Have you joined the Airbnb Nation or found some other way to make money renting your personal residence? Then there are some tax rules that could save you a bundle. Here’s your Taxes for Landlords 101:
Arguably the most important thing to know about taxes for landlords is that you don’t always have to pay tax on rental income. And, when you do pay tax, it’s taxed more lightly than earned income.
When do you pay no tax? When you rent out a personal residence for 14 days or less.
The 14-day rule says that if you rent out your personal residence for 14 days, or less the income is completely excluded from tax. And you don’t have to live in the home full-time to make it a personal residence.
For a house to be considered your personal residence, you have to live in it for at least 14 days — or more than 10% of the time that it’s rented to others – whichever is more. In other words, if you have a vacation home, as long as you live in it for at least two weeks a year, you can rent it out — federal tax free — for a couple of weeks a year, too.
And, in states that conform with federal tax rules, it’s generally free from state income taxes as well.
But if you rent that house for even one extra day, you could be making a costly mistake.
Let’s say you have an expansive home that you can rent through Airbnb for $1,000 a night. If you were able to secure a 14-day rental, that would generate $14,000 in rental income. After paying 3% to Airbnb, you take home $13,580 – tax-free.
If you rent your house for an additional day, you may make more before tax. However, you’d have to rent it considerably more to make more after tax.
Let’s say, for instance, that your vacation renter wants to take a 16-day trip and rent your home the whole time. You’d make an extra $2,000 in rent and clear $1,940 after the 3% Airbnb fee.
But now you need to pay income taxes on the $15,520 (the $16,000 rent minus the 3% Airbnb fee). Assuming your other deductible expenses are minimal, that would cost you $3,880 in tax, assuming you pay a 25% blended (federal and state) rate, and more if your combined tax rate is higher.
Naturally, that overwhelms the additional income by a wide margin. In this case, you’d be smarter to forgo those extra few days of rent.
No income limit
Notably, this 14-day rule applies no matter the purpose of your residential rental — or the amount you earn from it.
So if you rent your personal residence for special events and movie sets through sites like Giggster, Splacer, and PeerSpace, you still get to rent tax-free for that 14 days. And since these sites rent your home by the hour at rates that can amount to 10-times what you could get for a night’s rental with Airbnb (or any of the several dozen other sites that will help you rent your home, or spare rooms, to travelers), that could add to a lot of income.
Best advice: If you are in a high tax bracket and think the chance of renting your house for more than 20-30 days is slim, consider limiting your rental availability to no more than the tax-free 14 days. However, if you have significant rental expenses that are not covered by tenants or are in a lower tax bracket, you might want to consult a tax advisor to determine your best course of action.
For the purposes of rental rules, you can have a lot of residences. Any home that you live in for more than 14 days during the year qualifies, says Mark Luscombe, principal tax analyst with Wolters Kluwer. That means that if you rent it out for less than 14 days, the rent is tax exempt from each and every property that you can consider a personal residence.
If you rent out a house that you don’t live in for at least that 14 days, every penny you receive in rent is taxable.
If you have a guest house or vacation home that’s in hot demand, you’re naturally going to want to forget all about the 14-day rule because the income you can earn from a popular rental is a lot more important than the tax.
However, you’ll want to keep close track of all of the expenses related to the rental. You only pay income taxes on your net income. That’s income after expenses are deducted.
What’s deductible? Almost anything that’s reasonable and necessary to generate income from your rental. That includes everything from furnishing and cable to buy snacks, coffee, beach chairs, and bedding. You generally deduct the cost of these purchases in the year they’re incurred against your rental income. You can even deduct some home improvements; utility costs, insurance and maintenance expenses.
If the rental is a separate unit that needs its own gas, electric, cable and wifi, all of those costs are fully deductible too. If, however, you’re renting a room in your home and you are also using those same services, you are only allowed to deduct the business portion.
How do you calculate the business portion? Figure out what percentage of your home was set aside for renters. So, if you have a 1,000 square-foot residence and the bedroom and bath that’s exclusively used by renters is 250 feet, you could reasonably deduct 25% of these bills as rental costs.
In addition, if you needed to do major improvements or even an addition to support your rental business, those expenses can be deducted too. However, capital improvements are deducted over time through something called “depreciation.” The amount of time depends on the item. Since depreciation schedules can get a bit complex, it’s best to use a tax accountant or software that allows you to file a Schedule C and E.
If you are renting your personal residence, your deductions are limited to the amount of income you have from the rentals. In other words, you can’t claim a loss on renting a portion of your home. But you could potentially claim a loss on renting out a business property. (Though, be careful. If you lose money several years in a row, the IRS could call your “business” a hobby and disallow your deductions.)