Short-term stays using popular rental services like Airbnb are quickly becoming the norm. Those with listings on Airbnb are generally house hacking or using their homes as vacation rentals on a short-term basis. It’s a great system and an excellent way to earn a premium rental charge over a typical monthly rental.
But how do Airbnb taxes change your total liability?
If investors are not careful, they may end up subjecting the income earned from Airbnb or similar hosting services to self-employment taxes at an additional 15.3% rate. Let’s discuss how you subject yourself to this tax and ways to avoid it.
Dreading tax season?
Not sure how to maximize deductions for your real estate business? In The Book on Tax Strategies for the Savvy Real Estate Investor, CPAs Amanda Han and Matthew MacFarland share the practical information you need to not only do your taxes this year—but to also prepare an ongoing strategy that will make your next tax season that much easier.
Basics of self-employment taxes for Airbnb hosts
Self-employment taxes can be part of your experience when renting out your property on Airbnb or similar sites. Your income from renting your house will need to be reported to the IRS when you file your tax return.
Keep in mind that Airbnb does not withhold taxes from your rental profits. Airbnb will issue you a 1099-K if your earnings exceed $20,000 in one year, and the company will report your earnings to the IRS. It’s best practice to report your total earnings regardless of your profit each year.
With self-employment, you are able to deduct business expenses (more on deductions later in the post). However, there is an additional income tax involved with a rate of 15.3%. Since self-employed taxpayers are both the business and the employee, you are responsible for paying Social Security and Medicare taxes. This could decrease your annual earnings and increase your tax bill if you’re not careful.
Understanding the 14-day rule
If you rent your house or vacation house for 14 days or less during the year, you do not need to pay any state or federal taxes. Airbnb taxes are easy, then! The 14-day residence rule applies only if you live in the home for at least 14 days during the same year.
Reporting your earnings on Airbnb taxes
If you rent your house or vacation house for over 14 days per year, then you are going to be required to report rental income earned to the IRS. The question is whether you should report this income on Schedule E or Schedule C.
Generally speaking, you don’t have a choice and must report rental income on Schedule E. This is advantageous over Schedule C because reporting income on Schedule C subjects earned income to self-employment taxes. This explains why investors who flip and wholesale properties usually establish S corps to minimize the self-employment tax liability.
Reporting income on Schedule C will also generally disqualify that income/loss from the generous passive activity loss deduction, which can be up to $25,000 pending you meet adjusted gross income (AGI) thresholds. The IRS takes the position that if you are reporting rental activity on Schedule C, it is no longer rental activity but rather a business.
If your average rental period is over seven days but less than 30 and you perform substantial services, then the IRS assumes you are running a hotel or a bed and breakfast. This income will be reported on Schedule C and subjected to self-employment taxes.
The problem is that net losses from these activities are still going to be considered passive losses, and as stated above, you may be ineligible for the passive loss offset of $25,000. So, it’s really a lose-lose situation being that your earned income is subject to self-employment taxes or your losses can’t be deducted.
Substantial services defined
Substantial services are primarily for your tenant’s convenience, such as regular cleaning, changing linen, maid service, cooking meals, etc. Substantial services do not include the furnishing of heat and light, cleaning of public areas and trash collection. Basically, anything a hotel would do qualifies as substantial services for the convenience of your guests.
Implications of Schedule E vs. Schedule C for Airbnb taxes
To illustrate this, let’s assume you buy a place for $100,000 cash and use Airbnb and other hosting services to rent it out. For the entire year, you gross $25,000 and after all expenses, including depreciation and amortization, you have $10,000 net income.
Assuming your average rental period was more than seven days—and you did NOT provide substantial services—you will report the income and expenses on Schedule E, leaving your net income as $10,000.
If you DID provide substantial services, you will report your income and expenses on Schedule C, which subjects your net income to self-employment taxes, a 15.3% tax rate. Now your net income before being subject to your marginal tax rate is only $8,470.
How to mitigate Schedule C risks
- Set a minimum rental time period of eight days.
- Don’t provide your guests with substantial services such as cleaning their rooms each day, doing their laundry, changing their linens, and providing them daily meals.
- If you can, push your average rental period to greater than 30 days.
The key point is that income is generally better reported on Schedule E than Schedule C. Short-term and vacation rentals increase your reporting risks and can have a significant impact on your tax liability. Take the necessary steps today to mitigate your reporting and tax risks.
Business deductions on Airbnb taxes
You might be wondering if there’s anything else you can do to minimize your tax liability. If you are self-employed, you can deduct business expenses, such as rent or mortgage, Airbnb service fees, insurance, property taxes, and more.
Repair costs and home improvement costs can be deducted too! Be sure to save your receipts and keep your finances organized regarding your short-term rental property. It’s better to be prepared in case the IRS has questions.
Don’t forget occupancy taxes!
Occupancy taxes are paid to state and local governments when you own and operate a short-term rental property.
Airbnb automatically withholds occupancy taxes for certain areas. Check if your state has an agreement for Airbnb to withhold occupancy taxes. Otherwise, you must pay them from your net profit.