Tax strategy for vacation home vs rental?

11 Replies

Hello, I've been lurking here a while and this is my first post, I really value everyone's input!  My husband and I are under contract on a condo in a mountain town, something we've dreamed about for a long time.  We aren't totally committed to renting it out yet, and thought we'd dip our toes in by renting to a couple of select family/friends at first.  I would appreciate input regarding the most beneficial tax strategy for the home.  Our AGI will be above 150K.  I am aware that if we use it as a business, we would have to stay in the condo less than 14 days (not counting maintenance) or less than 10% of rented days, and that if we rent out for less than 14 days there is no obligation to report that.  We plan to own the condo for the foreseeable future.  Here are my questions:

1. Is there still any tax benefit to using the condo as a rental business (as opposed to a second home) if our income is above 150K?  We are usually hit with the AMT and that just confuses me to no end despite the time I've spent trying to educate myself.  

2. If we do intend to rent it out, should we put it under our LLC? I don't know exactly how this works but I assume it is something that is most easily done at or soon after closing, rather than waiting a year or so to test the waters - is this true?

3. How does the I R S *know* how many days it was rented for?  Is it simply our responsibility to keep track and then just report a number?  Same question for rent amounts.  I'm anticipating using spreadsheets to keep track of everything but am wondering if I need to keep other documentation, collect signatures, etc.  

I'd love to hear some answers to these questions. I have a vacation rental that started out as a vacation home. I have a meeting with a CPA in a couple weeks. Seems at this point in time the vacation rental world is something many people don't understand including banks. 

Disclaimer: I am not a CPA, nor a Lawyer.
However, I am an owner/PM of a Vacation Rental in a Colorado mountain town.

I started out with a dream of a second home in the mountains too. Then toyed with renting it out to some family friends after I remodeled it. This quickly turned into a full time business for me. And by full time, I spend about 4 hours a month on it and it's much more lucrative than my long term rental in the metro area.

I always assume that the IRS knows everything. It's just the safest route, in my opinion. However, you bring up a good point about those 14 days not including maintenance. I find that there is always some level of maintenance to be done, since a vacation rental has a lot of traffic. It's never anything major, but the little things add up. If I get up there once a quarter, there are usually at least 3 or 4 small things that need fixing. So, if you wanted to be there more often than that, you could certainly find valid maintenance reasons to visit.

As for how many days it was rented... this should be very easy for anyone to find out. I use VRBO and AirBNB to book my rental. I also have my own web site with calendar that reflects bookings. Those calendars are all tied together so I don't double book. Therefore, it's easy to see online just how many days I'm rented.

And signatures/documentation when you rent it? Yes, this is mandatory. You don't want to allow ANYONE to stay in your property without a lease in place to protect you and your property. Even if it's just the short term rental agreement on file with the vacation rental sites, which people must check a box to prove they've read and agree to before renting.

Again, my recommendation is to assume the IRS knows all. There are plenty of real benefits that the government gives to RE investors, so no need to hide anything. Consult a CPA for the full run-down of good reasons to rent this out and take full advantage of the associated tax breaks.

Ah, the old LLC question... it's more than just an LLC question though, it's also about how you would run this business, as a sole proprietorship, partnership, corporation? S-Corp or C-Corp is essentially what it boils down to most often.
You'll want to consult with a lawyer to help you make the best decision for you on this. But here is what works for me - An S-Corp LLC, with the property deed in the name of the LLC.
Why? Because having the business/property owned by an LLC gives me a level of protection from lawsuits.
Is it unassailable? Can they pierce the corporate veil?
Well, that depends on how much work they want to do. I'm also looking at setting up a land trust for the deed as an extra level of anonymity.

As a landlord, it's not if you'll be sued, but when. I feel it's best to do as much as possible to protect myself in advance. Including leveraging the property so there isn't a lot of equity in it to tempt people to try and take it away, as well as making it difficult for them to come after my personal assets.

Welcome, @Rochelle S. ! Good for you for jumping in. 

Congratulations on your condo in the mountains. What a dream. I'm not even going to attempt to answer questions about tax strategy. Here are some of my thoughts: 

If you just love spreadsheets, then have at it with keeping track of everything. (I know my wife gets a kick out Excel.) But Airbnb keeps track of all of that -- days rented, number of reservations, gross earnings, Airbnb fee totals, etc. -- and provides a pretty good earnings summary that you can access at any time. 

About the IRS, you're probably right to question how they know the number of days your place is rented. I can't imagine Airbnb passes along that summary I mentioned above to the IRS. All Airbnb does is is provide you with a 1099-k form for tax purposes, and they then report those earnings to the IRS. 

All this said, you probably don't want to mess around with the IRS. If they happen to audit you, they'd quickly learn of any obfuscation and that wouldn't be good for you.

Again, good for you for taking the plunge. I am Airbnb's biggest proponent. If done correctly, it can bring huge returns and help pay your mortgage. 

Thanks for the responses!  No intention of trying to fool the I R S (my computer keeps auto correcting to other random words), just want to make sure I'm keeping adequate records, especially if I rent to family outside of airbnb.  I do love spreadsheets!  I just have no idea what to keep track of for the condo.  Great to hear all the positive feedback about airbnb on this site, I had never used them till recently and as a vacation renter I've gotten frustrated with the fees on VRBO.  I think based on what we've read here we'll probably start out renting as frequently as we can through airbnb, sounds like they have some pricing tools that will help us out as well.  I'll make sure we have a contract even when renting to close family, I've heard some horror stories.  

@Rochelle S. At least at the beginning, I'd recommend you do your own pricing and not use the Airbnb Smart Pricing tool or whatever they call it now. In my experience, their recommended prices are well under what I was able to get. 

To start, simply search for Denver, zoom in on a 10-block radius or so around your place. Look for places of similar size, amenities and style. (Also be sure to see that the places you're comparing actually have a good number of reviews. You don't want to base your price off someone who's place isn't getting booked.) Once you figure out what that rough number is, cut it by 10-20% at least for the first few weeks or month after you post your listing. You want to make sure you stand out, get a few people in immediately and get great reviews. Reviews are one of the few factors Airbnb has publicly said affect where you show up in the list when potential guests search the listings. So do what you can to make those first few guests' stays great.

Once you have a couple 5-star reviews, then start bumping up your prices slowly until you see a diminishing interest, then back off. 

Also, you might reach out to @Stu Waters . He said in a forum recently that he was using a different pricing tool and that it worked well for him. 

Good luck!

@Rochelle S. so the way it works with the IRS is that you are guilty of tax evasion unless you can prove otherwise. So, it is up to you to prove what you claim if they audit.

@Rochelle S. Congrats on your new mountain home! Putting rental properties in LLCs is always a good idea in case of a lawsuit. The set up of the LLC is very simple; you just file a form with the Colorado Secretary of State. If you'd like an operating agreement for the LLC, you should have that drafted by an attorney.

The transfer is accomplished via a deed recorded with the county after you've closed on the house. The transfer should be done by an attorney or title company. I would be happy to discuss the LLC component with you further.

I highly suggest buying the property as the LLC, not transferring into the LLC later, unless you are financing, and the LLC has no credit. I transferred a property, and had to pay sales and recordation taxes all over again in Maryland. Perhaps Colorado is nicer, but you still need a lawyer or someone to draw the transfer papers and new deed. So much simpler to just purchase in the name of the LLC. If it is a simple LLC, no S-Corp or C-Corp, it is a disregarded entity to the IRS. So, it's treated the same as if you are sole proprietor.

@James Carlson Thank you for the valuable advice!  We really appreciate it.  

@Drew Fein @Tim Evans We have to finance, and have yet to set up the LLC, have planned to do so but haven't started the process yet. The advice I got from a mortgage broker is that any decent attorney could get to you through the LLC so it is actually not fully protective... any truth to this?

@Rochelle S. , the Colorado Real Estate Commission Contract to Buy and Sell Real Estate is not assignable by default, so, assuming you didn't make it assignable, you would not be able to by the property in the LLC anyway. As far as getting to you through the LLC, i.e., piercing the corporate veil, there is always a possibility that someone will try to come after you personally if you're sued. However, if you observe all the formalities of the LLC (e.g., hold meetings, have minutes, have an operating agreement, don't commingle funds, etc.), those claims are far less likely to succeed. So there is little truth to that statement. That being said, you are always personally liable for your own negligence.

I have thoughts on question 1, do you plan costly renovations, including furniture and fit-out?  How long do you plan on holding?

In a second home you maybe limited to claiming expenses.

In a business all expenses are deductible (though some maybe depreciable - deductible over time).  

If so, how would you like a 40% discount (whatever your tax rate is) on your reno/purchases?  You can depreciate the building as well.  

Armed with these answers i would consult local CPA for specifics of which makes better sense.

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