Real Estate Tax Benefits | Short Term Rentals

by Christopher Levarek

“Everyone’s got a moment or two in their life where something happens and you make a decision and then your entire life changes.”

- Brian Chesky (Founder, Airbnb)

Picture this scene, it’s early 2007 and two unemployed college graduates low on cash in San Francisco have an idea to rent out some of their apartment space to some attendees of a conference. Over a weekend, the graduates housed three people on air mattresses and even offered pop-tarts to the guests for breakfast.

Shortly thereafter, Gebbia and Chesky, the graduates formed a company called “Airbedandbreakfast.com” which would eventually become the now well-known AirBNB, a culture changing enterprise allowing homeowners to easily rent out space in their residential property.

Today, Airbnb and competing platforms such as VRBO have entirely disrupted the travel industry through their easy to use platforms. Indeed, Airbnb boasts an amazing 6 million listings worldwide with over 4 million hosts and over 1 billion guest arrivals as of September 2021.

So perhaps you have heard of this short term rental idea and question if it makes for a good investment?

Today, we are going to look at one interesting reason to consider short term rentals and that is regarding real estate tax benefits. Specifically, we are looking at how owning and managing a short term rental can allow the investor to realize tax deductions to offset other income streams, to include W-2 income. Let’s jump in!

Short Term Rentals

If you are not as familiar with this concept yet, it involves hosts or owners of real estate, renting out rooms or entire homes to traveling guests on a day by day basis just like a hotel. Guests browse listings on platforms such as Airbnb and VRBO in their location of travel and book a stay. Most if not all business is transacted through the platform and hosts/guests never need to meet one another.

For the investor, choosing a short term rental over a long term rental usually means more management. It involves day to day, if not week to week interactions online with guests regarding booking inquiries, property questions and guest reviews. If not properly structure with the right team or partners, managing a short term rental can be overwhelming. Yet, the cashflow, tax benefits and lifestyle benefits can be worthwhile.

Real Estate Tax Benefits of Short Term Rentals

Alright, to jump right into it, short term rentals have tax benefits for direct property owners/managers that are difficult to achieve with long term rentals. Why? To answer this question, it’s worth understanding that the best tax benefits are found for investors if they can achieve real estate professional status, see our article on the subject here.

In brief, an investor has to prove they work primarily in real estate as a job to achieve the best of these tax benefits.

Two main criteria serve as guidance for qualifying as a real estate professional :

More than 50% of the personal services you perform in all businesses during the year MUST be performed in a real estate business you materially participate.
You must work at least 750 hours in a real estate trade or business

So, let’s say you have a W-2 job but are a passive investor in a long term rental along with 10 other investors. It becomes really hard to show that you work 750 hours in that long term rental, let alone work 50% of your year in real estate! Thus, qualifying as a RE professional isn’t in the cards for this type of an investor in most cases.

…Enter short term rentals.

If you are owner of a short term rental, use the property to generate income, improve the property and said improvements will last over a year, the IRS allows you to utilize depreciation from these rentals. Depreciation is of course the natural loss on paper of the property and components over time.

An owner can even conduct a cost segregation study to accelerate this depreciation to be over 5-7 years instead of the traditional 27.5 years.

Example

If the depreciation on paper was say $150,000 over 27.5 years, this would equate to an annual loss of $5,454.

If the depreciation on paper was accelerated over 5 years with a cost segregation study, this would equate to an annual loss of $30,000.

But wait, there’s more, short term rentals also allow one to have such tax deductions as:

Deducting cost of Furniture purchases as an expense
Cleaning/Maintenance Fees
Airbnb Fees
PMI - Mortgage interest
Marketing Expenses

Alright, I can hear you saying, what’s the catch? How do I achieve these deductions without being a traditional “real estate professional”?

Qualifying for Tax Benefits

Using the deductions above against active income requires similar qualifications as a real estate professional yet they are more easily met. Mainly, an investor needs to prove the following :

14 days of non-rental per year.
500 hours of material participation in the property.

The 14 day rule simple means that for 14 days out of the year, the property is not rented. This is quite easy as most properties do not have 100% occupancy in any case. Or just book 14 days for yourself at your property!

The 500 hours of material participation or active participation in the management of the property are needed to prove the real estate professional status for the short term rental. Trackable hours focus around tasks such as staging, managing, dealing with guest inquiries, cleaning and restocking the property.

I advise you to consult a well versed CPA in short term rental tax strategy and see how else one can qualify as this is only one method. Once you meet the material participation test, tax losses from the short term rental can be deductible for the current tax year against W-2 income.

This is the sweet spot as you do not have to show that you spend 50% or more of your time in the area as you might with long term rental investment, one of the biggest blockers for W-2 earners. And there you have it, the inside secret on how to achieve tax benefits with short term rentals!

In Final

The tax benefits of investing in a short term rental are really quite extraordinary. I don’t want to say it’s a loophole but it definitely is an unknown a time of this writing by many investors. The ability to use real estate losses against W-2 income has always been the sought after strategy for many the investor and short term rentals offers the method for many.

Again, please consult a CPA knowledgeable in this area and familiar with tax code around short term rentals to perform your due diligence as well. Until next time, Happy Investing!