Short-term rental marketplaces such as Airbnb, HomeAway, and VRBO have made it easy for homeowners and property managers to market their rental property. Experienced operators know that in order to succeed, they need to treat their short-term rental like a business. Luckily, the IRS agrees, so if your rental-property owning clients already operate like a business, they also get businesslike deductions when income tax time comes.
It does pay to do a little research to make sure clients aren’t missing out on the deductions they could claim. Homeowners and property managers should especially pay attention to the Tax Cuts and Jobs Act (TCJA) deductions, which went into effect starting with the 2018 tax year.
Keep in mind that these deductions relate to federal income tax. It’s important that your clients understand the difference between income tax -- which is paid to the government based on income -- vs. lodging taxes, a tax guests pay on the cost of renting short-term accommodations.
The host doesn’t actually pay lodging taxes, but is responsible for collecting the tax and passing it on to the appropriate state and local tax authorities. There are no deductions to can claim for lodging taxes.
The 14-Day Rule
To maximize your tax deductions, a home must be classified as a full-time rental business. That means it’s used for personal stays of less than 14 days or 10 percent or less of total annual rental days, whichever is greater. Keep in mind that the days primarily spent repairing or maintaining the property won’t count toward personal use days.
If a client uses their rental home for personal use for more than 14 days a year, they’re only allowed to make deductions in proportion to the amount of time the property is being rented by guests. If they only rent out part of the property, they’ll only be able to deduct expenses in proportion to how much of the property they rent out.
A benefit of using a property as a full-time rental business is that you may be able to deduct up to $25,000 in losses each year, depending on your income. If a property is only a part-time rental business, you won’t be able to deduct a loss when you spend more on the property than you earn in rental income.
On the other hand, if the client offers their property for short-term rental for only 14 days or less during the year, and uses the property for themselves 14 days or more — or at least 10 percent of the total days they rent it out — then they do not need to pay income tax on that rental income.
10 Income Tax Deductions Clients May Miss
1. Pass-through business tax deduction
Under the Tax Cuts and Jobs Act, residential landlords who own their rental property through “pass-through” entities — including sole proprietorships (meaning they own the property individually), limited liability companies, or partnerships — may be eligible to deduct an amount equal to 20 percent of their net rental income. This is a personal deduction that can be taken even if you don’t itemize. However, it’s not an “above the line” deduction that reduces adjusted gross income.
2. Deduction for major improvements
Section 179 of the tax code allows owners to write off the costs of certain personal property used in a business. Changes to this section allow some vacation rental operators to write off the cost of fire systems, security systems, roofs, and HVACs. The amount that can be deducted for personal property under Section 179 was raised to $1 million starting in 2018; previously it was $500,000. Section 179 is applicable only to property used for rental more than 50 percent of the time.
3. New bonus depreciation deduction
Previously, business owners could only deduct 50 percent of the cost of personal property used for the business each year. The 2018 tax law changed that to 100 percent, meaning you can deduct the full cost of property such as appliances and furniture all in one year. The changes apply to new or used property placed into service from September 27, 2017, through December 31, 2022.
4. Mortgage interest
The 2018 tax law lowered the amounts that can be taken as personal deductions for mortgage interest on primary and secondary residences. Previously, you could take a deduction on interest on up to $1 million in newly acquired debt; the law changed that amount to $750,000. However, these limits do not apply to rental businesses, so you can deduct all mortgage interest on rental properties as a business expense.
5. Credit card and loan interest
If you use credit cards or personal loans to pay for expenses, you can deduct the cost of interest payments on those accounts. As of 2018, personal deductions for interest on home equity loans were eliminated altogether, but you can still deduct this type of interest as a business expense for a rental property.
6. Property taxes
The TCJA also lowered the amount that can be taken as a personal deduction for property taxes to $10,000; previously there was no limit. However, similar to the mortgage interest deduction, the limit does not apply to properties operated as rental businesses. So, owners of rental properties can take the full amount of property taxes as business deductions.
You can deduct the cost of any insurance that covers your rental property. You can also claim a deduction for private mortgage insurance (PMI) premiums on rental property for the year they were paid. However, if you prepay PMI premiums for multiple years in advance, you can only deduct the part of the PMI payment that applies to that year.
8. Marketplace fees
Airbnb charges a “host service fee” of at least 3 percent of the cost of each reservation while HomeAway charges $499 for an annual subscription. These fees are completely deductible, so make sure you keep track of them.
9. Travel and transportation expenses
When you travel overnight for business related to your vacation rental, you can deduct expenses such as airfare, accommodations, mileage, meals, and other travel expenses. This could include activities such as:
- Traveling to your rental property to do repairs or maintenance
- Learning related to your rental, such as classes, seminars, conventions, or trade shows
- Meeting with business associates who work with you in your rental business
Clients can also deduct mileage for travel closer to home in order to visit a property or other related travel, such as going to a store to pick up supplies or equipment. Keep in mind that any travel related to improvements, as opposed to those for repairs, may need to be added to the improvement’s tax basis and depreciated.
10. Home office
If you manage your rental business from a home office, you may be able to deduct expenses related to the office, including equipment, supplies, and a percentage of many of the costs of running your home.
Getting the Most Out of a Rental
While many tax deductions for your client’s rental business seem small, they can really add up. Make sure they record expenses as they go along. Keeping detailed records of any expenses related to a rental makes things much easier when it comes time to file taxes — as well as in case the IRS has questions down the line. Both knowing what you can deduct and keeping good track of those expenses can help clients take maximum advantage of tax savings on their rental property.