What Short Term Rental Expenses Are Deductible?

Operating a short-term rental can provide an income stream, and understanding the associated tax deductions is part of managing its financial success. Expenses incurred to operate your rental property can be subtracted from your rental income, which lowers your overall taxable profit. Navigating these deductions requires understanding how the Internal Revenue Service (IRS) classifies your rental activity and which costs are eligible.

Defining Your Rental Activity for Tax Purposes

The first step in managing your rental’s finances is to determine how your property is treated under tax law, which hinges on the number of days it is rented versus used personally. The IRS has a provision, often called the “14-day rule,” that provides a tax benefit for minimal rental use. If you rent your property for 14 or fewer days during the year, you are not required to report the rental income to the IRS, and consequently, you cannot deduct any of the associated expenses.

Once you rent the property for 15 or more days, you must report all rental income, and the ability to deduct expenses comes into play. A rental day is any day the property is rented out at a fair market price. A personal use day, as defined by the IRS, includes any day the property is used by you, a family member, or anyone else for less than fair rental value.

These definitions determine whether your property is classified as a rental property or a mixed-use property. If your personal use exceeds the greater of 14 days or 10% of the total days the property is rented at fair value, it is considered a residence, and expense deductions will be limited. Accurately tracking these days is necessary for the expense allocation process.

Identifying Deductible Expenses

Once you are required to report rental income, you can begin deducting the costs associated with operating the property. These expenses are categorized as either direct or indirect. Understanding the difference is fundamental to correctly calculating your deductions, as outlined in IRS Publication 527.

Direct Expenses

Direct expenses are costs that are solely for the benefit of your rental guests and are 100% deductible against your rental income. These are costs that would not exist if the property were not used as a short-term rental. Common examples include:

• The service fees charged by booking platforms like Airbnb or Vrbo
• Supplies purchased exclusively for guests, such as complimentary toiletries, coffee, or snacks
• The cost of professional cleaning services between guest stays
• Any specific insurance policies, like liability coverage, purchased just for your rental activity

Indirect Expenses

Indirect expenses are costs associated with maintaining and owning the property throughout the year, regardless of whether it is occupied by a guest or used personally. These expenses must be allocated between rental and personal use. One of the most significant indirect expenses is mortgage interest paid on the loan used to acquire or improve the property. Unlike the limitations on a primary residence, the mortgage interest attributable to the rental portion of your property is fully deductible as a business expense.

Property taxes are another major indirect expense that can be deducted. Similar to mortgage interest, there is no cap on the deductible amount for the rental-use portion of your property taxes. Other common indirect expenses include utilities like electricity, gas, water, and internet service. Landlord or hazard insurance premiums, homeowners’ association (HOA) fees, and general advertising or marketing costs to promote your rental are also deductible.

It is important to distinguish between a deductible repair and a capital improvement. A repair is an expense that keeps the property in good operating condition, such as fixing a leaky faucet or patching a hole in the wall, and is fully deductible in the year it is paid. A capital improvement is a cost that adds value to the property, prolongs its life, or adapts it to new uses, such as replacing the entire roof or remodeling a kitchen. These costs are not deducted immediately but are recovered over time through depreciation.

Allocating Expenses for Mixed Use Properties

When a property serves as both a rental and a personal residence during the year, you cannot deduct the full amount of your indirect expenses. Instead, you must divide these costs between personal and rental use. The IRS provides a specific formula to make this allocation, ensuring that you only deduct the portion of expenses that relates to the income-producing activity.

The formula for allocating indirect expenses is based on the ratio of rental days to the total days of use. To find the deductible portion of an expense, you divide the total number of days the property was rented at a fair market price by the total number of days it was used for both rental and personal purposes. Days when the property was vacant but available for rent are not included in this calculation. The resulting percentage is then multiplied by the total amount of the indirect expense to determine the deductible amount.

For a clear example, consider a property that was rented for 90 days and used personally for 30 days in a year, making the total usage 120 days. The rental use percentage would be calculated as 90 rental days divided by 120 total use days, which equals 75%. If the total indirect expenses for the year—including mortgage interest, property taxes, and utilities—amounted to $20,000, you would be able to deduct 75% of that total. This means $15,000 ($20,000 x 0.75) could be claimed as a rental expense.

This allocation method must be applied to all indirect expenses, such as insurance, maintenance, and HOA fees. It is important to keep meticulous records of both rental and personal use days to substantiate your calculations in the event of an IRS inquiry.

Understanding Depreciation

Depreciation is a non-cash deduction that allows property owners to recover the cost of their real estate and its assets over time. It accounts for the gradual wear and tear, deterioration, or obsolescence of the property. You can begin to depreciate a property when it is placed in service, meaning it is ready and available for rent. This deduction reduces taxable income without affecting cash flow.

The assets that can be depreciated include the building itself, major improvements, and personal property used in the rental activity, such as furniture and appliances. Land, however, is not depreciable because it is not considered to wear out. To calculate depreciation on the building, you must first determine its basis, which is its cost, and then subtract the value of the land. This building basis is then recovered over a set period defined by the IRS.

For residential rental properties, the standard recovery period under the Modified Accelerated Cost Recovery System (MACRS) is 27.5 years. This means you deduct a portion of the property’s basis each year for 27.5 years.

Just like indirect operating expenses, the annual depreciation deduction must be allocated based on the rental use percentage if the property is used for both rental and personal purposes. You would apply the same rental-use percentage calculated for your other indirect expenses to the total annual depreciation amount to determine the deductible portion for that year.

Reporting Income and Expenses

After calculating your total rental income and determining the deductible amounts for all your expenses, the final step is to report this information to the IRS. This is done using Schedule E (Form 1040), Supplemental Income and Loss. For most individuals with short-term rental activity, Part I of Schedule E is the relevant section.

On Schedule E, you will list the physical address of your rental property and report your gross rental income on line 3. The form then provides separate lines for various categories of expenses. You will enter your pre-calculated totals for items such as advertising, insurance, mortgage interest, repairs, and taxes on the corresponding lines.

Utilities are entered on their own line. Any other expenses not specifically listed, such as cleaning fees or guest supplies, can be grouped on the “Other” expenses line.

The depreciation deduction you calculated is reported on its own line. If you are placing a property in service for the first time, you may also need to file Form 4562, Depreciation and Amortization, and attach it to your return. After listing all your expenses, you will total them and subtract this amount from your gross income to arrive at your net rental income or loss.

This net figure from Schedule E is then carried over to your main Form 1040, where it becomes part of your adjusted gross income calculation. It is important to complete a separate Schedule E for each rental property you own.