Globally, vacation rental investment is the latest craze. One of the popular topics on Google is how to invest in real estate for passive income. New and seasoned investors are searching for how to invest in apartments, short-term rental investments, etc.
Some vacation rentals are listed on platforms like VRBO, Airbnb, etc. Others manage their short-term rentals themselves or hire property managers. This type of rental property investment has a higher cash flow than long-term rental.
But, taxes on these properties can get you to the bottom of a financial hole when you don’t handle them properly. Here are the tips to handle taxes and avoid tax traps on short-term rentals.
Let’s get started.
Basic Requirements for Short-Term Rental Taxes
Although many list their properties on Airbnb as short-term rentals, some don’t fall under that category when it comes to taxes. As a matter of fact, rental property investments are referred to as short-term due to the number of days you rent them out.
The 14-day rule determines whether a property is a vacation rental home or a personal residence. This rule affects how you calculate your taxes and the number of tax-deductible expenses.
For tax purposes, short-term rentals are available for rent out for over 14 nights each year. You don’t need to report rental income generated from renting your property for less than 14 weeks.
But, your rental income is eligible for deductions if you rent it out for more than 15 days. Thus, you should deduct certain rental expenses like:
- Mortgage interest
- Maintenance expenses
- Insurance premiums
- Property managers.
The amount to deduct varies based on the number of days guests stayed in your vacation home. Therefore, when evaluating where to buy rental property to generate real estate passive income, you should research the state, federal, or country’s income tax responsibilities. Short-term rental tax deductions are restricted to the size of rental income.
Strategies to Reduce Taxes on Vacation Properties
Most successful people know the secret of rental property investment. They work to invest heavily in the best and most well-strategized short-term rental investment because of the high cash flows it generates. With a high occupancy rate, you can make outsized real estate passive income from your vacation properties.
Because of this, new and seasoned investors are actively looking for buying rental property tips, and also for a buy short-term rental strategy. Indeed with an appropriate STR strategy, you can reduce your taxes as an Airbnb host.
Here are different strategies for handling your taxes throughout the year with the aim of reducing them.
1.Understand Your Tax Benefits
You get many tax benefits when you invest in short-term rentals. Most of them are better than what you get when you buy a long-term rental property. Investing in short-term rentals allows you to offset taxes using excess rental losses from such properties.
Some of the tax benefits include:
- Deductible operating expenses that you use to manage and maintain the rental property
- Tax-deductible mortgage interest
- Depreciation deduction on the rental property to help you recover the cost of wear and tear
- You’re allowed to defer on capital gains tax payment
- You don’t pay the FICA taxes
Here are the eligibility criteria
i.Use at least 500 hours to participate in your short-term rental activities.
ii.When you participate at least 100 hours in vacation properties, ensure no one else spends more time in them than you.
iii.Engage in nearly all short-term rental property activities and ensure your participation supersedes the time others spend.
These activities include:
- Managing your property
- Marketing
- Handling your guests to give them a memorable experience
- Restocking the property
- Cleaning
- Repair and maintenance, etc.
You qualify to deduct any net tax losses in the present tax year and offset taxes from W-2 income when you meet one of these eligibility criteria.
Additionally, file and submit a W-9 form to all online rental property sites handling your bookings. Otherwise, the government will retain a large amount of your income as tax up to the end of the year.
2.Increase Your Tax Deductions
Usually, the more cash flows your short-term rental investments generate, the higher your profits. But, if you are not careful, the taxes can take up a big chunk of your income. The good news is that you can reduce the figure through tax deductibles.
Here are several tax breaks for your vacation property:
- Commissions and service fees
- Mortgage interest
- Marketing and advertising costs
- Business-related transport costs
- Property insurance
- Cleaning supplies and services
- Maintenance/repair costs
- Legal costs
- Furniture
- Home office deduction
- Cost segregation
- Depreciation
- Various indirect expenses
3.Track Your Expenses
Track your short-term rental expenses just like other investments. If you have a diversified real estate portfolio or several vacation rentals, track every expense and income for each property.
Also, remember to add an eligible home office, business meals, transportation costs, and educational expenses related to the short-term rental investments. Indeed, it’s crucial to capture all expenses that can help offset taxes linked to the passive income from a rental property.
4.Income Shifting
Shifting your income can help maximize tax savings on passive real estate income. For instance, you should pay your family members or friends who help to market, repair, maintain or clean your short-term rentals.
In fact, you need to treat what they do as service fees. While the cost will help you save on taxes, it will motivate them to continue taking care of your rental property investments.
5.Make the Most of Depreciation
Before investing in vacation rental property, you should consider the high start-up costs you need. You should invest in modern furniture, state-of-the-art fixtures, and smart appliances in order to make your property stand out.
But. you don’t have to purchase entirely brand-new items to qualify for bonus depreciation. Instead, you can buy used items eligible for this tax deduction.
So, if your short-term rentals are near the lake or river, consider buying the following:
- Kayaking gear
- Hiking gear
- Fold-up chairs
- Badminton equipment
- Inflatables, bodyboards
- Bikes, etc.
Just picture yourself as a guest and provide what you would want to find in a vacation rental. These basic amenities will give your guests more fun while you get good reviews, higher income, and savings on taxes.
Parting Shot
Rental property investments have the potential to generate high income. But, a big chunk of your income can go to paying taxes if you don’t understand your tax benefits. Tax deductions help reduce taxable income.
Thankfully, the above 5 strategies can help you handle your short-term rental taxes and harvest a lot of savings. So, track all legally allowed expenses and use them to offset taxes from your income.
