Short-Term Rentals

Growing in popularity with the success of short-term vacation rental listing platforms, such as Airbnb and VRBO, and fueled by demand born from the covid-19 pandemic, short-term rental properties have increasingly become a savvy investment tool loaded with tax planning opportunities if done carefully. IRS Publication 925, which covers passive activity and at-risk rules, provides favorable classification of such activities if certain conditions are present. Of the most prevalent, an average rental period of seven days or less may allow for the treatment of a short-term rental property to be considered not as a rental, but as a: 'regular trade or business', reportable as ordinary income. By electing this tax treatment, real property ordinarily depreciable over a 27.5-year period as a residential rental property, must stretch this depreciation to 39 years, that of a commercial property. Ordinary income from this activity would also be subjected to self-employment tax if reported on a Form Schedule C or Form 1065 if treated as a partnership. However, if the activity incurs a loss, it can not only be deducted to offset other ordinary income, such as W2 wages, it can also reduce self-employment taxes assessed from other self-employment activities. Further, if coupled with a cost segregation study, a significant amount of additional depreciation could be utilized to generate an even larger loss to offset against ordinary income and carry forward for future tax years. A cost segregation study is a specific accounting engagement that allocates the real property structure into several components, each with various allowable depreciation periods, many of which qualify for accelerated section 168 bonus depreciation.

There are numerous factors that should be considered when making a decision to invest in a short-term rental property, well beyond the income tax benefits summarized above. Among them:

  • Location, location, location! Where is the property located and what are the nearby attractions? Is it in the vicinity of a resort destination? What reason do visitors have for staying at your home? The secret to a successful short-term vacation rental is having an existing market for the destination. Then you need only to provide a lower cost for comparable accommodations, or a better experience with ambiance and amenities, or both.

  • Does the local municipality or owners' association have rules in place to reduce or prevent short-term rental activity in the area? More importantly, will they put such rules in place after you have made your purchase? It is prudent to do your research, get to know the local board and council members and attend meetings to learn more about the community.

  • What is the inventory like in the area for short term rentals? Many areas have become saturated from the days of the pandemic and the demand and nightly rates on your property may have decreased significantly.

At the end of the day, you are making an investment for a sum of money greater than the anticipated tax savings. So it still needs to be a smart decision that can provide a return on investment for years to come. Contact our office and schedule a consultation to discuss your individual opportunities today!

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