Today many people earn extra money by temporarily renting out their entire home (or a room in their house or apartment) through rental services such as Airbnb, HomeAway, or VRBO. If you do this, you may have to pay federal and state income tax on your rental income. Rental services like Airbnb ordinarily report to the IRS the rental payments they send to their hosts each year by filing IRS Form 1099-MISC. So the IRS will know you have such rental income and expect it to appear on your tax return.
Unfortunately, the tax rules involved can be complex. But it’s up to you to understand and follow them because room and home rental services won’t do it for you.
Tax-Free Rental Income for Short-Term (Less Than 14 Days Annually) Rentals
You can rent out all or part of your home or apartment for up to 14 days per year and all the rental income you receive is tax-free, no matter how much you earn. In fact you don't even have to report the income to the IRS. Your rental income is tax free if, during the year:
- you rent out your home for 14 days or less), and
- the home is used personally for more than 14 days, or more than 10% of the total days it is rented to others at a fair rental price. (IRC Sec. 280A(g).)
See the Nolo article Rent Your Vacation Home Tax-Free for details.
If you only rent out a room in your home or apartment and continue to live in the rest of the space, you’ll have no problem meeting the personal use requirement. But if you rent out the entire home or apartment, you need to keep careful track of your rental or non-rental days.
If you qualify for such tax-free treatment, you may not deduct any operating expenses for the property or take any depreciation deduction. You don’t file Schedule E, the tax form landlords file to report their income and expenses, because your home is not classified as a rental property.
Tax Issues When Renting Your Home For More Than 14 Days Per Year
If you rent your main residence (house or apartment) over 14 days during the year, and live in it 15 days or more, you won’t qualify for the tax-free treatment described above. Instead, you’ll have to report and pay income tax on your rental income by filing IRS Schedule E along with your tax return. But you’ll also be allowed to deduct your rental-related expenses, within very strict limits.
You list your rental income and expenses on Schedule E. You must pay income tax on any profit left over after you deduct your rental expenses from your rental income. However, your annual rental deductions are limited to your rental income from the home. If your expenses exceed your income, you may not deduct the loss from other income you earn that year. Such a loss can be carried forward to future years and deducted from your rental income from the property, if you have enough.
You are allowed to deduct your expenses from your rental income, but there are strict limitations designed to ensure that you don’t deduct personal expenses as rental expenses.
Direct Rental Expenses
You are allowed to deduct 100% of your direct rental expenses. These are expenses that apply only to renting, such as fees or commissions you pay to the rental agency, advertising, credit checks, insurance for the rental, cleaning costs, repairs solely for the rental portion of your home, and depreciation (limited to the rental portion of the home).
You may also deduct a portion of your general expenses to own and operate your entire home, such as mortgage interest and real estate taxes, utilities, insurance for your entire home, cleaning expenses for the entire home, repairs for the entire home, Internet connection fees, gardening, and other home maintenance expenses. You must allocate your deduction for such general expenses based on the aount of time the property served as a rental, compared to the total time it was used during the year.
Example: Paul lives in his Bay Area condominium for 300 days during the year and rents it out for 65 days. The property was used as a rental 18% of the time ( 65 ÷ 365 = 18%). Thus, Paul can deduct 18% of his general expenses up to the amount of rental income he earned from the condo during the year, which was $10,000.
If, instead of renting your entire home, you rent out only a room or rooms you can only deduct your general expenses in proportion to the amount of the home rented. For example, if you have a five-room home and rent one room, you could deduct 1/5 of your general expenses for your entire home subject to the limits described above.
Tax Issues When Operating a Bed and Breakfast or Hotel
In some cases, renting out all or part of your house or apartment can be classified for tax purposes as the equivalent of running a bed or breakfast or hotel. This will be the case if you dedicate a room or rooms in your home solely for the use of paying customers and never personally live in such rooms. You’ll also be classified as running a hotel business if you provide substantial services that are primarily for your guest’s convenience, such as regular cleaning, changing linen, or maid service.
In this event, your rental activity will be treated as a business for tax purposes. This means you’ll have to pay both federal income and self-employment (Social Security and Medicare ) taxes on your rental income, which will increase your tax burden. On the other hand, the restrictions on your deductions described above won’t apply, except that there may still be limits on any annual losses you’re allowed to deduct. Ordinarily, you’ll report your rental income and expenses on Schedule C (Form 1040), Profit or Loss from Business.
Obviously, the way to avoid having your rental activity being classified as a bed and breakfast is not to provide substantial services to your guests—don’t provide them breakfasts, clean their rooms each day, or do their laundry. Charge renters a cleaning fee at the end of their visit that is separate from their daily rental charge.
Tax Issues and Rental Property Owners
If you're renting property full-time, as opposed to renting out a room or your entire home on an occasional basis, there are are numerous tax issues to consider. See the Tax Deductions for Landlords section of the Nolo website for a variety of useful articles and the Nolo book Every Landlord's Tax Deduction Guide for detailed information on the subject.