Hi All- I just started hosting after renovating one of my detached buildings for Air BnB. I also receive a widower’s pension from Social Security. If my income on schedule c goes too high (I’m also self employed), they deduct or eliminate my benefit. My accountant told me all rentals are schedule E income, not C. This would be great for me, since schedule E or passive income doesn’t count against my benefit, but I’m not sure she’s right. Has anyone had to deal with this issue, and how do I decide how to report my Air BnB income? Thanks!
Is your accountant also a tax professional? If he/she is then listen to what that person says. That’s their job.
This is a bit of a gray area that is affected by average length of stay and your level of personal services provided.
Your tax advisor sort of has to pound a square peg into a round hole as the tax code was not designed with Airbnb in mind. It assumes you’re either doing a long term rental or running a hotel.
I’ve seen varying opinions on income treatment, when and whether you can use Schedule E, whether the income is passive or not even if you use Schedule E, and whether the income is subject to self-employment tax if you use Schedule C or you can “back it out.” I’ve even seen an opinion that says to set a minimum stay of at least 8 days to avoid problems – which may not make any kind of sense in your market!
Therefore, I would rely on the direction of your accountant in these murky matters. They’re the one who will have to defend the interpretation with you.
(For discussion purposes only, not a professional tax opinion.)
I do my own taxes via Turbo Tax and I do mine on Schedule C. I also take deductions for business expenses and I pay self employment taxes. My reasoning was that I’m actively managing the rental, I live here, I do the cleaning and if the guest has an issue while checked in I’ll be the one dealing with it. I often had back to back one night stays before covid and will again after covid. It’s not passive income for me.
Every year around tax time we have this question and you will get answers for both and people claim their accountant/tax professional advised them. So even pros don’t agree for the reason given above: this is a new and unclear area of tax law.
True. Here’s a good article about the difference between passive and active rental income.
I would suggest that you figure out a way to track your hours if you are going to try to claim “material participation.” The good news is that you don’t usually have to do this indefinitely. Tracking for a month or two just to get an average should suffice. 500 hours averages to just 10 hours per week. Your hours can include all communications with clients, advertising (making posts on social media platforms etc) and of course the actual cleaning of the unit if you do that yourself. Doing any of your own “bookkeeping” would also add to those hours.
IANAL (I am not a lawyer) and I did not sleep at a Holiday Inn last night.
Technical point, there are actually seven alternative tests for material participation. More than 100 hours is generally a safe harbor, unless someone else, such as a property manager, participated more than you. This is covered in part in BumbleBee’s article.
Regarding the article, my understanding is that peer to peer lending income from vehicles such as Lending Company and Prosper is considered ordinary interest income, not passive income, for tax purposes. So be careful out there!
Back to rentals. Rentals are generally by IRS definition a passive activity and the question of material participation does not arise (unless you are a real estate professional, then it flips to active, but let’s not go there). That’s what the OP is interested in establishing.
You do get a break in that if you actively participated in Schedule E passive rental real estate activity, you may be able deduct up to $25,000 of loss from the activity without having passive income, if you meet a number of specific requirements. “Active participation” is different from “material participation.” Active participation is a lower bar and just requires making management decisions.
So, the IRS says it’s NOT a rental if stays average 7 days or less OR stays average 30 days or less and you provide “significant personal services.” They don’t care what it looks like to us normal folk, it’s not a rental.
So in that case you’ve been booted off of Schedule E, and find yourself on Schedule C. (Your accountant may have a different interpretation. See “murky” comment in prior post.)
The next question is material participation. Material participation is required for the income to be considered active, not passive. That’s why there’s a question at the beginning of Schedule C about material participation.
It can be confusing but the basic thrust is that the IRS does not want you to pick and choose or fiddle. If you’re really interested in taking a loss to reduce your active income, they don’t want you to pretend your rental activity is active instead of passive. If you have passive gains (such as from a partnership), they don’t want you to hide your material participation in your B&B so you can offset your passive gain with B&B losses.
See this 2000 tax court opinion where the owners used Schedule C due to rentals being of 7 days or less average duration, but were required to consider their Schedule C losses as passive losses due to lack of material participation, because they used a property manager. This is an example of Schedule C passive activity.
Some accountants advise that self-employment tax, not being applicable to passive income, is not required for such Schedule C passive income. That saves a 15.3% hit on your income, but I think it is a gray area as IRS instructions are that you must pay SE tax if you are in business for yourself and therefore self-employed. Also, if you select “no” as to material participation on Schedule C, I see no instructions modifying the SE calculation.
Be sure to have your documentation in order here. Your IRS examiner, whom I hope you never have to encounter, would initially expect to see passive income from rental real estate, royalties, partnerships, S corporations, estates, trusts, and residual interests in real estate mortgage investment conduits as reported on Schedule E.
Consult your tax professional on the complex topic of passive income.
(For purposes of discussion, not a professional tax opinion.)
This is what I used when I started hosting at the end of 2018.
I really like this chart and have forwarded it to several folks! It is a good practical approach.
I notice H&R Block sends you to Schedule E even if your rental is 7 days or less on average, and therefore not a rental as defined by IRS. And they’ve come up with the term “non-passive,” which isn’t quite accurate or a real term in my opinion. 7 days or less can be passive if there is no material participation.
Their approach also finesses the issue of justifying not showing self-employment tax on your Schedule C.
I’m kind of embarrassed to admit it but I’ll mention it here in case anyone reading could possibly benefit from my experience.
I’d recently started looking into my self employment tax considerations. I’d panicked because I don’t file quarterly self employment taxes. I was looking into my future social security payments and misunderstood what I was seeing. I realized after consulting a friend that all was well with regard to paying those taxes.
This is something I looked into in 2013 when I started my dog boarding business. But in the intervening years I forgot why I was doing what I’m doing. Since I report the dog income on schedule C I had increased my witholding from my check from my teaching job to cover income tax and self employment tax.
Also as someone who didn’t pay into the social security system as a TX teacher, it’s to my benefit to continue paying into it to increase the amount I’ll be entitled to when I claim it. I already had the needed 40 quarters from other jobs over my lifetime but the amount I’d contributed was very low as those were all low paying or short term jobs.
The last consideration is that I can continue to contribute to my IRA as long as I have earned income. Schedule E income doesn’t qualify as earned income for IRA purposes.
Those reasons are exactly why we ran our STR business under my wife’s name. She has fewer working years and much lower income during those years. Putting it on Schedule C under her name will boost her “averaged indexed monthly earnings” for Social Security and she will also be able to contribute more to a SEP IRA.
I’ve always actively managed, even when the upstairs was on year leases. I do all the management and most of the repairs and maintenance, and I have always used Schedule C and paid self employment tax.
My mom’s accountant set her up that way, so I just looked at a couple of her tax returns after I bought the house from her estate. When the executor settled the estate, each of us 4 children got 1/4 of her tax loss carry forward, about $10,000 each.
When I called her accountant the next January and they told me that they might be able to file in July, I started using Turbotax, since I use Quicken for my checkbooks, except that I had to restart depreciation with the value I had paid for the house.
So 50% of utilities, interest, expenses and the depreciation mean that I always run a loss.
It’s got to be active management with an 80 year old house.
This is all great info. I’m wondering if you operate at a constant loss doesn’t IRS deem you a hobby and bill forback taxes after 5 years?
The IRS is more tolerant to my understanding of continual losses on Schedule E. Real estate frequently shows many years of losses due to depreciation, improvements, etc., and the owner may eventually realize gain on sale. Or not. Real estate is great gig, taxwise. Witness Trump’s tax bill.
Three out of five years profitable is the rule of thumb for Schedule C sole practitioner being a business ( 2 of 7 if horse-related), not a hobby.
This does not mean you are out of luck, only that there is burden on you, if audited, to demonstrate intent to earn a profit, such as showing marketing efforts, are your losses beyond your control, did you put in time and effort, etc.
You used to be able to deduct hobby expenses up to hobby income if greater than 2% adjusted gross income. With tax law changes, you are now taxed on income and can no longer deduct expenses.
Many businesses lose money for long periods, including several listed on the NYSE!
(For discussion purposes only, not a professional tax opinion.)
Also, don’t forget about depreciation recapture when selling property. I would expect the 250K/500K exclusion will eliminate depreciation recapture for most hosts that rent out space in their primary residence, but it can be a really big tax bill when selling investment property whether you filed Schedule C or E.
I have been self-employed for most of my life, as a healthcare provider, long before I started hosting so I was already comfortable with Sched C and enthusiastically pay my SE taxes Some of this doesn’t apply to you @openhand (since you already have your SS), but will apply to many hosts.
So, I just want to speak up for the benefits of paying SE tax. As KKC and Brian have already mentioned:
A couple of other things to consider about Sched C.
My favorite thing is the Self Employed Health Insurance Deduction. It allows me to deduct not only my own insurance premiums but also my husbands (because he never has employer based health insurance), which is usually around $15000+ a year for both of us. And it’s above the line so it is effectively a credit and lowers our AGI, which then often allows us some other credits and benefits and is sometimes enough to drop a tax bracket and makes me feel better about paying those high premiums. But you do have to show a profit to take the insurance deduction.
And even though I know people like to try and pay as little tax as possible, I don’t think it’s a good idea to avoid showing income just to avoid paying SE taxes, because sometimes you need to prove that you do have an income (for loans, etc).
Feck me, that’s a lot of money.
Is this the norm in the US?
As someone who hasn’t paid into the Spanish social security fund, I pay €60 per month for my Health Card which gives me access to primary care, hospital care etc with no restrictions. Prescriptions are heavily subsidised also.
If we wanted private coverage, it would be around €125 per month, each. Still a long way off $15,000!
Back when my sister was in her 50s and 60’s she didn’t have health insurance because she felt it was too expensive. She wasn’t employed and had a preexisting condition, diabetes. The one time she mentioned the cost to me it was $500 a month. That would have been in the mid 2000’s. So she got by with paying for doc visits herself and buying insulin and other drugs in Mexico.
I pay $200 a month and have insurance through my pension plan as a retired teacher. If I had anyone on my plan with me it would be much more.
I’m in the US, and I don’t know what the norm is in the US. When my husband and I were running our own company, we formed a two-person health insurance group. Doing that reduced the cost of my health insurance significantly, while it raised his slightly. Before becoming a “group,” my individual policy cost us about $28,000 a year. His individual policy was about $7,000 a year. After we were a group, our combined cost was more like $20,000 a year. When the ACA was approved, we dropped the group and were both individually insured through ACA, saving thousands more a year.
Yep, around these parts, if you get sick, cheaper to just die and get out of the way.
Well, the $15,000 is for both of us. We don’t pay taxes on it and we have HSA (health savings accounts) with our policies too. The HSAs let us contribute another $7200 for the year that is also tax free as long as we use the account for health and medical related costs (like dental work, glasses, aspirin, tampons, etc).
I don’t think so, I think most people pay a lot more if they have their own private policies, like we do. However, a lot of people I know don’t pay anything at all, or maybe $30/a month, because their employers pay the bulk of it for them, as a benefit to the job.
We pay a little less because we have a high deductible (which means we’d pay the first $6000 if we needed a major expense, like surgery or something), which is required to have the HSA account. We prefer it this way because we don’t really go to the doctor and don’t have any prescriptions - our policy is more of a backup plan for something major like a bad car wreck or cancer.
The tax benefit for the HSA is really good and we can access care that we actually want/need, like acupuncture and eyeglasses. With the high deductible and the HSA account, at least I don’t feel like I’m paying for a bunch of doctors I’m not going to go see. Some stuff we get for free without paying extra, like breast exams, flu shots, wellness exams, etc, even with our plan but we’d have to pay for less routine stuff. People who go to the doctor a lot they will pay more monthly so that they don’t have to pay when they visit the doctor.
Yeah, people here with private insurance (like mine, as opposed to employer plans) will pay a lot more than $15000/year for that kind of access. I’m just glad I don’t need it. Or want it. I’m more of a crawl into the bushes and bleed to death kinda girl
That being said, we don’t pay much in taxes even with a good income. And people with a lower income get some or all of their plans paid for. If you are poor enough, you get a plan called Medicaid that is free, which is, oddly, better than many of the plans people pay for (depending on which state because it is state-run).
I know that changes need to be made, but it’s so much better than it was 20 years ago (thank you Obama ). When I was younger, I went without any insurance at all for years at a time because I was self-employed and it was either difficult or impossible to get a policy or too expensive (I actually paid $11,000 one year for a policy for only me in 1997 and it covered nothing). And one imperfect pap-smear or a suspicious mole then no one would sell you a policy at all (and they didn’t have to). Now I can just go online and pick out the policy I want, ugly mole and all.