Know These Tax Rules If Your Average Rental Is Seven Days or LessTax Planning
Do you own a rental property for which the average rental period is seven days or less for the year?
Such properties can include condominiums, cottages, cabins, lake or beach homes, ski lodges, and similar properties.
If the period of average rental is seven days or less, you have a vacation hotel of one sort or the other, as uniquely defined by the tax code.
Seven days example. Say you have a beach home and you rent it 15 times during the year, for a total of 85 days. Your average rental is 5.7 days. That’s an average of seven days or less for the year.
This puts you in the vacation hotel areas of the tax code. And yes, there’s more than one possible landing area.
To make the rules come to life, let’s say further that you have no personal use of the property. Your beach home or other vacation rental is either rented or vacant for the day. Here’s what we will examine in this article:
- Is your seven-days-or-less-average rental property a business reported on Schedule C or a rental reported on Schedule E?
- Do the passive loss rules apply to the seven-days-or-less-average rental property, and can you count the hours spent on this property as participation hours for the purpose of qualifying to deduct rental losses by becoming a real estate professional as defined by the tax code?
Schedule C or E
IRS Reg. Section 1.1402(a)-4(c) states that providing services with short-term rentals creates a business that’s reportable on Schedule C and subject to self-employment taxes.
Services. You render services to the occupant when such services are other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only. For example, with the sevendays-or-less rental, you render more than occupancy services when you clean the unit, supply clean linens, wash the dishes, and provide maid services.
If all you do is clean public entrances, exits, stairways, and lobbies; collect the trash; and so forth, you are not rendering more than occupancy services.
Net income. If the short-term rental on Schedule C produces a net income, you likely have qualified business
income for the possible 20 percent tax deduction under new tax code Section 199A.
Net loss. If the rental that’s reported on Schedule C produces a tax-deductible loss, you combine that loss with other self-employment income to find the net earnings subject to the self-employment tax.
Example. Your proprietorship sales business produces a net Schedule C income of $100,000, and your Schedule C rental produces a net loss of $20,000. Your income subject to the self-employment tax is $80,000 ($100,000 - $20,000).
Passive Loss Rules
For purposes of the passive loss rules, your property with an average rental of seven days or less is not a rental, even when it’s reported on Schedule E.6 With an average rental of seven days or less, the property
- does not qualify for the $25,000 active participation rental loss break;
- does not produce material participation hours that you can use to become a real estate professional; and
- stands alone under the passive loss rules (albeit possibly grouped under the general business—not the rental—grouping rules).
Example. You spend 200 hours on the seven-days-or-less rental and 600 hours on your other two rentals. You don’t have the 750 hours needed to qualify as a real estate professional because you may not count the hours spent on the seven-days-or-less rental.
If your seven-days-or-less rental produces a tax loss, regardless of reporting the loss on Schedule C or E, you may deduct the loss in the current year only if you materially participate in the seven-days-or-less rental property.
There are seven material participation tests, but it’s likely that only one of the two tests below will work for you on this seven-days-or-less-average rental property:
- The combined participation by you and your spouse constitutes substantially all the participation in the seven-days-or-less-average rental activity when you consider all the individuals who participated (including contractors).
- The combined hours of participation by you and your spouse in the seven-days-or-less-average rental activity are (a) more than 100 hours and (b) more hours than the participation of any other individual.
Example. Your seven-days-or-less beach rental produces a $20,000 tax loss for the year. On this rental, you spend 65 hours during the year. No other person works on the rental. You materially participate in this rental, and the $20,000 is deductible—period (regardless of its location on Schedule C or E).
For the purposes of this article, you have no personal use of the property. Personal use triggers the Section 280A vacation home rules.10 We’ll deal with those rules and their unique considerations in an upcoming article.
The right type of beach home or vacation cottage can produce great tax results when the average rental period is seven days or less.
But it’s tricky because when the average rental period is seven days or less, the property is not a rental property as defined by the tax code. Instead, the property is
- a commercial hotel type property that you report on Schedule C of your tax return if you provide services in connection with the rentals,
- or a weird in-limbo property that you report on Schedule E when you don’t provide services.
If the property shows a loss, you can deduct that loss on either Schedule C or Schedule E if you can prove that you materially participate. With the seven-days-or-less-average rental, you likely have only two ways to materially participate, as we explained above.
The two paths to material participation are easy to understand and apply. Make sure you have a record of the hours to prove your work on the property.
If you have a profit on the rental, you likely have a Section 199A deduction when you report the rental on Schedule C as a business. Although not deemed a business by Schedule E reporting, the Schedule E rental could rise to the level of a business as defined for the Section 199A deduction.