Short term rentals have blown up in the United States. Once restricted mainly to people with vacation homes in resort areas, the market has now opened up to just about anybody with a guest room or a couch thanks to websites like Airbnb. Many people are bringing in a substantial side rental income and are set up to be shocked next April when the IRS comes to take their cut of tax on rental income. It is essential for accountants to help their clients understand the tax implications of rental income. The following four pitfalls are the most common and often the most devastating.
1. Neglecting Lodging Tax on Rental Income from Short Stays
Short term rental properties are subject to far more taxes than longer term rentals. Although the definition of a short term rental varies from state to state, but is usually less than thirty days. Florida and Hawaii have stricter laws, defining short term as anything less than six months.
It is important to know whether your clients have a short or long term rental because these rental property income has special tax rules. The host is required to pay lodging taxes, which are 10-15% of the charge in most cases. Unlike other rental expenses, there are no tax deductions to defray these costs.
Because people renting on Airbnb and other popular sites can make a substantial amount of income, this tax on rental income can add up quickly. Landlords may be hit with a surprise bill of thousands of dollars. Many people have never encountered this kind of tax and are not aware of which agencies to contact. The exact agency in charge of lodging tax varies by area, so every accountant should take the time to find out the details.
2. Failing to Take the Right Income Tax Deductions
While lodging and sales taxes are not subject to deductions, there are many ways for landlords to lower their income tax burden. You can deduct a wide variety of rental expenses, such as rent, utilities, property maintenance, depreciation of the property, cleaning, and even property taxes. As a result, many short term rentals operate at a net loss, with negative rental income.
Many clients are not aware of the wide variety of deductions they can take while remaining totally compliant with tax rules and thus end up paying too much. For most landlords, lodging and sales tax should be the only significant taxes that they pay.
3. Forgetting Sales Tax
Long term rentals are not subject to sales taxes. Short term rentals, however, are subject to these. Sales taxes vary by the area but are often around 10-15% of the rental charge, comprising a significant tax on rental income. As with lodging tax, these are paid to a separate agency rather than the IRS. Many people are shocked when they are hit with a multi-thousand dollar tax bill.
One of the key issues with Airbnb and other websites is that people do not see it as a small business. They view it as a gig and treat the income like garage sale income, pocketing the total. It is important for accountants to ensure that they view it as a small business from the outset, which brings us to our last point.
4. Failing to Keep Good Records
People who rent property for extra income are small business owners – and very small business owner should become very comfortable with record keeping. This includes tracking income, which can be surprisingly complicated for those who are using multiple websites to manage their short term rentals. In addition, it is important to keep careful details of expenses, even small ones such as cleaning products, to increase deductions and ultimately lower their tax on rental income. Failing to keep receipts and books can have huge tax implications for your clients. It’s important that accountants help them to develop a solid system from the beginning.
Many Americans are turning to small businesses as a way to augment their income. They may see these activities as a gig, but the IRS and local tax authorities will see them as much more. Helping your clients to prepare for and avoid these four common pitfalls will ensure that there are no unwanted surprises and that they pay as little tax on rental income as legally possible.
