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It Figures Podcast: S4:E6 – The Ins and Outs of Airbnb and Vrbo

Join CRI Charleston Partner-In-Charge, Carrie Lanning and Partner, Stephanie Spinucci as they discuss the tax benefits and breakdowns of your Airbnb, Vrbo, and other short-term rentals.

Speaker 1:

From Carr, Riggs & Ingram, this is, It Figures, the CRI podcast, an accounting, advisory and industry-focused podcast for business and organization leaders, entrepreneurs, and anyone who is looking to go beyond the status quo.

Stephanie Spinucci:

Thank you for tuning in to the It Figures CRI podcast. My name is Stephanie Spinucci.

Carrie Lanning:

And I am Carrie Lanning.

Stephanie Spinucci:

And we are from the CRI Charleston office. We are new to the CRI family, so we’re super excited. And our topic today is Airbnb and Vrbo short-term rentals. Charleston has been ranked top travel destination for, I don’t know how many years, maybe we’re not top this year, but-

Carrie Lanning:

I think we were.

Stephanie Spinucci:

Were we?

Carrie Lanning:

I don’t know, feels like it with the traffic.

Stephanie Spinucci:

Yes, it does. But we see a lot of our clients wanting to buy short-term rentals on Isle of Palms, Sullivan’s Island and so forth. So we wanted to talk today about the tax implications. What can you deduct? Where is it reported? Or-

Carrie Lanning:

Should I do a cost segregation?

Stephanie Spinucci:

Yes. How to maximize deductions. Right? Isn’t that what we’re all here for? Let’s maximize deductions.

Carrie Lanning:

It’s not so easy. We’re going to tell you why.

Stephanie Spinucci:

So here’s a great example that we see often. Let’s just jump into an example. So you have a doctor, he works in his medical practice full-time and-

Carrie Lanning:

W-2 employee.

Stephanie Spinucci:

W-2 employee, and he comes-

Carrie Lanning:

Works a lot of hours a year.

Stephanie Spinucci:

Whole lot of hours. We all know about billable hours, and he works a lot of hours as well. So he comes to us and says, “I want to buy a house on the Isle of Palms on the beach and make it a short-term rental. How can I deduct everything associated with this house.”

Carrie Lanning:

Maximize deductions.

Stephanie Spinucci:

So how does it happen, Carrie?

Carrie Lanning:

So I think the first thing we need to do is step back and just talk about in general. So in general, rental property is deemed passive and there are lots of rules around passive activities. So unless you are a real estate professional, which I think we’re going to maybe tuck away for another podcast, unless you’re a real estate professional, rentals are passive and you cannot deduct losses. If your income is over $150,000 of AGI, you cannot deduct losses unless you have passive income.

So in the case of our doctor, let’s say he has no other investments, he’s got his W-2 and he wants to take big, big deductions on this rental property, the general answer is you make more than 150,000 and you have no other passive income. So you can’t deduct it. So you just spent a whole lot of money on a beach house, furnishing it, doing all these things and the loss is not currently deductible.

Stephanie Spinucci:

Now not at all loss though, as we all know, passive losses are kind of carried forward in a little bucket each year and will be released in a year you have other passive income or in the year you dispose of that passive activity like the rental house.

Carrie Lanning:

But we all know that that client is shelling out a lot of cash in the current year and wants losses and thinks that it’s going to be an immediate thing. So yes, Steph, you’re right, it definitely gets preserved, but it’s not an immediate, “I get to take a loss.”

I will say though, caveat, if said doctor maybe wasn’t uber successful or working part-time and made under 150,000, you could take up to $25,000 of a loss for a passive rental.

But I think why we are here is how can you deduct it? Is there a way? And it really hinges on the fact of it being a short-term rental. And there are some regs, don’t want me to quote sections, but if you’re curious, 469 regs, on when a short-term rental is not deemed a rental. And that’s what all of this hinges on is can you say that a rental isn’t a rental and therefore doesn’t fall under the passive activity rules?

Stephanie Spinucci:

And if not a rental, it’s deemed a business.

Carrie Lanning:

Correct. So what are those tests or what are the things? I think, Steph, there’s like six, but the two that we’re going to see the most and that resonate is it is not a rental if the average use is seven days or less.

Stephanie Spinucci:

So think a hotel, typically, people stay at a hotel under seven days.

Carrie Lanning:

And the one thing I will say there is it is an average use for the year. We have seen, especially like Isle of Palms, the rentals in our area, you rent it less than seven days in the summer, it’s a Vrbo, Airbnb and then, kind of the traffic dies down a little bit in the winter. And so, you say, “Okay, well, I found this great tenant for January through April that’s going to rent.” When you do the math on that of having a person in there for four months, same person, it could drag your average use to higher than the seven days. So be very careful about having a long-term renter during your period that you are trying to keep the average use to seven days or less.

Stephanie Spinucci:

But fear not because if you have an average period of 30 days or less and significant personal services, you are still not treated as a rental and you’re deemed a business. But what is significant personal services? We’re talking about, you’re the one doing the cleaning, the repairs, you are monitoring, you’re doing the booking-

Carrie Lanning:

The booking, the rental, you’re filing the sales tax returns, the occupancy taxes.

Stephanie Spinucci:

Essentially, you don’t have a management company doing those things for you.

Carrie Lanning:

And possibly not a maintenance company or a cleaning company, you are doing it all yourself, which we do have some downtown properties where the owner is actually doing all the things and like a little bed and breakfast behind their house and that would qualify. I think the key there is to know that the caveat to that is if you rent it 30 days or less to the same person and you provide the significant personal services, it then is deemed an actual business and it would get reported on a Schedule C, which means you could, in a year of income, be subject to self-employment tax. So be very careful of trying to go down that path, which is fine if you’re producing a loss, that could be what helps you, but just be careful going down that path that if it ever flipped to an income situation, you could have self-employment tax on that income.

Stephanie Spinucci:

So once it is deemed a business and not a rental property, depreciation changes. So now you’re able to depreciate it 39 years and any leasehold improvements is considered QIP.

Carrie Lanning:

Which for your tax nerds, that’s yeah, QIP.

Stephanie Spinucci:

15-year property. So that’s kind of cool. And then, you want to take it a step further if you meet all of these tests, to do a cost seg, so you are frontloading depreciation on this property and you’re able to take those losses.

Carrie Lanning:

And a little plug, CRI does have a cost seg group that can look at this. But in general, I always hear, you don’t cost seg a rental, a residential rental, it’s a waste of time. Well, in general, it is if you don’t meet these tests. But if you can meet the seven days or less or the 30 days and substantial services, Steph’s exactly right, it becomes a 39-year business type property, which means that you fall under the rules where you can take bonus and that you do have qualified improvement property. So I mean, you could be talking a really big loss in the first year that you get this rental property going.

Stephanie Spinucci:

So let’s talk about one more hurdle, active or passive. So let’s say you hit that seven days or less, your Airbnb hits the seven days or less, you don’t provide significant personal services because maybe the doctor doesn’t live in Charleston and he bought the Isle of Palms beach house, he’s not here changing the sheets, running the laundry-

Carrie Lanning:

Nor does he have the time.

Stephanie Spinucci:

Nor does he have the time, but he buys this beach house and it is average of seven days or less. Now we have to jump the hurdle of is this passive or non-passive?

Carrie Lanning:

So that whole argument comes back into play, but in a different scope. So again, now this is not considered a rental, it’s considered a business. And again, back to my tax nerds out there, some of you know that if it is considered a business, you have to default to the active and passive test, which are the material participation rules. So you’ve got to then go test to make sure that you materially participate, which means you spend 500 hours, you’re the only one doing all the work, you spend a hundred hours and those hours are more than anyone else. Steph, I think there’s a few others.

Stephanie Spinucci:

Regular, continuous, and substantial activity in that business,

Carrie Lanning:

Which doesn’t include once a quarter or a booking once a month.

Stephanie Spinucci:

You perform, substantially, all of the work. And in terms of those hours, we’re talking about the hundred hours and more than anyone else, or more than 500 hours. Well, what are those hours? What kind of time are you doing that constitutes hours?

Carrie Lanning:

That gets you to meet those tests. Because the key is, let’s say you make this not a rental, it’s a business, if you don’t meet the material participation test, you go back to the passive rules and then your loss gets suspended. So where you’re trying to head with this is seven days or less or 30 days in personal service and you materially participate. That’s kind of where you’re trying to head to make this to be a slam dunk from a tax standpoint.

Stephanie Spinucci:

And here’s one cool thing, material participation, let’s say you’re married, let’s say the doctor is married, his wife does not work, material participation just has to be by one of the spouses. So let’s say the doctor, he’s way busy, he’s performing surgeries, he is too busy in his day-to-day job, but his wife meets the material participation test for their Airbnb, now they’re able to deduct these losses.

Carrie Lanning:

I mean, that’s a good point, Steph. I think, yeah, back to kind of what you were teeing up is what makes material participation? And what kind of things does the IRS look at when you’re trying to meet the 500-hour test or you’re trying to meet the hundred hours and more than anyone else? I think the thing that really throws you out, at least what we always see is do you have a management company? If you’ve got a management company managing the rental, it is really hard to get to the material participation rules. Even in the audit field guide, it’s like the number one thing that auditors are going to look at is do you have a property manager? Now, in Steph’s example, if the wife says, “Okay, I’m going to do the property management. I’m going to get on Vrbo, I’m going to get on Airbnb and I’m going to manage it.” That’s great because then you don’t have that management company that’s basically probably spending more hours than you are on your rental.

Stephanie Spinucci:

100%. And some other things that the audit guide… It’s really cool that the IRS put out a guide that says, “Hey, this is what we’re looking at.” Great thing to read guys. But a couple of other things they’re looking at, was the rental property hundreds of miles away from the taxpayer’s residence? Well, then they know, hey, you’re not there all the time cleaning the sheets.

Carrie Lanning:

You’re not cleaning. Right. You’re not cleaning the property, you’re not fixing the plumbing that just broke. You can’t.

Stephanie Spinucci:

So that’s one another big thing that they’re looking at. They’re also looking at, did the taxpayer have a W-2 job with significant compensation? Now, that doesn’t throw you out because you could have a spouse that is not working that then meets the material participation test.

Carrie Lanning:

But let’s say the spouse is also a physician and they’re both working all the time making beaucoups of W-2 money, it’s going to be really hard to argue that one of them finds the time to spend the 500 hours or even the hundred hours and more than anyone else.

Stephanie Spinucci:

Correct. Now let’s talk about time. So we talk about these a hundred hours, we talk about 500 hours, what is non-qualifying time? What does the I-

Carrie Lanning:

This is the thing in the audit guide that Steph and I were like, “Ro-ro.”

Stephanie Spinucci:

“Ro-ro.”

Carrie Lanning:

We kind of thought that sounded like legit time, but the IRS-

Stephanie Spinucci:

And maybe you guys thought it was legit time too, so let me tell you, it’s not.

Carrie Lanning:

But IRS says it’s not legit time. So that’s-

Stephanie Spinucci:

The non-legit time would be travel time. So you traveling to visit the rental property is not qualifying time that falls under your hundred hours or your 500 hours. Also, investor type activities, if you’re just analyzing a P&L or analyzing-

Carrie Lanning:

Or searching on the internet for the next property to buy, I always tell people, “Well, I mean, if you’re buying lots of rental properties and you’re searching for the next one, oops, time doesn’t count.”

Stephanie Spinucci:

That time does not count. So I know a lot of clients will come to me and say, “Well, I was searching for a property and I traveled to and from Charlotte to Charleston checking on my property.” Eh, eh, IRS says, that does not count toward your hours.

Carrie Lanning:

So getting to the hours is harder than one would think if you have to remove the travel time and the time that you spend to research, invest. It’s really going to be just active hours, which is what the IRS is trying to get at is you need to be actively engaged and meet those tests to be able to take losses. The thing Steph, I think we also need to mention and haven’t, and we get this a lot, is how can it be a 100% business rental or even rental? How much can I use the property personally?

Stephanie Spinucci:

So of course, you live in Charlotte, you buy a house on the Isle Of Palms, of course, you want to rent it out, you want to make some money, but heck, you want to enjoy it, don’t you? You want to bring the family down and enjoy this house on the beach that you have, so how do you do that but also still have the ability to deduct expenses related to this property?

Carrie Lanning:

Exactly. So IRS says that you can only use the property personally, and that means for personal enjoyment, 14 days or less or 10% of the days rented. So let’s say this thing is actively rented 300 days a year. You could then use it 30 days personally, but if you go over that, it becomes a mixed use property and then, everything we’ve just talked, again, save that for another podcast, but it does not fall into these rules the minute you start using it too much personally.

Stephanie Spinucci:

And in general, your deductions will be limited to your-

Carrie Lanning:

Income as you can’t create a loss if you’ve got a mixed use property. Share a little tidbit of a story, which it may be too much information for our clients, but we did have a client that had a place in Kiawah and claimed that he did not use it personally. And again, it’s a hard thing for the IRS to know. I mean, how does the IRS know where you were three years ago? Well, Kiawah has a gate and every time someone goes through said gate, it gets logged and the IRS agent actually pulled the logs from the Kiawah gate to see how many times this client was coming and going into Kiawah-

Stephanie Spinucci:

Busted.

Carrie Lanning:

… just so happened to be on Friday afternoon and he would leave Sunday morning. So just keep that in mind, be smart about your personal use days. Think like an IRS agent would think or really make this a business, which is what they’re looking for is for you to treat this like a quick turnover Airbnb, Vrbo, I spend my time managing this, I intend to make money off of it. If you can get there, then I think you’ve got yourself that deduction that you’re looking for.

Stephanie Spinucci:

And we don’t want to deter necessarily from getting into a short-term rental, we’re not trying to do that. Let’s say you don’t meet these tests, let’s say that there’s no way you’re going to be able to meet the-

Carrie Lanning:

Or you don’t have the time to manage it.

Stephanie Spinucci:

Correct. It’s still not an awful investment. All that rental income and as some of these Airbnbs and Vrbos are cash cows, that income still, you could wipe out with expenses, but just know you’re not going to be able to deduct the net loss. But again, those losses are kind of dropped into a bucket and used for the future, so it’s still not an awful deal.

Carrie Lanning:

Which I don’t hate. We see, especially in our area, huge equity in houses in the growth on the profit and the fair market value. So you turn around and sell it in three years and you have this massive gain. Well, the gain is a capital gain, right, except for recapture. But then, you have that bucket that you’ve been building up and building up with all of your losses, it dumps in the year of sale. So you could find that even if this doesn’t get you an immediate tax deduction right in the year you bought, it still makes a lot of good sense from a tax perspective. If you find a place that appreciates in value and you’re expecting to dump, it still makes sense. So you’re right, Steph, you don’t really need to look complete short-term, “I want my deduction today,” it still can be very beneficial down the road.

Stephanie Spinucci:

So that’s Airbnbs and Vrbos. I’m sure there are plenty of other markets other than Charleston that has seen this kind of growth. A lot of people traveling to those destinations and don’t want to get a hotel, they have larger groups, they would much rather get a house, everyone stays more comfortably. So this could be a really lucrative investment for a lot of your clients.

Speaker 1:

If you want more CRI insights or interested in learning about our firm, please visit our website at cricpa.com. Thanks for listening to this episode of It Figures, the CRI podcast. You can subscribe to It Figures on iTunes, Spotify, or wherever you prefer to listen to your podcasts. If you liked what you heard today, please leave us a review.

 

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