Thinking of Renting Your Home? There are Tax Consequences

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With the rise of Airbnb (along with hotel prices), it’s not a surprising trend. Homeowners looking to earn some extra income are renting out their homes to short-term visitors.

In August 2017, Business Insider reported that Airbnb had 4 million listings. That’s more than the combined total of all top five hotel brands.

At the same time that short-term rentals have exploded, long-term renting has also been on the rise.

More people are choosing to rent their homes instead of owning one.

The number of U.S. households who are renting has reached a 50-year high, as the Pew Research Center reported in July 2017.

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What does all of this mean?

There are more landlords than ever before… and a huge need to know the tax rules on renting.

Are You Running a Business… or Receiving Passive Income (and Why Does it Matter?)

When you rent out your home through Airbnb, you may be starting a business without realizing it.

Renting out your home or other property is usually considered a passive activity and not a business… with some exceptions.

One exception is if you pass the “material participation” test – as many homeowners who rent through Airbnb would. If so, you are considered to be actively participating in the business.

What does this mean for you?

When you own your own business, you are likely to pay a self-employment tax. This is in addition to the federal and state income taxes. You will also have to report your business income and expenses on Schedule C.

Currently, the self-employment tax is 15.3% on net income of $400 or more. (Social Security tax accounts for 12.4% of this, which you pay on your net income up to $128,400, and 2.9% is Medicare, which you pay on your net income).

How do I know if am receiving passive income or running a business?

You are actively running a rental business if:

  • The average rental term is seven days or less, OR
  • If the average rental term is 30 days or less AND you as the owner “provide significant personal services” beyond what you would expect for a long-
    term rental, including maid or linen services costing less than 10% of the rental fee, OR
  • The main purpose of the business is to provide personal services, so that the rental is “incidental” or secondary.

So in plain language: If you are actively involved in running a rental business – washing sheets, cooking meals, or providing breakfast and coffee, for example – you are considered to a business owner.

Contrast this with a typical rental arrangement where renters bring their own furniture, cups, plates, etc. They wash their own sheets and buy and cook their own food. In this case, the rent received is passive income because you are not doing anything for them on a regular and continuous basis. Even if you rent a furnished place, if no other services are provided, it is generally not considered a trade or business.

Timeframe Matters

When you endeavor to rent all or a portion of your home out, the timeframe can make a big difference in your taxes.

Renting Out Your Home for Two Weeks or Less

If it’s just 14 days or less a year that your home is rented, you don’t have to report the income.

That’s right – this money is tax-free.

And there’s no limit on how much you can charge for those 14 days.

Not only that, you can still take your mortgage interest and real estate tax deductions if you itemize.

However, unlike a rental, no other expenses are deductible (i.e., utilities, repairs, depreciation of the property, etc.).

A word of caution: Be very, very careful about the timeframe.

If you go just one day over that 14-day limit, you there are a host of tax consequences you may not be prepared for.

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Renting Out Your Home for Two Weeks or More

When you rent your home for 15 days or more, what you have done (in the eyes of the IRS) is to take your full-time residence and turned it into a “mixed-use property.”

Not only does the rent you receive count as income, you won’t be able to claim all of your expenses on your tax return.

Instead, you will have to allocate your expenses based on days rented (or available for rent) at “fair market value.” If you are renting a portion of your home, you’ll need to figure the portion of expenses you can deduct by the number of days and by square footage.

This is where an Enrolled Agent can help you!

After all, you don’t want to trigger a severe penalty from the IRS for under-reporting your income.

Owning Rental Property That You Don’t Live In (or Use)

The IRS looks at renting out your home versus owning a rental property as two very different things.

Rent money you collect from a rental property is considered income.

You can deduct your expenses as well – including depreciating the building (and any improvements you make) over time. Depreciation gives you a tax deduction over the “useful life” of the property (i.e., 27.5 years for residential real estate).

Because you are able to deduct depreciation and most expenses, it’s actually possible to have a loss on your taxes yet earn a profit.

A word of caution: Remember to back out the cost of land before calculating depreciation, as land does not depreciate.

If you haven’t already, you will have to have a market appraisal done which breaks out the cost of the land at the time you purchased the property. You may not use the county’s tax assessor’s numbers, unfortunately.

Complicated… but Worth It

As you can readily see, rentals can be a great way to earn income.

However, the rules around rental income are complex.

So complex, in fact, that we’ve only scratched the surface here.

An Enrolled Agent (EA) is well versed in the complicated web of tax laws and court rulings surrounding rental income and property.

An EA can help you sort through the myriad of rules on rentals and perform calculations for you based on different scenarios.

Most importantly, he or she will find a (legal) way to realize the most net profit and pay the least amount of tax.

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Jeffrey Schneider, EA, CTRS, NTPI Fellow has the knowledge and expertise to help you reach a favorable outcome with the IRS. He is the head honcho at SFS Tax & Accounting Services as well as an Enrolled Agent and a Certified Tax Resolution Specialist.
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Now What? I Got A Tax Notice From The IRS. Help! Defining and deconstructing the scary and confusing letters that land in your mailbox. Jeff defines and deconstructs the scary and confusing letters in a fashion that mixes attention to detail with humor and an intricate clarification of what is what in the world of the IRS.

The book is available in paperback and ebook on https://Amazon.com
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For more on SFS Tax Problem Solutions, visit: http://sfstaxproblemsolutions.com/
For more on SFS Tax & Accounting Services, visit http://sfstaxacct.com/
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738 Colorado Avenue Stuart, FL 34994
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