The Tax Impact of Airbnb & Short-Term Rentals: What Investors Should Know

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I see many people posting success stories on the Forums about how they rented their properties using popular rental services like Airbnb. These people are generally house hacking or renting 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 have they thought about a strategy to mitigate changes to their tax liability?

Probably not… and they should. If they’re 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. I’m going to explain how you subject yourself to this tax and ways to avoid it.

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Schedule E or Schedule C?

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 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.

Average Rental Period

If you have an average rental period of less than 7 days, the IRS will automatically assume you are running a business, and that income will be reported on Schedule C. This is significant because investors are making a killing on short-term rentals without fully understanding the tax implications of their business.

If your average rental period is over 7 days but less than 30 and you perform substantial services such as a maid service, breakfast, or cleaning, 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 I 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.

Related: The Upsides & Downsides of Airbnb: A Landlord’s Perspective

Substantial Services

You may have noticed that if your average rental period is more than 7 days but less than 30 days AND you provide substantial services, your business will be classified as a hotel or a bed and breakfast. So what are substantial services?

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.

Example of Income Reported on Schedule E vs. Schedule C

To convince you that you need to strive to avoid operating a hotel or bed and breakfast, I have laid out a short example to you to show you how taxes impact overall earnings.

Let’s assume you buy a place for $100,000 cash and utilize 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 greater than 7 days, less than 30, and you did NOT provide substantial services, you will report the income and expenses on Schedule E. So your net income before it’s subjected to your marginal tax rate will still be $10,000.

Now let’s assume your average rental period was greater than 7 days and less than 30, but you DID provide substantial services to your tenants. You will now 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.

By reporting your income on Schedule C over Schedule E, you’ve decreased your return on investment (ROI) from 10% to 8.47%, which is substantial in terms of investor returns.

How to Mitigate Schedule C Risks

This is actually easier than it may seem. The obvious answer is to strive to have an average rental period of over 7 days in order to avoid automatic Schedule C reporting requirements. Simply making guests stay 8 days will mitigate this risk.

Related: Landlords Beware: The Potential Problem With Airbnb No One Talks About

If you have an average rental period greater than 7 days but less than 30, 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. Additionally, you absolutely need to charge your tenants a separate cleaning fee at the end of their stay. It’s important that this fee is a separate item on the bill because if not, the IRS may take the stance that you are providing cleaning services (substantial services) as part of the rental rate.

Lastly, if you can push your average rental period to greater than 30 days, you will likely be fine and this article will be a moot point.

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 necessary steps today to mitigate your reporting and tax risks.

Investors: Have any questions about taxes when it comes to Airbnb and short term rentals?

Leave them below, and let’s talk!

About Author

Brandon Hall

Brandon Hall, owner of The Real Estate CPA, is an entrepreneur at heart who happens to be good at taxes. Brandon is a real estate investor and CPA specializing in providing business advice and creative tax strategies for real estate investors. Brandon's Big 4 and personal investing experiences allow him to provide unique advice to each of his clients. Sign up for my FREE NEWSLETTER to receive tips and updates related to business and taxes.

23 Comments

  1. In Florida (and I’m assuming many other states) there’s additional taxes and fees on short term rentals. And, in some areas there are zoning restrictions and HOA rules against short term rentals. Potential landlords need to consider these as well.

  2. Pyrrha Rivers

    Brando,
    Thank you so much for this article. I’m not involved in vacation rentals but although I read only out of curiosity, your clear and simple explanations made it possible for me to grasp your points and actually learn something new.
    Love your writing style!

  3. Minh Le

    Brandon,

    I have a couple friends who do Airbnb so please allow me to ask a couple of questions.

    1) Guy A – He doesn’t have a job. Airbnb is his full-time gig. He rents houses and does Airbnb with them. Does this mean he has to report the income as ordinary income and pay self-employment tax?

    2) Guy B – he has a full-time job, but he also rents houses and does Airbnb on the side. Since this individual doesn’t own the properties, should he be filing with Schedule C?

    Thank you.

    • Brandon Hall

      Hey Minh, thanks for reading and asking these questions. I’ll preface this by saying you cannot take what follows as tax or legal advice, this is simply my opinion.

      1. Guy A – He absolutely has to report income, however it doesn’t have to be ordinary income even if he is unemployed. Rental income is passive income, unless he is meeting the criteria for Schedule C reporting – average rental less than 7 days or 30 days with substantial services provided. If he is meeting this criteria, report on Schedule C and subject to self-employment tax.

      2. Guy B – Yes he needs to report the income and will be reporting on Schedule C. I have a few friends that do this and must report on Schedule C. Additionally, he needs to make sure these practices are okay with his landlord AND the city (NYC has made a big fuss about Airbnb).

      Hope this helps.

  4. Minh Le

    Thanks for your reply Brandon, but I’m still unclear about Guy A’s scenario. Airbnb is his full-time gig. He has a couple of cleaners that clean these houses once a week. He also has an on-site manager at each house, who’s getting discounted or free rent for a bed. He’s averaging $75k gross/month with net between $25k-$30k/month. I don’t know how he’s reporting his taxes. However, I guess the IRC is open to interpretation based on your response.

    • Brandon Hall

      Hey Minh – the takeaways for Guy A are:
      1. The income is still rental income, regardless of whether or not it’s his full-time gig.
      2. Rental income is reported on schedule E (regardless of how much he makes), unless he provides substantial services with an average rental period between 7-30 days OR he has an average rental period of less than 7 days.
      3. If he meets the two criteria described above, the rental income is reported on Schedule C and subject to self-employment taxes.

      Guy A should be speaking with a CPA if he hasn’t done so already.

  5. Thomas Morris

    I want to get the facts clear in my mind, Many airbnb hosts are themselves renting property that they offer on airbnb. My assumption is that they can still use schedule E if they are subletting, so long as you don’t provide “substantial services”, and can then deduct the rent you pay the property owner on the property they are subletting as an expense on schedule E. Is this the way you understand the IRS regulations?

    • Brandon Hall

      Thomas – you cannot deduct rental expense paid in connection with a residential residence. Typically you may only deduct rent you’re paying in connection to a property that’s used exclusively for business, such as office space, a retail pad or a warehouse, the IRS typically allows the business to claim its rent.

      In terms of income reporting, it depends on the average rental period of the sub-letter. If the average rental period is short-term, you may run into problems.

  6. You mentioned greater than 7 days and less than 7 days… what about renting for exactly 7 days, with no substantial services? Schedule E? And if you meet income requirements, under these circumstances, can you deduct your passive losses against income from your other job?

  7. There is one part of this article that does not make sense to me:

    \”The problem is that net losses from these activities are still going to be considered passive losses, and as I 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.\”

    Why would net losses be considered passive for businesses with average rental periods of under 7 days? First, the IRS says such activities are considered business activities and NOT rental activities, and the IRS also says that as long as you \”materially participate\” in the business then it is active not passive income (or losses).

    \”Materially participate\” might be hard to show if you hand your VRBO property over to a management company to do all the work for you, but if you rent and manage it yourself, you only need to spend 100 hours or more, provided no one else spends more time than you. This test does not seem difficult for those of us who handle our own VRBO or Airbnb property.

    Of course I agree that paying self-employment tax is a downside during profitable years, but if you are getting a VRBO business going and having losses for a couple years, wouldn\’t Schedule C be your best friend, allowing the losses to offset other income from your or your spouse\’s regular job?

    Am I overlooking something here? Thanks.

    • Brandon Hall

      Amy – as long as your rental days are more than 14 and personal use days are less than 14 in any given year, the Sch C loss can be deducted. However, if you use the property at all for personal use, it becomes tricky.

      I’ve only had one client generate a loss from their AirBnB rentals. All of my other clients are generating taxable income. Hence the reason I didn’t touch much on this subject 🙂

  8. James K.

    Hi Brandon,

    Correct me if I’m wrong here, but I think it’s important to note that if you have W-2 income that is at least $118,500 (for 2015 tax year), than your self employment tax rate drops to 2.9% on your schedule C income.

    I assume that most Airbnb hosts are doing this part time, so this exception makes reporting on Schedule C alot more palatable.

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