This article is written by Sam J. Adams CPA, P.C.
The advent of sites such as Airbnb, HomeAway and VRBO have created the opportunity for millions of people to run a great side business renting out their home. There are people who make tens and even hundreds of thousands of dollars a year.
Making rental money through these sites is like every other business endeavor, however – the government wants its cut. You can minimize how much the IRS takes as well as make sure you stay out of hot water if you follow a number of steps we discuss below.
The 14-Day Rule
Essentially the 14-day rule means you do not have to report rental income to the IRS (nor do you get to take any deductions) if you meet both of the following:
- You rented your home for 14 days or fewer throughout the year;
- You used the property yourself for 14 days or more during the year or at a minimum of 10 percent of the days it was rented.
The beauty of the 14-day rule is its simplicity for the occasional renter. But things get a little more complicated if you start to make real money.
The rental websites keep track of all your activity and send you a Form 1099-K showing the total gross income received during the year. The 1099-K reporting requirement kicks in if you have more than 200 transactions and earnings more than $20,000 over the course of the year. Keep in mind that even if you are below these thresholds, you still need to report your income to the IRS but you might not receive a 1099-K.
It is important to note that the amount reported on the 1099-K will be a gross rental income amount. It will not reflect any commissions, local tax payment, etc. that the site took out via its system. Remember to deduct these items because otherwise you will be overpaying taxes.
Schedule E or Schedule C
Typically, owners of rental properties file the income and related expenses for each property on Schedule E of their tax returns. But rental hosts who rent out rooms in their own abodes will typically file on Schedule C instead. The details of this distinction are beyond the scope of the article, but you should know that the IRS has a seven-factor test. If you are unsure about where you fall in this respect, you should consult a qualified tax advisor.
So what does this mean for you? Well, each schedule has its own advantages and disadvantages. With Schedule E for example, you avoid paying the 15.3 percent self-employment tax; however, losses are generally suspended as passive activity losses and carry over until you make money with the same property or sell it and then offset the gains.
Schedule C on the other hand allows you to take any losses in the current year, but you are liable for the self-employment taxes in years you have inc ome. Remember that the driver between which schedule you file has nothing to do with your preference for tax treatment, but is driven by IRS rules.
There are basically two types of expenses you need to consider – direct and indirect. In all cases, keep detailed records to support your deductions.
Direct expenses are those that relate solely to the rental activity and therefore are 100 percent deductible. Indirect expenses are those where only a portion of the expense is directly related to the rental and as a result you will need to pro-rate these expenses appropriately.
Indirect expenses are much more common where you are renting out a room or a portion of your residence. In these cases, shared expenses such as internet, depreciation or even cleaning (if you hire someone to clean your whole house, for example) need to be allocated or pro-rated to the rooms you are renting out.
Keep these items in mind when you file your taxes – and happy renting.