Is Your Short-Term Rental Subject to Self-Employment Taxes?

The internet has created unique business opportunities, including allowing people to earn money from the ‘sharing economy’ and side gigs such as rideshare (Uber, Lyft), food delivery (DoorDash, Uber Eats, Grubhub) and home-sharing (Airbnb, VRBO, Homestay).  While this provides revenue and flexibility, it may have income tax consequences which could be overlooked. A recent memorandum from the IRS Office of Chief Counsel analyzing when short-term rental properties are subject to self-employment taxes serves as a good reminder. Let’s look at the unique tax rules for short-term rentals and the implications of the IRS memorandum.

Short-term rentals are a great way to make extra money. If you rent all or part of your home for 14 days or fewer per year, you don’t have to report any income; although, you can’t deduct any rental expenses (mortgage interest and property taxes may still qualify as itemized deductions). If you rent your home for more than 14 days per year, tax reporting then depends on the average length of stay and whether you provide ‘services’ to your guests.

Rental activities are generally treated as passive, unless you are a materially participating real estate professional. But rentals with an average length of stay of 7 days or less don’t follow the general rule. Like other businesses, these short-term rentals are treated as nonpassive if you materially participate (regardless of whether you’re a real estate professional). The differences between passive and nonpassive income are beyond the scope of this article, but the tax implications can be big. Short-term rental owners should be aware of the distinctions, so they aren’t caught unaware.  

To further complicate things, rental income can be subject to self-employment taxes when you provide ‘substantial services’ to the renter. If you are wondering when services are considered ‘substantial,’ you aren’t alone. The IRS Office of Chief Counsel memorandum provided some clarity on the issue by addressing two separate fact patterns where short-term rental owners provided varying levels of services.  

In the first, the owner provided daily housekeeping services, including the delivery of individual-use toiletries and sundries, access to dedicated wi-fi service, access to the beach and other recreational equipment for use, and prepaid vouchers for ride-share services between the rental and the nearest business district. The net income from this rental was subject to self-employment taxes because the services provided were deemed ‘substantial.’  

In the second, occupants only had access to the common areas of the house to enter and exit the room and bathroom they were renting (no kitchen or laundry room access) and there was no daily housekeeping service. The owner only cleaned the rental space between occupants. In this case, the rental income was not subject to self-employment taxes because the services weren’t considered ‘substantial.’ 

Most short-term rental owners likely provide a level of service that falls somewhere in the middle of the two examples above. With the 2021 tax filing season just getting started, now is the perfect time for short-term rental owners to discuss the tax implications of their operations with their accountant. Whether the rental activity is passive or nonpassive, or subject to self-employment tax, can have a profound effect on the after-tax profit of their rental property business.   

Have questions or need assistance? The experts at PP&Co are ready to help. Contact us at info@ppandco.com or (408) 287-7911 for more information.