[Editor's Note: Today's post is from Passive Income MD. You've heard of people making a killing with AirBNBs and VRBOs, but it's also entirely possible to have a bad return on your time and money with short-term rentals. With short-term rentals you're not in the landlording business, you're in the hotel business. As many people discovered during the pandemic, the hotel business can be pretty fragile. Tread carefully, limit leverage, have cash reserves, and use conservative projections when running the numbers.]
Introduction to Short-Term Rentals
Over the past few years, short-term vacation rental platforms like Airbnb and Vrbo have gained immense popularity.
It makes sense; short-term rentals (STRs) can be cheaper than hotels, they provide plenty of space, and they are often much more conveniently located. In fact, these days, many vacationers skip looking for a hotel entirely, using one of these platforms exclusively.
Especially in this time, many people feel safer renting a short-term rental that has strict cleaning protocols than staying in a larger hotel with a ton of other people.
That’s great for the consumer (you may have even booked an Airbnb or two yourself). But do STRs present a great opportunity for investors as well?
Well, as with anything, there are many factors to consider. There are some major perks to investing in STRs—even over traditional long-term rentals. Perhaps surprisingly, one of the biggest benefits comes in the form of some major tax breaks you may have never considered.
So let’s jump right into why a short-term rental might be just the thing to add to your portfolio.
Why Consider Short-Term Rentals?
Profit
While traditional, long-term rentals (like single-family homes) do provide consistent monthly cash flow, deciding how much to charge in rent is based on many factors, including the local market average.
With a short-term rental, though, most people understand and are willing to pay a premium price for a shorter stay. This means that, potentially, one or two tenants a month could bring in more profit than a traditional monthly rent payment.
For example, let’s say that you have a rental property within an hour’s drive from a national park. While a traditional lease may bring in $1,500 in monthly rent, you could make that much from a single 5-night stay when listed as an Airbnb.
The same is true of cities with popular college football teams, tourist attractions, or simply locations with good year-round weather.
Of course, the flip side of this is that while you do make more money from a single tenant, your rental property could go vacant for several days—even weeks—at a time. This can potentially eat into those profits fairly rapidly.
As you might have guessed, this means that running a short-term rental does require more hands-on management than a traditional rental. Between marketing (like customer reviews), property management, and cleaning services, some people do consider it to take more time than it’s worth.
On the other side of the spectrum, plenty of people enjoy the time and effort spent making a property irresistible to potential renters. And, with the right location, a short-term rental really can be far more lucrative than a comparable long-term rental.
Control
With a short-term rental, you are in complete control of the property—including its appearance. Tenants won’t be making any changes (in fact, other than the occasional horror story, lodgers make little impact, if any) or additions.
For some, knowing that you have this control adds some peace of mind. For others, though, it does add a bit more pressure, making sure that everything is always up-to-date and thoroughly inspected after every tenant leaves.
Tax Benefits
Normally, thanks to IRC section 469 of the Tax Reform Act, high-income earners are unable to offset their W-2 income using depreciation from their rental properties. That is, unless they achieve something known as “real estate professional” status.
In other words, passive losses can only be used to offset passive income, and active income can only be offset by active losses.
Many high-income earners strive to achieve real estate professional status because, if you can offset the income from your day job using depreciation from your rental properties, you could effectively lower the overall amount of taxes you pay, and even drop into a lower tax bracket. The problem is that this is way easier said than done, and it’s often not worth the trouble.
Short-term rentals, on the other hand, are the exception to the rule. IRC section 469 states that an activity isn’t considered “rental activity” if the average length of the stay is seven days or less. So what does this mean, exactly?
Well, it means that, with an STR, you can deduct rental losses as non-passive, allowing you to offset income from your day job without attaining real estate professional status.
Needless to say, for high-income earners like physicians, this is a huge advantage. We normally don’t have many ways to reduce our taxable income. Come tax time, the ability to deduct depreciation from your real estate properties means that you’ll likely pay significantly less to Uncle Sam.
As a quick side note: the flip side of this advantage is that you can’t count short-term rental hours toward your real estate professional status. So if that’s a goal for you, STRs won’t be a great way to help you get there.
Is a Short-Term Rental Right for You?
As with any investment, short-term rental properties are not without risk. The biggest one has to do with the economy. After all, most people seek out STRs for vacations, and if people are losing jobs or are otherwise strapped for cash, vacations are usually the first thing to be cut from the budget.
And of course, if you aren’t able to fill your property with tenants, you could be losing money.
However, between the significant tax breaks and fantastic profits, short-term rentals can be a truly lucrative addition to your portfolio.
Also, I typically don’t recommend that doctors and busy professionals manage these types of places themselves. Their time is worth way more than the hassle, in my opinion. So you have to factor the cost of management into the numbers.
So, in order to make the best decision, ask yourself how comfortable you are with that level of risk, and how hands-on you want to be. Because when it comes right down to it, though STRs do require more attention, they can be equally rewarding.
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Have you ever considered a short-term rental property? If so, did you decide against it, or did you go for it? Let me know in the comments; I’d love to hear about your experience.
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I am pretty sure the tax advice in this article is not accurate.
There are only two ways to be able to have the. Rental activity loss be deductible against w2 income.
1. Be a real estate professional (as you pointed out)
2. Provide enough services with the rental that it is more like a b&b. Simply being “short term” and being less than 7 days on average does not meet this test. Cooking your guests breakfast or cleaning the room every day does.
If one meets the test for 1 above the rental stays on schedule E. If one meets the test for 2 put the rental on schedule C.
If one is planning to use the real estate professional route and one has full time W2 income it will be hard to meet the test. But a non w2 spouse might be able to more easily.
Hope this helps
(Note if the rental is more than 7 days average length. Losses are deductible against w2 provided ones income is low enough for this not to be phased out (150k i think, and only 25k losses)
Interesting on # 2. Let’s see what Peter says about that.
I looked it up a bit and found this:
https://www.taxpros.org/blog/short-term-rental-special-treatment/41678
This suggests some gray area. I mean, if you clean every 2 or 3 days when the client turns over, does that count or do you have to come in during their stay? Not exactly clear.
The following link includes a tax court ruling on this. Bottom line is to be deductible as a short term (less than 7 day rental) one has to meet the material participation test as outlined. Its more easily done if one self manages, than if one has a property manager.
https://www.journalofaccountancy.com/issues/2000/jan/shorttermrentalsclassifiedaspassiveactivitylosses.html
This ruling is from 22 years ago. Is this still relevant today? Would be a huge boon to be able to count depreciation against W2 income.
Yeah, STRs do qualify for the depreciation write-offs but you have to meet certain standards such as being materially involved with 100 hours and more than any one else (ie, can’t have property manager) or 500 hours (meaning multiply STRs). Good thing with the 500 hrs is that you don’t need to have more hours than anyone one else for this. There are some other rules to reach it but these are the big 2. Always talk with your real estate accountant before doing this though.
IMHO short term rentals are the scourge of cities. If you have ever lived next to a STR then you know what I’m talking about. You are right, STRs are hotels. And guests treat the property and neighborhood just like that. Guests are loud and obnoxious. Think your neighbors will like you running a STR next to them? I’ll save you the suspense. They won’t. They will actually hate your guts.
STRs have been banned outright or heavily regulated in many major cities and more will follow because of these problems. It wouldn’t surprise me if the STR landscape was very different in a few years.
So thinking of getting in the STR game? Sure, you may make some money, but your neighbors will despise you. And understand you are contributing to homelessness by driving up rent and forcing families out of affordable housing. I know this is not the direction this post was going, but this is a side most people don’t even consider. The day will come when the house next to you will be turned into a STR and then you will understand what I’m talking about.
I agree with you wholeheartedly Ed IF it is used solely as an investment property. When an Airbnb is strictly owner occupied, as many municipalities are making them now, the nightmare scenario you are describing is virtually non existent. In fact they become the oasis that they were originally developed to be. A nice place to rest your head with a host who lives there and can assist in making your stay more pleasurable. In areas where owner occupied Airbnb’s are the norm neighbor complaints are mitigated because the guests are staying in someone’s home who is in fact home. Big difference when the owner isn’t there.
I don’t know if others feel the same way, but during the current pandemic I’d much rather stay in a well-established hotel chain than in some rando’s rental house.
Thanks for the post. Two questions
1.How many weeks per year does someone need ones property to be available as a STR to qualify as being able to depreciate ones property?
2.Any chance of combining STR with renting out your house to your business? This came up in your Top 20 ways to save legally on taxes – when you mentioned that you could rent out your house to your LLC for up to two weeks per year. This could then be deducted from the LLC income as an expense, correct? Of the answer to #1 above is as short as two weeks (any substantial personal services qualification could easily be met!) Could one then depreciate ones property as well? Seems like a double dip, but if it is legal…. and pro small business…
Thanks,
Paul
1. https://sharedeconomycpa.com/blog/depreciating-your-home-as-an-airbnb-host/#:~:text=Depreciation%20is%20a%20method%20used,your%20home%20can%20be%20depreciated.&text=According%20to%20the%20IRS%2C%20the,someone%20that%20is%20not%20you.
Doesn’t sound to me like you need very many at all, but I probably wouldn’t try it unless you’re renting it out at least 15 days a year.
2. No. The key to renting it out to your business is to only do it for 14 days so you don’t have to pay income on it.
Hello Paul,
Great article and great summary. You are one of the few people that know the exception to the STRs; even my own CPA who does not specialize in real estate got this wrong. I work part-time as a physician and just started doing a short term rental and it has been a lot more work than anticipated but also more enjoyable. We took a bonus depreciation so were able to write off 500K in paper loses to offset W2 income. However the bonus depreciation will be gradually phased out in the upcoming years.
I have two items I wanted to comment on. I took a five week course on the tax advantages offered by real estate ownership by a CPA Brandon Hall, who only works with real estate owners. Initially he was under the impression that the hours put towards STRS do not count towards the total 750 hours needed to qualify for REP status. However after looking further he the stated that the hours for the STRs to count towards the total 750 hours needed to qualify for REP but that the properties managed by REP status would have to meet other criteria to qualify under the REP.
Secondly if the STRs are given to a management company, they cannot be used to offset W2 income as they are not being actively managed by the owner. They would then fall into the passive rental category.
PIMD,
This is a great post about STRs. We enjoy owning and managing our STRs and the tax benefits available without requiring REPs is a huge bonus. I think the story line of being too busy to self-manage or that it is too hard is a carry over from days past. With WiFi smart locks, ring door bells and automated management software it is easier than people think. If you can use a smart phone and text then you can learn to self manage. The key is getting past the limiting belief. As far as time, I think the tax breaks can definitely make it worth your time and effort…. but I would not recommend owning an STR just for that goal. We actually enjoy the process, it is our hobby and we take pride in our properties. The greatest part of the investment is personal use. As for Ed’s post I agree with that position and that is why we invest in resort communities where STRs are welcome and a vital component of the local economy. I encourage anyone interested in the tax details to check out Brandon Hall (The Real Estate CPA). Lastly, we own both LTR and STR property and I find managing our STR to be far more enjoyable. Thank you for a great post.
We own 4 ski in/ski out STR’s in Breckenridge, CO. We self manage and it definitely takes time and it’s a learning curve. It helps to have a good website and presence on social media. My wife is known as local “Breckenridge Expert” and she gets a lot of questions online. We also have many repeat guests. It’s dangerous to put all your eggs in one basket and only depend on Airbnb and HomeAway as these large companies have a lot of leverage and can unilaterally change their policies as demonstrated during the pandemic.
Hi Carpe Diem,
Where do you have your short term rentals and long term rentals? Do you live near them as well?
Thanks!
Hi M,
We own our STRs in Mammoth Lakes, CA and live about 5 hours away. Our LTR triplex is in Spokane, WA.
For those of you not using AirBnb or Vacasa, etc., how are you marketing your STR?
Social media presence, word of mouth, repeat guests, emailing news about the resort to past guests, being known as the “local expert” on the destination. Google ads.