapter 9).”
“Line 10: Legal and other professional fees
This includes tax advice and preparing tax forms for your rental activity.”
“Line 11: Management fees
These are fees charged by property management companies. If you hire
a manager to handle your short-term rental activity, deduct the total
cost here.”
“Line 12: Mortgage interest paid to banks
If you have a mortgage on your property, you may deduct a prorated
amount on Schedule E based on your rental use of the property. The
remaining amount may be deductible as a personal itemized expense on
Schedule A.”
“Line 14: Repairs
Repairs keep your property in good working order. They do not add
significant value to your property or extend its life. Do not include the
cost of improvements in this line; they must be depreciated over several
years. (See Chapter 6.)”
“Line 15: Supplies
This includes office supplies and supplies you use for repairs and
maintenance—for example, paint and brushes, or fertilizer. It does
not include materials you purchase to undertake improvements—for
example, it would not include the cost of the shingles used to install a
new roof on your rental property.”
“Line 16: Taxes
This includes the prorated amount of property taxes paid for the property
based on the amount of rental use. Property tax you can’t deduct as a
rental expense may be deductible as an itemized personal deduction on
Schedule A.”
“Line 17: Utilities
This includes charges for water, garbage pickup, gas, and electricity you
pay for property. The amounts must be prorated based on your rental use
of the property. Don’t include utilities for a home office here.
“Line 18: Depreciation
If you have multiple properties, you list your total depreciation
deduction for each property in the depreciation line and then include the
total for all properties on Line 23d. You must also complete and attach
Form 4562, Depreciation and Amortization (Including Information on
Listed Property), if you are claiming:
• regular and bonus depreciation on property first placed in service
during the year
• regular and bonus depreciation on listed property including a
vehicle, regardless of the date it was placed in service, or
• a Section 179 expense deduction or amortization of costs that
began during the year.
You should complete depreciation worksheets for each of your
properties for which you claim depreciation, but you don’t have to
attach them to your return.”
“Line 19: Other expenses
Use the “Other” line to list other expenses not included in the above
categories. You can deduct any expense for your rental activity that is
ordinary and necessary. This includes:
• personal property items that cost $2,500 or less deducted under
the de minimis safe harbor
• home office expenses
• gifts
• homeowners’ association dues for condominiums and planned-
unit developments
• start-up expenses
• registration or license fees for your short-term rental activity
• if you receive payment through PayPal or a similar online
payment service, the fees the service charges
• the cost of purchasing a lockbox or having duplicate keys made
• the cost of storing your belongings while guests are staying in
your home
• the cost of any credit reports you obtain in order to screen
potential guests
• dues and subscriptions for your rental activity
• casualty losses, and
• equipment rental.”
“Line 22. If you’re not subject to the vacation home rules (see
below), you may be able to deduct all or part of your loss from
other nonrental income. You may be able to deduct up to $25,000 in losses by using the $25,000 offset. If so, you don’t
need to file Form 8582, Passive Activity Loss Limitations. If you
can’t deduct your losses by using the offset, your losses will be
deductible only if you’re a real estate professional and materially
participate in your rental activity. You’ll have to complete Form
8582 to figure the amount of loss you can deduct, if any. Enter
the deductible amount of your loss, if any, on Line 22.”
“You need to follow special rules to complete your Schedule E if you
have a rental loss for the year and you’re subject to the vacation home
rules. You have a loss if all your deductible expenses for the year exceed your rental income. You are subject to the vacation home rules if you
personally used the property you rented for the greater of 14 days or
10% of the rental days (if you personally used the property 34 or more
days you’ll always be subject to the vacation home rules). Most short-
term rental hosts are subject to the vacation home rules, which apply not
just to vacation homes, but to any home you both live in and rent out.”
“The IRS has created a helpful worksheet you can use to figure out
your deductions to complete Schedule E. See Worksheet 5-1, contained
in IRS Publication 527, Residential Rental Property (this, and all other
IRS publications can be downloaded at http://www.irs.gov). (Note, however,
that the rental use percentage part of this worksheet (Part I) does not
use the Bolton method to allocate expenses for mortgage interest and
property tax—it can be advantageous for you to use the Bolton method;”
“Partnerships
and most multimember LLCs file Form 1065, U.S. Return of Partnership
Income. S corporations file Form 1120-S, U.S. Income Tax Return for an
S Corporation. They must include with their returns IRS Form 8825,
Rental Real Estate Income and Expenses of a Partnership or an S Corporation,
to report rental income and deductions. This form is very similar to
Schedule E.”
“Airbnb . When you list your property through Airbnb (and other
commission-based rental platforms), your guests pay Airbnb (or the other
platform) which then pays you. Airbnb issues a 1099-K to hosts located
in the United States who have earned over $20,000 and had more than
200 reservations in a calendar year. Since the average Airbnb host only
earns about $7,500 per year and has far fewer than 200 transactions,
such rental income usually doesn’t get reported on 1099-K forms.”
“HomeAway and VRBO. HomeAway and VRBO themselves don’t
process payments for users and don’t issue any 1099s to anyone. However,
they do offer credit card payment processing services through third-party
partners (such as VacationRentPayment) which follow the same reporting
guidelines as Airbnb.”
“Moreover, you need not report payments you make to corporations.
For example, if you hire a roofer named John James to fix your roof and
pay $1,000 to him as an individual, the reporting requirement applies.
But if you hire John James, Inc., to fix your roof, and pay $1,000 to his
corporation, you need not report the payment.”
“The 1099 filing requirement applies only if you pay an unincorporated
independent contractor $600 or more during a year by check, cash, or
direct deposit for rental-related services. It makes no difference whether
the sum was one payment for a single job or the total of many small
payments for multiple jobs.”
“You need not file a 1099-MISC if you pay an independent contractor:
• through a third-party settlement organization (TPSO) like
PayPal or Payable
• by credit card, or
• by debit card.”
“However,
it is not difficult to complete and fill out 1099-MISC forms yourself. One
way is to order the official IRS 1099-MISC forms (which are scannable)
from the IRS (you can’t photocopy or download this multipart form
from the IRS website). Go to http://www.irs.gov/businesses/online-ordering-
for-information-returns-and-employer-returns. You can also use tax
preparation or accounting software to prepare your 1099-MISCs.
Alternatively, there are inexpensive online services you can use to
complete and file the forms.”
“If you wish to file electronically
yourself, you have three options:
• You can use accounting software such as QuickBooks or Xero.
• You can use online 1099-MISC filing services like efilemyforms.
com, efile4biz.com, tax1099.com, and efile1099now.com.
• You can electronically file 1099-MISC forms directly with
the IRS yourself by using its FIRE Production System. To do
so, you must get permission from the IRS by filing IRS Form
4419, Application for Filing Information Returns Magnetically/
Electronically. This form need only be filed one time, and can
be filed online. You must obtain a Transmitter Control Code
(TCC) from the IRS, and create a user ID, password, and ten-
digit PIN for your account. For more details, visit the IRS Filing
Information Returns Electronically (FIRE) webpage at http://www.irs.
gov/tax-professionals/e-file-providers-partners/filing-information-
returns-electronically-fire.”
“If an independent contractor won’t give you his or her number or
the IRS informs you that the number the independent contractor gave
you is incorrect, the IRS assumes the person isn’t going to voluntarily
pay taxes. So it requires you to withhold taxes from the compensation
you pay the independent contractor and remit them to the IRS. This is
called backup withholding. If you fail to backup withhold, the IRS will
impose an assessment against you equal to 24% of what you paid the
independent contractor.”
“Have the independent contractor fill
out and sign IRS Form W-9, Request for Taxpayer Identification Number
and Certification, and retain it in your files. (You can download it from
the IRS website at http://www.irs.gov.) You don’t have to file the W-9 with the
IRS. This simple form merely requires the IC to list his or her name and
address and taxpayer ID number.”
“These rules are confusingly called the ‘dwelling unit used as a
home’ or ‘dwelling unit used as a personal residence’ rules by the IRS.
We’ll refer to them more simply as the vacation home rules. However,
they apply to any type of property you both live in and rent out and they
apply whether you own or rent your home. Moreover, they can apply
to more than one property you own—for example, to both your main
home and a vacation home.”
“The vacation home rules don’t apply if you rent a room or rooms in
your home full time. ‘Full time’ means that the room or rooms are either
occupied by paying guests or available for rent, and never used personally
by you. In this event, the hotel business or regular rental activity rules apply
to any losses you incur.”
“Your rental losses are subject to the vacation home rules if (1) you rent all
or part of your home for more than 14 days during the year, and (2) you
make personal use of your home for the greater of:
• more than 14 days, or
• more than 10% of the number of days the property is rented for a
fair rental during the year. (IRC § 280A(d)(2).)”
“The vacation home rules will always apply
if you make personal use of your home for 34 or more days during the
year. They could also apply if your personal use is less than this amount.”
“The passive
activity loss rules that normally apply to long-term residential rentals
and that permit some landlords to deduct their losses do not apply
here. Instead, you are permitted to deduct your expenses only up to the
amount of your ‘gross rental income limitation.’ This is an important
number. It is equal to your total rental income for the year minus the
following expenses:
• the rental portion of mortgage interest, real estate taxes, and any
deductible casualty losses you incurred, and
• the full amount of direct rental expenses not related to the use of
the home itself.
Direct rental expenses include any expense you incur solely to
rent your property to short-term guests.”
“Assume you’re subject to the vacation home rules and
earned $10,000 renting your home through Airbnb this year. The rental
portion of your mortgage interest was $5,000 and prorated property
tax was $2,000. Your total direct operating expenses were $1,000. You
may deduct these amounts in full from your rental income. After you
do this, your gross rental income limitation is $2,000 ($10,000 – ($5,000

  • $2,000 + $1,000) = $2,000). Thus, you may only deduct $1,000 of all
    the other expenses you incurred for your rental activity during the year.”
    “Any undeductible losses you have for the year can be carried forward to
    future years and deducted from your rental income from the property, if
    you have enough. You deduct them using the same three-step process for
    determining your gross rental income limitation described above (this is
    so even if you’re not subject to the vacation home rules for the current
    year). In real life, however, these losses are rarely deducted in future
    years because the property usually does not generate enough income.”
    “When the vacation home rules apply, you
    must follow strict ordering rules when calculating and reporting your
    deductions on Schedule E to ensure that you don’t deduct too much.
    You must deduct your expenses from your rental income in the
    following order:
    • Category 1 expenses. These are the rental portion of your mortgage
    interest (plus deductible private mortgage insurance), real estate
    taxes, and any deductible casualty losses.
    • Category 2 expenses. Fully deductible direct expenses incurred
    solely to rent the home, such as rental platform fees or travel
    expenses—these don’t include expenses to operate or maintain
    your home.
    • Category 3 expenses. The rental portion of operating expenses
    for the home include such things as repairs, utilities, insurance,
    maintenance, and cleaning.
    • Category 4 expenses. These are the rental portion of depreciation
    for your home.”
    “Subtract Category 1 and 2 expenses from your rental income. The
    difference is your gross rental income limitation for the year. Your
    deductions for Category 3 and 4 expenses cannot exceed this amount.
    Category 1 and 2 expenses can be deducted even if they exceed your
    rental income.”
    “Instead of using the number of days the property was actually used
    during the year to figure your rental percentage, you use 365 days.
    This is often referred to as the ‘Bolton method,’ based on the court
    case that established it. This is not the way the IRS would like you
    to allocate these expenses, and you won’t find a word about it in any
    IRS publication or regulation. However, the courts have approved it,
    reasoning that interest and property taxes are paid for an entire year,
    not just when a home is used. (Bolton v. Comm’r, 694 F.2d 556 (9th Cir.
    1982); McKinney v. Comm’r, 732 F.2d 414 (10th Cir. 1983).) Thus, this
    is a permissible method for you to use.”
    “If Rick used the Bolton method, his allocation percentage for his
    tax and interest would be 25% instead of 75% (90 ÷ 365 = 25%).
    Thus, Rick would deduct only $500 of his property tax and $2,500 of
    his interest from his $10,000 in rental income. Now, his gross rental
    income limitation is $6,000 instead of $250. This allows him to deduct
    an additional $6,000 in operating expenses and depreciation. He could
    deduct the other 75% of his taxes and interest as a $9,000 itemized
    deduction on his Schedule A.”
    “Using the IRS method will give more mortgage interest to deduct
    as a rental expense. Thus, you’d be better off using the IRS method if
    you’re unable to deduct the mortgage interest allocated to personal use
    on Schedule A as a personal itemized deduction. This would be the
    case, for example, if you are unable to itemize your deductions because
    the standard deduction exceeds your total itemized deductions. The
    Tax Cuts and Jobs Act roughly doubled the standard deduction to
    $12,000 for singles and $24,000 for married people filing jointly. It
    also eliminated many personal deductions for 2018 through 2025. As a
    result, many more hosts than ever before will be unable to itemize their
    deductions because their mortgage interest, property tax, and other
    personal deductions (such as charitable contributions) don’t exceed the
    standard deduction.”
    “For 2018 through 2025, a total of $10,000 in property tax
    can be deducted each year for a main and second home. For main and
    second homes purchased December 15, 2017 through December 31, 2025,
    mortgage interest on only up to $750,000 in acquisition debt can be
    deducted as a personal itemized deduction.”
    “If either or both of these limitations prevent you from deducting
    part of your property tax and/or mortgage interest payments, you could
    be better off using the IRS method and claiming more mortgage interest
    as a rental expense. You should run the numbers both ways to decide
    which method to use. But, once you choose a method, you must stick
    with it. You can’t switch back and forth whenever you feel like it.”
    “If the average rental period is more than seven days but less than 30
    days, your activity will still be classified as a hotel business if you provide
    ‘significant services’ to your guests. … Examples include:
    • maid service
    • meals or snacks
    • laundry services
    • concierge services
    • transportation
    • amenities like linens, irons, hangers, shampoo, and soap, or
    • other hotel-like services.”
    “IRS examples indicate that such services are significant only if their
    value is equal to at least more than 10% of the income received from
    the activity.”
    “When the hotel business rules apply, you can deduct your losses from
    other nonrental income if you ‘materially participate’ in the business.
    You materially participate in a business only if you are involved with its
    day-to-day operations on a regular, continuous, and substantial basis.
    (IRC § 469(h).)”
    “If you don’t materially participate, you can’t deduct your rental losses
    from your other income you have for the year. However, these losses don’t
    disappear. Instead, they become ‘suspended passive activity losses’ that
    are carried forward indefinitely to future years. You may deduct them
    from passive income you earn in any future year—that is, rental income
    or income from other businesses in which you don’t materially participate.
    You may also deduct such losses from any profit you earn when you sell
    the property to an unrelated party—that is, a person other than a relative.
    “If you continually incur losses on your rental, the IRS could claim that
    your primary motive for renting it is something other than earning a
    profit. If your rental is deemed to be a not-for-profit activity, starting
    in 2018 through 2025, you will not be allowed to deduct your rental
    expenses from your rental income and you must pay tax on your income.”
    “This means your guests stay on average
    more than 30 days; or they stay at least eight to 30 days on average
    and you don’t provide them with significant services. In this event, for
    purposes of deducting losses, your short-term rental activity is treated
    the same as a long-term residential rental.”
    “You’re allowed to take full advantage of the $25,000 offset only if
    your modified adjusted gross income (MAGI) is less than $100,000.”
    “If, like most small short-term rental hosts, you haven’t formed a separate
    business entity to own your property and you have no employees, you
    need three types of records for tax purposes:
    • a record of your rental income and expenses
    • supporting documents for your income and expenses, and
    • a record of how your property was used during the year.”
    “Although it’s not mandatory, it’s a good idea to set up a separate checking
    account for your rental activity. Your rental checkbook will serve as
    your basic source of information for recording your rental expenses and
    income. Deposit all of your rental income into the account and make
    rental-related payments from the account. If you’re paid electronically—
    for example, through PayPal—have the payments deposited into this
    account. Don’t use your rental account to pay for personal expenses or
    your personal account to pay for rental activity items.”
    “When you write rental activity checks, you may have to make some extra
    notations besides the date, number, amount of the check, and the name
    of the person or company to which the check is written. If the purpose
    of the payment is not clear from the name of the payee, describe the
    rental reason for the check—for example, the equipment or service you
    purchased.”
    “Use a separate credit card for rental activity expenses instead of putting
    both personal and rental items on one card. Credit card interest for
    rental activity purchases is 100% deductible, while interest for personal
    purchases is not deductible at all.”
    “You can keep your journal manually on paper; set up
    an electronic spreadsheet, such as Excel (you can download spreadsheet
    templates for this); use personal finance software such as Quicken; use
    more powerful accounting software, such as QuickBooks, or use software
    especially designed for landlords, such as Quicken Rental Property Manager
    or Buildium. There are also apps such as Hurdlr especially designed for use
    by short-term hosts. Use whatever method works best for you.”
    “Schedule E lists 13 expense categories:
    • advertising
    • auto and travel
    • cleaning and maintenance
    • commissions
    • insurance
    • legal and other professional fees
    • management fees
    • mortgage interest paid to banks
    • other interest
    • repairs
    • supplies
    • taxes, and
    • utilities.”
    “The Schedule E categories probably include most of your expenses,
    but you may have others that are not listed—for example:
    • home office expenses
    • gifts
    • homeowners’ association dues for rental condominiums and
    planned-unit developments
    • amenities you purchase for your guests
    • storage costs for your personal items when you rent
    • start-up expenses
    • casualty losses, and
    • equipment rental.”
    “However, at a minimum, every deduction should be
    supported by documentation showing:
    • what you purchased for your rental activity
    • how much you paid for it, and
    • whom (or what company) you bought it from.”
    “When you purchase any property with a useful life of more than one
    year, you must keep records to verify:
    • when and how you acquired the asset
    • the purchase price
    • how you used the asset
    • the cost of any improvements—for example, adding a new roof to
    a rental building
    • Section 179 deductions taken (see Chapter 7)
    • regular and bonus depreciation taken
    • when and how you disposed of the asset
    • the selling price, and
    • expenses of the sale.
    You should create a depreciation worksheet showing this information
    for all your long-term assets, and update it each year. The instructions to
    IRS Form 4562, Depreciation and Amortization (Including Information
    on Listed Property), contain a blank worksheet. You can also use a
    spreadsheet or computer accounting program, such as QuickBooks. You
    don’t need to file the worksheet with your tax returns, but it will provide
    you with all the information you need to claim your depreciation
    deductions on your taxes. And you will need it if you are audited.”
    “Whenever you incur an expense for rental-related travel, meals, gifts,
    or entertainment, you must document the following facts:
    • The date. The date you incurred the expense will usually be listed
    on a receipt or credit card slip; appointment books, day planners,
    and similar documents have the dates preprinted on each page, so
    entries on the appropriate page automatically date the expense.
    • The amount. You’ll need to be able to prove how much you spent,
    including tax and tip for meals.
    • The place. Where you incurred the expense will usually be shown
    on a receipt, or you can record it in an appointment book.
    • The rental activity purpose. You’ll have to be able to show that the
    expense was incurred for your rental activity—for example, that
    you took an out-of-town trip to inspect or repair your property.
    • The rental activity relationship. If gifts are involved, show the
    business relationship of the people receiving the gift—for
    example, list their names and any other information needed to
    establish their relation to you as a host.”
    “Finally, you need to have a record of how your home was used
    throughout the year—that is, how many days it was:
    • used personally by you or others
    • rented to short-term guests, and
    • not in use because it was vacant or undergoing repairs or
    maintenance.”

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