Tax Considerations for Short-Term Rentals

Vacation Rental Amenities May Impact Tax Obligations

Turning a spare room or vacation home into a short-term rental arrangement has proven to be a lucrative business opportunity and an income generator, especially during COVID-19. Vacation rental platforms like Airbnb and VRBO have been instrumental in helping property owners easily market and rent their properties throughout the year. This growing revenue opportunity has not gone unnoticed by the Internal Revenue Service (IRS). The IRS recently released guidance surrounding short-term home rentals that property owners need to be aware of to minimize their tax liability and to stay compliant.

In Chief Counsel Advice 202151005 (CCA), the IRS analyzed two general fact patterns for a short-term rental arrangement and provided guidance as to whether or not the net rental income can be excluded from net earnings from self-employment tax (NESE). By definition, net rental income from real estate is generally excluded from NESE unless the income is received by a real estate dealer, or the rent includes substantial services provided to the occupant for the occupant’s convenience. The CCA addresses non-real estate dealers and focuses on the second exception to illustrate what is considered substantial and how the level of service(s) provided may cause the net earnings to be included in NESE.

What does the IRS consider substantial service for short-term rentals?

1. An individual rented a fully furnished vacation property and provided occupants with a variety of amenities to make the property fully habitable including linens, kitchen utensils, toiletries, daily maid services, access to dedicated Wi-Fi, the beach, and other recreational equipment in addition to prepaid vouchers for ride-share services. The IRS determined that the services provided went beyond those required to maintain the space in a condition for occupancy and were therefore substantial. The services provided were for the occupant’s convenience and were of such nature that the related compensation for the services constituted a material portion of the rent essentially paying rent in exchange for services. As a result, the net rentals were included in NESE and subject to the self-employment tax. The regulations also provide other examples of rentals where substantial services are rendered for the occupant’s convenience including hotels, boarding houses, warehouses, and storage garages.
2. The taxpayer is an individual who rented a fully furnished room and bathroom in a dwelling. The taxpayer cleaned the room and bathroom in between each occupant’s stay and occupants only had access to common areas of the home to enter and exit the room and bathroom. No other services were provided. In this context, the IRS determined that the net rentals were excluded from NESE because the taxpayer’s cleaning service provided did not go beyond maintenance of upkeeping the space as a condition suitable for occupancy.

It is important to note that both examples in the CCA relate to short-term rentals where the occupant’s average period of use was seven days, and the taxpayer materially participated in the rental activity so the passive activity rules did not apply. Without proper planning, a taxpayer could potentially be subject to the passive activity rules, net-investment income tax (NIIT), self-employment tax, and income tax if they are not careful in how they set up and operate the rental property. The usage of a property management company or extended stay with attractive service offerings could result in additional taxes.

Short-Term Rental State & Local Tax Considerations

There are also state and local tax considerations for short-term rentals. Homeowners offering vacation or short-term rentals may be subject to different local registration and tax requirements. For Virginia property owners, our article, Short Term Rentals: New Virginia Local Requirements and Tax Considerations, is a good resource on requirements. If your property is outside of Virginia, please check with your specific state and locality for more information.

Although the CCA may not be used or cited as precedent, its analysis of the examples, regulations, and case law is a good reference tool. The determination of whether services are considered substantial as rendered to the occupant is based on the facts and circumstances; however, identifying whether the service is required to maintain the space in condition for occupancy is critical. Amenities like those mentioned above are frequently offered with rental properties and the online rental marketplace. Taxpayers engaged in rental activities may want to consider whether the amenities offered to entice renters to stay is worth the potential self-employment tax if services are found to be substantial.

The Keiter Tax team is closely monitoring this and other real estate property-related tax guidance. We will keep you informed on new and changing regulations to assist you with tax planning and saving strategies.

If you have tax questions specific to your rental property, contact your Keiter Opportunity Advisor.