In this article, the author, Wis Laughlin, tells you how to pay the lowest legal taxes on your Airbnb rentals, particularly after 2017 Tax Reform. This article is based on a May 10, 2018, talk at Memphis Investors Group at the Embassy Suites. Handouts are below.
So, are you an Airbnb host or thinking about it? Airbnb is just being explored by the IRS and by tax preparers, so there is a lot of wrong information. Forbes.com warns: “deciphering the tax consequences of a part-time rental is no picnic.” Unlike long term rentals, Airbnb hosting generally produces significant profits.
MINIMUM RENTAL LOOPHOLE
If you use the Airbnb property as your home more than the greater of 14 days or 10% of the total days rented and you rent it for less than 15 days during the year-you need not report the rental income at all.
My advice: If you are close to meeting this rule, plan to rent for less than 15 days. Then you need to read no further.
HOW DOES THE IRS TAX AIRBNB HOSTS ?
How is Airbnb income reported, tax-wise? It depends. If it is classified as a real estate rent-al activity, you report it on your Form 1040 Schedule E. It is subject to regular income tax.
If it’s classified as small business income, then it must be reported on Form 1040 Schedule C. Schedule C income is “self-employment income” on which you pay 15% self-employment taxes (social security and Medicare) in addition to regular income taxes.
My Advice: Make sure you have rental in-come instead of self-employment income. Read on to learn how.
HOW TO AVOID SCHEDULE C INCOME
Is your Airbnb producing self-employment income? Not if you know what you are doing. Your income will be self-employment income if, like hotels and boarding houses, you provide your tenants with substantial services like regular cleaning, changing linens, or other maid services.” In contrast, furnishing heat and light, cleaning public areas, or trash collection are not substantial services.
My advice: If you want to avoid the self-employment tax– avoid providing substantial services. Don’t feed your tenants and don’t provide regular cleaning, changing of linens, or any other maid services.
NET INVESTMENT INCOME
Airbnb hosts are vulnerable to the “net in-vestment income” tax, a 3.8% additional tax on the lesser of (1) the taxpayer’s net invest-ment income (NII), or (2) ) the taxpayer’s AGI exceeding: $200,000 for a single filer, and $250,000 for joint filers. NII includes interest, dividends, capital gains, annuities, royalties and passive rental income. A real estate pro-fessional is not subject to this tax.
VACATION HOME RULES
If you use your Airbnb home personally for more than 14 days, or 10 percent of its rental use, the “Vacation Home” rules apply. Those rules require you allocate deductions between personal use, reported on Schedule A, and rental use, reported on Schedule E. Rental ex-penses are limited. See IRS Publication 527.
DEDUCTIONS — YOUR MAIN WEAPON
Your first defense against taxes is your operating expenses.’ See Schedule E.
Typical deductions include: advertising, listing fees and commissions, auto & travel expenses cleaning, maintenance, the Airbnb fee, insurance, legal and profes-sional fees, management fees, mortgage interest, Other interest, repairs, supplies, state and local sales and occupancy taxes, depreciation and amortization of points and loan closing costs. There are many more. I use experience and checklists to find you more deductions.
Capital expenditures purchase items that last more than one year, like a building, roof, or air conditioning unit. These cannot be deducted in the year purchased. The cost is prorated and deducted as depreciation over the item’s useful life. For example, a residential rental property is deducted over 27.5 years, 3.636% of the cost (adjusted basis) per year. Land is not depreciated.
The cost (“basis”) of your rental property is its contract price plus certain closing costs, plus the cost of improvements. The “adjusted basis” of the property is reduced by prior depreciation deductions. See GAIN OR LOSS.
My advice: To increase depreciation, sepa-rately depreciate items like furniture and ap-pliances, which have a shorter useful life.
GAIN OR LOSS
If you sell a property, you generally have tax-able gain to the extent its selling price exceeds its adjusted basis. If you hold a property for 12 months or more, the gain on the sale is con-sidered “long-term capital gain,” which quali-fies for lower tax rates. If you are a real estate “dealer,” regularly buying and selling properties, you do not qualify for long term capital gain treatment.
TRAP: Beware of “phantom gain” on a sale. Phantom gain exceeds the cash you receive. It often occurs if the property’s adjusted basis has been decreased by depreciation or if you refinanced the loan and took out cash.
PASSIVE LOSS RULES
The “Passive Activity Loss” rules apply to limit deductible losses on most rental activities. However, losses are generally not a problem with Airbnb. Besides a property is not subject to these rules if you use it personally for more than 14 days per year.
YOUR 20% DEDUCTION — TAX REFORM AT ITS BEST
Airbnb hosting is a pass-through, eligible to deduct up to 20% of its profits in 2018, but not more than 20% of taxable income. This deduction reduces taxable income even if you don’t itemize. There are limits on QBI and certain service providers do not qualify but these limits do not apply to a single taxpayer with taxable income not exceeding $157,500 ($315,000 for a joint filer). See the handouts below: 199A Calcs and Primer for 20% Deduction.
YOUR TAX RETURN
It is useless to understand the tax rules unless you know how to take advantage of them on your tax return! With Airbnb, you will have profits and taxes to deal with. I recommend professional tax preparation, but not just anyone. A preparer who doesn’t fully understand the tax rules may make costly mistakes or just be too shy. It takes years of education and experience to understand the tax rules. Don’t assume that a CPA is a tax expert. Less than 25% of the CPA exam covers taxes. An H & R Block preparer may have less than 90 hours of training. I advise you to use a tax lawyer or a CPA with a masters in taxation. Don’t risk your tax dollars!
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