Short-term rentals may bring long-term tax problems
Short-term rentals, often called vacation rentals, have exploded onto the travel scene, becoming hugely popular with homeowners and travelers alike. With the help of technology, it is incredibly simple for a property owner to broadcast their rental across the world.
Millions of people in the U.S. are currently renting their homes or apartments on Web sites such as HomeAway, VRBO and Airbnb. With this level of activity, it is vital that accountants and tax professionals have an understanding of property rentals and income tax implications. Though sometimes overlooked, sales and lodging taxes are an entire class of taxes that expose clients to a significant liability.
A significant liability
Short-term rental property owners are required to collect and remit sales and lodging taxes on the gross rent collected from guests – the same taxes a hotel is required to collect. Short-term in most states is less than 30 days, but there are a handful of states that have 90-day definitions and a few, such as the popular travel states of Hawaii and Florida, where short-term is defined as up to six months.
The property owner or host is required to collect lodging taxes from the guest on any short-term stays. These taxes are typically 10 percent to 15 percent of the gross rent collected – overnight accommodations are heavily taxed. Sales and lodging taxes are a type of gross receipts tax and there are no deductions.
The average short-term rental will generate $20,000 to $30,000 per year in rent, thus amounting to $2,000 to $5,000 in sales and lodging taxes that must be collected and paid. This is a significant liability if your client is not compliant, especially if they are audited for three to five years of history. These lodging taxes can build into a huge hidden liability for unsuspecting or unknowing clients renting their primary or second homes.
Income tax vs. lodging tax
It is well understood that income tax treatment is completely different from sales and lodging taxes. For income taxes, a client may deduct operating expenses from the rental property such as mortgage interest, utilities, maintenance, property taxes and even depreciation. In fact, most short-term rentals do not have taxable income after expense deductions – they operate at a net loss position. Even if there is net taxable income, after expense deductions, it is often a small amount, especially when compared to 10-15 percent lodging tax on gross rent.
As a result, most short-term rental properties have a significantly greater sales and lodging tax liability compared to income tax. Income tax is typically minimal or zero, whereas lodging taxes average several thousand dollars or more per year in taxes to be collected from the guest and remitted to the proper agencies.
Lodging taxes are often overlooked
Lodging tax can be easily overlooked because a large number of owners are often unaware of these requirements. Most homeowners or hosts have never heard of or dealt with these taxes before, and the rental activities are to simply generate additional income. Long-term rentals are typically defined as greater than 30 days (this definition varies by state), and are usually not required to collect lodging or any other transaction taxes.
Further complicating lodging taxes is the fact that there are often different city, county and state taxes that apply to reach rental. Essentially, there are multiple levels of government that are potentially each applying a separate tax. The state department of revenue may only handle a portion of the required taxes, and the remaining portion will need to be remitted directly to city or county tax agencies.
How to be compliant
Lodging taxes function similarly to sales taxes and many accountants and tax professionals who deal with state and local taxes will be familiar with the ways to ensure compliance. A note of caution – rarely are lodging taxes solely collected by the state revenue agency. There are usually additional city or county taxes (sometimes both) that the state will not be aware of. This is one major difference from sales taxes where, in most states, the state revenue agency collects 100 percent of sales taxes.
Below are the basic steps in order to be compliant:
- Determine the tax rate. Start with the state revenue agency and search for hotel or transient room taxes. Once you find hotel tax requirements, this also applies to vacation rentals. Based on what you learn from the state, check with the city and county where the rental property is located. It is important to confirm that the property address is within city and county boundaries, as you can’t always rely on ZIP codes or mailing address.
- Register. Once you determine the applicable tax rate, your client will need to register with city, county and state agencies that administer the taxes. This may include obtaining a business license or rental permit. You should find the forms required when you are researching the taxes and tax rates with each agency.
- File and remit. The tax agency determines the frequency of remittance, though sometimes the tax agency will allow you to request a frequency when completing the application forms. These taxes are almost always required to be remitted monthly or quarterly, and most vacation rentals will be required to remit taxes to two different agencies, such as the city and state. Like all sales taxes, returns are usually due by the 20th of the month and there are stiff penalties for not filing on time or missing a filing.
Many of your clients are already engaging in this activity, or will be soon. They will need help and guidance, and will likely expect you to know about these requirements and to aid in the management. Be on the lookout for your client’s short-term renting and make sure that they, and you, are not missing these taxes that are required for each rental transaction.