by William E. Rogers MBA, CFP, EA
Vacation rentals are nothing new. For centuries travelers have opted to stay in private residences over hotels for a variety of reasons. It’s quite common here in Southern California with the lure of our local beaches and mountains for property owners to rent out their properties on a transient basis. Vacationers have long used the Internet to search for available properties by visiting sites like Craigslist or VRBO.com (Vacation Rentals by Owner). The emergence of Airbnb over the last few years has taken the industry to a whole another level. In fact, Airbnb has gained such large scale prominence that its nightly occupancy rates rival many major hotel chains. In 2015, 155 million guests stayed in Airbnb hosted properties that is 22% more than Hilton Worldwide.[i] Unlike other aspects of the sharing economy, long established tax rules do exist for vacation rentals.
The vast majority of property owners (hosts) on Airbnb rent their homes out on an occasional basis. The primary reason for doing so is because they desire to earn a little income while being away on travel. According to Code Section 280A(g), a residence that is rented for less than 15 days in a calendar year, is tax free. In this situation, a taxpayer does not report any income from the rental activity, nor is able to claim any deductions.
However, what happens when a property owner rents outs their home for more than 15 days per year? According to Temporary Treasury Regulation Section 1.469-1T(e)(3)(ii)(A), if the average rental period is seven days or less, the activity is not a rental, but instead a business. Additionally, the regulation stipulates that if the average rental period is 30 days or less, and significant personal services are provided by or on behalf of the property owner, the activity is also deemed a business.
Significant personal services would constitute any of the following activities:
- Cleaning of the rental unit while occupied
- Concierge services
- Guest tours and outings
- Providing meals and entertainment
- Any other services typically provided by a hotel
Most stays on Airbnb are for less than a week at a time. So, anyone who rents out his or her property on a repeated basis would most likely fall into the “hotel / motel classification”. This means that the activity is no longer reported on Schedule E as a rental. Instead, it gets reported on Schedule C as a business. Consequently, any net profit earned from the hotel is subject to self-employment tax. Furthermore, it is absolutely imperative that the property host keep their personal and business areas separate. The portion of the property that is being used as a rental unit must be used exclusively for business; otherwise, the deduction limitations of 280A would apply. Also, if the taxpayer does not materially participate in the activity, any losses from the hotel are considered passive.
Moreover, any rental period that is 30 days or less, is subject to the transient occupancy tax (TOT). TOT taxes are locally administered taxes by the city in which the rental property is located. If the property is located in an unincorporated city or town, then the applicable TOT tax is administered by the county.
For years, property owners have avoided paying TOT taxes by discretely renting out their vacation rentals. However, the Internet makes such discrete rentals almost impossible. Local tax authorities can easily monitor listings at the click of a mouse, and then quickly contact property owners to verify their compliance with local ordinances.
In the event that Airbnb does not collect TOT taxes on behalf of the host, it is the property owner’s ultimate responsibility to register as a transient operator with the city. TOT tax returns are filed on a monthly basis along with remittance of the tax. TOT functions exactly like a sales tax in that the guest is charged the tax along with any applicable surcharges, in addition to the rent being charged. Failure to collect tax from the guest does not absolve the property owner from liability of the taxes due. The authority to levy such tax is granted to cities and counties by virtue of California Revenue and Taxation Code 7280. Each city determines its own TOT tax rate along with any additional assessments by voter approval.
Finally, one of the biggest backlashes against Airbnb as of late has been an uproar of local communities complaining that their neighborhoods are being tarnished due to the operation of illegal “motels”. Depending upon local zoning requirements, short term rentals may or may not be permissible for many properties listed on Airbnb. So property owners, take caution and investigate all local ordinances prior to renting their property on Airbnb.
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[i] PWC. (2016). The Sharing Economy. New York, NY: Pricewaterhouse Coopers LLP.
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