While a short term rental can cost a lot of money to set up and maintain, you can offset many of those costs through tax deductions. You should always consult with a tax professional, this article will help you to get a head start on learning which deductions can work for you.
Short Term Rental Tax Deduction Requirements
Before you can deduct expenses on your property, you’ll first need to make sure you qualify. You must own the property in question, and you must generate income on that property by renting it out for 15 or more days during the fiscal year. You will also be able to take more deductions if the property is not your dwelling. Personal use of the property for 14 days or 10% of the total days it is rented to others (whichever is greater) qualifies the property as a home and changes which deductions you can take.
If you rent the property out for 14 days or fewer, you are not required to report the profit as income and so will not be eligible for rental-related deductions. However, you may receive a letter from the IRS if you do not report, so be sure to keep documentation on hand to prove that you met the conditions.
The income from short term rentals is taxed as regular income tax, either on a cash basis (reported yearly) or accrual basis (reported when earned). Most AirBnB property owners will report on a cash basis. If you are required to use Schedule C, you may also be subject to a self-employment tax.
You’ll need to keep receipts for deductible expenses, including proof of mortgage payments, improvements you made, tenant-paid improvements, real estate taxes, property taxes, advertisements, and tax preparation fees related to the rental property. You should also keep lists of repairs and improvements, log of rentals, security deposit records, and copies of your advertisements.
1. Pass-through Tax Deduction
If you are a one-person business and own all assets related to your business, or a partnership, or are registered as an S-corp, LLC or LLP, then you may qualify for a pass-through tax deduction, also known as Section 199A. The term “pass-through” refers to the fact that such businesses pay no taxes as a business but instead “pass through” profits and losses to the owner(s), who then report profits and losses through their personal tax returns. Pass-through business owners can deduct up to 20% of net business income from income taxes. This deduction was introduced in the 2018 Tax Cuts and Jobs Act, and it offers a major opportunity to small business owners.
Under the pass-through deduction, qualified business income is determined by subtracting other deductions from your total business income. It excludes capital gains (short or long term), interest income and dividends, and income made in wages. There are some limits on the deduction for taxpayers who make above $170,050 for individuals and $340,100 for joint-filers, as of 2022. The deduction is calculated using Form 8995 or Form 8995-A and entered on line 13 of the 1040.
This deduction is scheduled to end in 2026, unless extended by Congress.
2. Real Estate Depreciation
Real estate depreciation is a deduction for the cost of a rental property (excluding land) and its improvements across its useful life. To have a useful life, it must be something that will eventually wear out over time, therefore having a projected period in which it will still be useful to the business. That useful life must be projected at over one year in order to be claimed under the real estate depreciation deduction. You can claim this deduction as soon as the property is ready for rental, even if it is not yet rented. To qualify, you must own the rental property, use it to generate income, and be able to estimate its useful life.
Because land is excluded from depreciation value, you will need to separate the cost of the land from the cost of the building. If you are uncertain of the market value of the land opposed to the building(s), the IRS says that “you can divide the cost between them based on their assessed values for real estate tax purposes.” Additionally, some costs associated with land can be included if they are substantially associated with the depreciating property, like landscaping that would need to be removed to alter or replace the building.
The deduction is calculated as cost basis (the initial value of the property) divided by useful life (usually 27.5 years), so usually 3.636% each year over 27 and a half years, 39 years if the property is four or more units. It is placed on line 18 of the 1040 tax form, and you’ll use the supplemental form 4562 to calculate the deduction. The depreciation of property ends when you retire it from service.
Bonus depreciation is an extra tax incentive in which you can immediately, in the first year of use, deduct a substantial percentage of the cost of assets. The Tax Cuts and Jobs Act of 2018 greatly increased the amount of bonus depreciation business owners can claim. While bonus depreciation is being phased out and is currently scheduled to end in 2027, right now you can still claim some bonus depreciation. It applies to property purchased after September 27, 2017, and before January 1, 2023. This is useful if you don’t want to space out the depreciation of your property over a longer period.
Possible deductions include:
- Amount paid for the property in cash or mortgage (building only)
- Some closing costs
- Additions with a useful life of >1 year
- Improvements with a useful life of >1 year
- Costs of setting up property to receive utilities
- Appliances with a useful life of >1 year included in rental
- Furnishing with a useful life of >1 year included in rental
- Some limited landscape improvements with a useful life of >1 year
3. Business Expenses
Business expenses are deductible if they are paid, ordinary, and necessary. An ordinary expense is one that is common to your field, while a necessary expense is one that helps your business, even if it is not strictly indispensable. Deductible costs exclude capital expenses such as startup costs, assets, and improvements. It’s important to keep strict records and receipts throughout the year in order to claim these expenses.
As a sole proprietor, you will need to fill out Schedule C and claim the deductions on your 1040.
Possible deductions include:
- Rent or mortgage on the rental property
- Maintenance costs, including cleaning
- Insurance on the rental property
- Property fees on the rental property
- Property taxes on the rental property
- AirBnB service fees
- Transportation and travel fees associated with the property
- Education or conferences associated with property management
- Furnishings in rental property
4. Home Office Expenses
If you run your business out of a home office, you can deduct some of the costs. To qualify, your home office needs to be your principal place of business, and you must use it regularly and exclusively for conducting business. You can use a simplified square footage calculation of $5 per square foot, up to 300 feet, or the regular method of dividing the operating expenses between home and business use.
Possible deductions include the business portion of:
- Mortgage or rent
- Real estate taxes
- Maintenance costs
- Equipment and machinery
- Office supplies
- Office furniture
Be sure to talk to a tax professional to understand which deductions will be most beneficial to you. By taking advantage of as many tax deductions as you can, you can offset many of the costs of running your business.