Tax Tips for Vacation Rental Owners
Like other forms of real estate, rental properties are subjected to property taxes. However, due to its business nature, taxes apply differently for vacation rental properties. The thing about taxes is that they’re often confusing, and a slight mistake could cause a significant deduction to your income.
In this article, we’ll provide several tax tips for rental owners and essential information regarding vacation rental property taxes. By familiarizing yourself with this concept, you can safeguard your income from hefty tax errors and make the best financial decision for your business.
How Is Mixed-Use Rental Property Treated on a Tax Return
As you already know, real estate properties serve two primary purposes: residential or rental (commercial). By legal definition, a property is considered residential or personal use if you dwell on it for more than 14 days of the tax year. On the other hand, a property is considered purely rental if you don’t use it for personal use or rent it out for more than 15 days of the tax year.
However, there’s a third, middle-ground category for these two. A mixed-use rental property is defined as a dwelling space used for residential purposes for more than 14 days and rented for more than 14 days. Is this making your head spin? Let’s make a sample scenario below:
John owns a winter vacation house in Park City, Utah. He stays in this property for more than two weeks every December but rents it to someone for the remainder of the season. This setup makes John’s property a mixed-use rental property.
These categorizations are crucial because tax returns are treated differently according to your property type, as stated by Cornerstone. In mixed-use rental properties, you must divide your overall expenses between rental and personal use according to the number of days. If your expenses exceed your gross rental income, you can carry them to the next tax year.
What’s the Difference Between Expenses & Improvements for a Short-Term Rental?
Improvements and repairs are essential parts of maintaining a profitable rental property. Without routine maintenance and repairs, your rental won’t stand out from the competitors. However, many property owners get confused with these, and differentiating them could significantly affect your taxable income.
Repair expenses refer to the overall cost of fixing damaged structures in your rental property. In other words, you’re making a broken unit operational again. An excellent example of this would be repairing a broken sink or mending a hole in the drywall.
In contrast, improvement expenses are the monetary cost of increasing the value of your property or lengthening its lifespan. For example, suppose you want to install new laminate flooring or upgrade to an energy-efficient electricity system for your rental. In that case, it’s classified under improvement expenses.
According to Nolo, repair expenses can be directly deducted from your rental income in the same tax year. However, improvement expenses are depreciated throughout 27.5 years, which could mean drastically lower deductions for the current year.
Can Depreciation of Rental Property Lower Taxes?
In simple words, yes. You can deduct real estate depreciation from your taxable income, but determining your tax deduction by depreciation can be complicated. Three primary factors determine how you can deduct depreciation from your taxes:
The basis of the property: You can get this by calculating the cost of purchasing your rental property. Once you have that amount, you must separate the value of the land and the house.
The depreciation basis used: Depending on the nature of your rental property, you can use the General Depreciation System (GDS) or the Alternative Depreciation System (ADS).
The recovery period: Now that you’ve identified the appropriate system, you’ll apply the correct recovery period to your property. For GDS, it’s 27.5 years, which is the standard according to the IRS. For ADS, it’s 30 years.
Does Rental Property Income Count as QBI?
QBI stands for Qualified Business Income, and it’s often a point of confusion for most rental property owners. According to the IRS, QBI is a business deduction allowing you to deduct up to 20% of your earnings from taxable income. QBI also entails other deductions depending on the business nature of the eligible taxpayer.
In terms of rental property, full-rental properties often don’t qualify for QBI deductions. However, mixed-used properties could be eligible for QBI as a safe harbor. If you want to qualify, the property should have been rented for over 250 hours over the past five years.
Is Filing a State Tax Return Required for My Rental Property?
In general, you have to pay state taxes if you have rental properties in various states. The filing requirements also vary from state to state, and it’s worth further researching the specific regulations in states where you have rental properties. You may need to file a non-resident tax return in some states.
However, this doesn’t always mean you must pay taxes multiple times if you own several rental properties nationwide. Some states provide tax incentives to property owners who paid taxes in another state. Understanding the state tax regulations where you have rental properties could save you some money.
Do Airbnb Hosts File a Schedule C or Schedule E?
Another point of confusion among rental property owners — particularly those who rent through Airbnb — is what tax schedule form they should use. A common question is whether to file a Schedule C or Schedule E. To further understand this topic, let’s differentiate the two forms.
Schedule C: According to the IRS, this form reports income or loss for sole proprietorship businesses. In this case, sole proprietorship refers to individuals or independent contractors who own their business.
Schedule E: In contrast, this form reports income or loss from estates, rental properties, residual interests in REMICs, royalties, S corporations, and trusts, as described by the IRS.
You probably know you should file a Schedule E form for rental properties by now, but you should understand that the confusion here is often caused by Airbnb hosts who classify as sole proprietors.
Avoid Hefty Tax Mistakes When You Do It the Right Way
Tax filing is a daunting topic many business owners, rental property owners, and even individual workers find challenging to understand, and we don’t blame you. Taxes are inherently complicated, but with the proper guidance, you won’t have to stress over this financial aspect of your business again.
If you want to ensure that you’re paying the right amount of tax for your rental property, we are here to help! With our tax assistance service, you can leave the complicated math to us and focus on keeping your rental property fully booked.