Renting out one or more short-term vacation rentals can be a very lucrative business. On the downside, figuring out short-term rental income taxes can be quite overwhelming. Thus, it’s not surprising that many vacation rental business owners turn to tax preparers for help.
However, if you intend to manage short-term vacation rental taxes yourself, understanding the tax system is extremely important in order to avoid tax-related accounting errors that could lead to penalties and fines. Here are some important aspects you should be aware of.
Vacation Rental Tax Rules
When it comes to vacation rentals, there are two main scenarios in terms of taxation:
- you rent out the property for fewer than 14 days or use the home yourself for more than 14 days or 10% of the time it is rented over the course of a year; in that case, the home is considered a personal residence, which means that you’ll get to keep all of the rental income tax-free;
- you rent it out for a majority of the year and use it for personal purposes for less than 14 days or 10% of the days it is rented; from a tax viewpoint, the property will be considered a rental and the income taxed accordingly.
Payroll or Self-Employment Tax Obligations
The payroll or self-employment taxes you’ll need to pay depend on the legal structure of your business and whether you have employees or not. If you’re the owner of a small vacation rental LLC and don’t have any employees, you’ll be treated as a sole proprietor for tax purposes. What does this mean? In a nutshell, you’ll need to report your profit or loss on the Schedule C form and submit it together with your 1040 tax return. If you have employees, you must withhold and pay payroll taxes from their paychecks, such as FICA, FUTA, and local taxes (e.g. income and disability insurance taxes), if applicable.
If you’re self-employed, you may need to pay income taxes in addition to self-employment taxes. Assuming that you expect to owe more than $1,000 in taxes, you’re required to make quarterly estimated tax payments during the year. Failing to pay enough tax throughout the year or missing a payment may result in penalties and fines. Therefore, it’s important to calculate the amount of income and self-employment taxes you owe as accurately as possible and pay them on time.
An important aspect is that the self-employment tax is based only on your net earnings, which is your gross income minus your business expenses. It’s also worth noting that some states, like Florida, Texas, Nevada, and Tennessee, don’t have an income tax. However, if you make money from renting out a vacation rental, specific Federal taxes may apply.
According to the IRS, here are the most common expenses you may be able to deduct, depending on what state and local laws apply to you.
- Property taxes: Property taxes can be deducted either as business or personal expenses, with some limitations. For instance, the personal use of a rental property for more than 14 days or 10% of the time it’s rented will limit the deduction to $10,000 for singles, heads of households, and married couples who are filing jointly, and to $5,000 for married couples filing separately.
- Mortgage interest: According to the IRS, vacation rental property owners are allowed to claim mortgage interest, including prepaid interest (e.g. discount points), against rental income.
- Insurance: Though insurance fees increase your monthly operating costs, they’re counted as deductible business expenses.
- Property management: Property management fees are considered ordinary and necessary business expenses. As a result, any fees associated with property management services can be deducted. As well, you can deduct every dollar spent on advertising your vacation rental(s).
- Professional service fees: The IRS also allows vacation rental businesses to write off specific professional costs, including accounting fees, legal fees, court costs, and similar expenses.
- Cleaning, maintenance, repair, and utility costs: Any bills for cleaning, maintenance, or repair work as well as energy, heating, water, and internet bills are deductible for tax purposes.
- Software: The cost of any software solutions you use for your business along with the money you spend for installation or technical help will qualify as tax deductions.
For instance, if you invest in lodging management software to manage different areas of your business, including the complicated and time-consuming tax compliance activities, you can deduct its cost on Schedule E.
As you work through your vacation rental income taxes, remember that tax rules can vary from one state to another and from year-to-year. To ensure compliance and avoid problems down the road, it’s always best to consult with a tax professional before filling out and submitting any tax forms for your business. If you’re looking for award-winning lodging management software that can help you manage all the operations of your vacation rental business, including the tax filing process, contact us today! Our experienced professionals will be glad to provide all the details you might require!