If you have short term rentals, you’ll want to be aware of some important tax opportunities. There are several ways to get short term rental tax benefits that could improve your financial outlook and make your rentals even more lucrative. Most investors understand that long term rentals provide some benefits, but they may not be aware of advantages for short term rentals.
For investors who want to focus on short term rentals, though, or for those who have a mix of properties in their portfolio, getting significant tax benefits on the short term properties can be extremely important for a solid, secure portfolio. Here are a few of the best ways to reduce taxes with short term rentals.
Basic rental property deductions are the place to start, and that includes things like maintenance and upkeep. You may need to make trips to your rental frequently to stage it, perform routine care, or address other tasks. If that’s the case, you want to document those trips and the maintenance or repair costs.
If you’ve made a big purchase for your short term rental maintenance, such as a truck to haul furniture for staging and other supplies, you may be able to deduct the entire purchase price. That could give you a substantial tax break for your short term rental, to offset some of the income.
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Real Estate Professional Status
If you spend more time on real estate than you do in any other job, you may be able to claim real estate professional status on your taxes. That’s not always easy if you work full time in addition to your investments, but there are some ways to make it happen. It’s easier for short term rental tax deductions, which are treated differently.
You can then use any losses on the rental properties against your W2 income, without technically having to claim real estate professional status. You still have to show that you’re participating in your rentals in a material way, though, which you can do by meeting just one of the seven tests required by tax law. The most common ways to do that include:
- Participating in your short-term rental business for at least 500 hours in a year
- Participate in your short-term rentals for over 100 hours per year, with no one spending more time than you.
- Participate in all the short-term rental activities, with your total contribution being more than the contributions of everyone else combined.
If you meet the participation test you may be able to deduct any net losses you experience, which will help you offset the money you make on a W-2. If you have several short term rentals you can generally combine the hours you spend on all the rentals, to show your level of participation.
Cost Segregation Studies
A cost segregation study looks at the purchase price of construction cost of a property that would typically be spread over 27 1/2 or 39 years as depreciation. Instead, the depreciation is 5, 7, and 15 years for all property-related costs that are eligible for those time periods.
In short, if you’re depreciating some items over shorter periods of time the amount you can depreciate in that time period could be significantly larger. Those depreciation amounts could then be used against your income to reduce your tax burden. Often, 20% to 40% of the components that are typically used to calculate depreciation can be written off on a shorter timeline.
That could create a significant amount of tax savings, and is among the biggest short term rental tax benefits available. Dissecting the costs carefully, with the help of a trained professional, is the way to see savings on your income tax. If you’re not used to handling short term rentals, though, you may not be aware of this important benefit.
A 1031 Exchange makes it easy to swap one investment property for another one, which lets your investment in real estate continue to grow while deferring taxes. You’ll still owe taxes on the sale, but you can put that off for years simply by not selling outright. As long as you’re selling and buying in one transaction, and following the IRS rules to do so, taxes will stay deferred.
With a short term rental you can get even bigger benefits from a 1031 Exchange. If you have a short term rental property that you’ve earmarked for a vacation home, for example, you can stay there as much as you need or want to, as long as you’re working on the property during that time.
Normally, there’s a 14-day limit, but that limit doesn’t count time that you’re doing work. After two years of capping your official vacation days at 14 per year, and making sure the property is rented to others 10 times more than that, you can stay as much as you like, and that investment property just becomes your vacation home.
You can get even more value from your vacation home / short term rental, though, if you continue to rent it out at least 14 days per year to paying guests. By doing that you can generally write off a lot of your rental expenses, which will reduce your taxes even further.
Since there aren’t any rules to how many times you can do a 1031 Exchange, you can keep building your investment and work your way into a very nice vacation home at the same time.
The Bottom Line
The bottom line on how to reduce taxes with short term rentals is that there are many options and opportunities to consider. Reducing taxes through legal deductions can mean more value for your investment portfolio and can make it easier to continue to invest for the future.
Making sure you understand the short term rental tax deductions you’re eligible for gives you the ability to take your investments further. There’s no reason to avoid any deductions you’re entitled to take, and you don’t want to miss out on important strategies for saving on your taxes.