How Is Short Term Rental Income Taxed?

An increasing number of property owners are generating income by renting out homes, apartments, or spare rooms for short periods. This activity involves specific federal income tax responsibilities that require proper compliance and financial management. This guide covers the rules that determine when income is taxable, how to calculate net income, how the activity is classified by the Internal Revenue Service (IRS), and the required reporting procedures.

Determining the Taxability of Rental Activity

The first step is to determine if your rental income must be reported to the IRS, which is governed by the “14-day rule.” If you rent your property for 14 days or fewer during the year, you do not have to report any of the rental income. This income is nontaxable. The trade-off is that you cannot deduct any expenses associated with the rental. For tax purposes, the property is treated as a personal residence.

If you rent your property for 15 days or more, you must report all rental income to the IRS. The benefit of crossing this threshold is that you can deduct the ordinary and necessary expenses associated with the rental. This allows you to reduce your taxable income. The property is now considered a rental property for tax purposes, and you must maintain detailed records of income and expenditures.

For example, if you own a cabin that you rent for 10 days and use personally for 30 days, the income is tax-free and you do not report it. You also cannot deduct costs like cleaning fees or utilities for those 10 days. If you rent that same cabin for 20 days, you must report all rental income, but you can then deduct a portion of your expenses against that income.

Calculating Net Rental Income and Expenses

When your rental activity crosses the 15-day threshold, you must calculate your net rental income. This begins with determining your gross rental income, which includes all payments received for the use of your property. This encompasses the nightly rate, cleaning fees, and any other charges passed on to the guest.

From this gross income, you can subtract deductible expenses, which are separated into two categories: direct and indirect. Direct expenses apply only to the rental activity and are 100% deductible. These include:

• Service fees charged by rental platforms
• Advertising costs
• Supplies specifically for guests (like toiletries and coffee)
• The cost of cleaning the property between renters

Indirect expenses are costs for maintaining the property for the whole year, such as mortgage interest, property taxes, insurance, and utilities. Because these expenses cover both rental and personal use, they must be allocated. The IRS requires this allocation to be based on the number of days the property was used for rental versus personal purposes. You cannot deduct the portion of these expenses attributable to your personal use.

To allocate indirect expenses, you must track the total days the property was used, separating them into personal and rental days. A rental day is any day the property was rented at a fair market rate. To find the deductible portion of an indirect expense, you multiply the total expense by a fraction: the number of rental days divided by the total number of days used.

For instance, assume you rented your vacation home for 90 days and used it personally for 30 days, for a total of 120 days of use. Your total indirect expenses for the year were $15,000. The rental portion would be calculated as ($15,000 (90 rental days / 120 total days used)), which equals $11,250. This is the amount you can deduct against your rental income.

Depreciation

Depreciation is a mandatory deduction for the rental portion of your home that allows you to recover the cost of your property over its useful life. The IRS considers the useful life of a residential rental property to be 27.5 years. You must calculate and claim depreciation for the portion of your home used for rental purposes. Failing to do so can have negative consequences when you sell the property, as the IRS requires you to recapture depreciation that was allowable, whether you claimed it or not.

Classifying the Activity for Tax Purposes

How your short-term rental is classified by the IRS affects how you treat income and losses. The default classification for any rental is that it is a “passive activity.” The primary consequence of this involves the passive activity loss (PAL) rules, which limit your ability to deduct rental losses against other forms of income, such as wages.

Under the PAL rules, if your rental expenses exceed your rental income, the resulting loss can only be used to offset income from other passive activities. If you have no other passive income, the loss is suspended and carried forward to future years. It can then be used to offset passive income in those years or be fully deducted when you sell the property.

An exception exists that can reclassify a short-term rental from a passive activity to a non-passive business. This often depends on the level of service you provide. If you provide “substantial services,” your activity may be treated as a business. Substantial services are those for the guest’s convenience that are not provided in long-term rentals, such as regular cleaning during a stay, providing meals, or offering concierge services.

To determine if an owner’s involvement rises to the level of a non-passive business, the IRS uses “material participation tests.” An owner must meet one of these tests, such as spending more than 500 hours on the activity during the year or performing substantially all of the work. If the average customer stay is seven days or less, the activity is not considered a rental activity for passive loss purposes, making it easier to qualify as a business if you materially participate.

Required Tax Filings and Reporting Procedures

The classification of your rental activity determines which tax forms you file. If your activity is treated as a rental (the default), you will report your income and expenses on Schedule E (Form 1040), Supplemental Income and Loss. You will attach Schedule E to your personal tax return, Form 1040.

If your activity qualifies as a business because you provide substantial services and meet a material participation test, the reporting requirements change. In this case, you must file Schedule C (Form 1040), Profit or Loss from Business. Reporting on Schedule C means your net income is subject to both regular income tax and self-employment taxes, which cover Social Security and Medicare. Income on Schedule E is not subject to self-employment tax.

Many owners will receive a Form 1099-K from their rental platform. This form reports the gross amount of payments processed on your behalf. It is important to ensure the gross income you report on your Schedule E or Schedule C is at least the amount shown on your Form 1099-K to avoid automated notices from the IRS.

If you anticipate owing $1,000 or more in tax for the year from your rental income, you are required to make quarterly estimated tax payments. Since this income is not subject to automatic withholding, you are responsible for paying tax on it throughout the year. Failing to make these payments can result in underpayment penalties. The payment due dates are:

• April 15
• June 15
• September 15
• January 15 of the following year