Home sharing? Be aware of the tax issues
The sharing economy is sweeping America. With the help of new services such as Airbnb, HomeAway and VRBO, more folks are able earn additional income from renting their homes and apartments when they aren't using them.
And while collecting additional rental income has its immediate and obvious advantages, it also comes with some headaches, some which aren't immediately apparent. That is, until you're filing your tax returns.
When you rent your home or apartment, you'll have to report and pay federal and state income taxes on your net rental income. Home-sharing services, such as Airbnb and HomeAway will typically send you a form 1099- MISC, which means they also let the IRS know the total amount of rental income you received through their service.
You need to become familiar with a new form you'll be required to file with your tax return: Schedule E - Supplemental Income and Loss. You'll also need to know the rules for reporting rental income and deducting rental-related expenses, which are included in IRS Publication 527, Residential Rental Property.
One of the best tax breaks for people who rent all or part of their residence for short periods is that the rental income received can be completely tax free. According to the so-called vacation home rental rules, if you rent your residence for 14 days or less and you personally use the residence for 15 days or more, or 10 percent of the total days it was rented to others, then the rental income is tax free, regardless of the amount.
If this is your situation, you aren't required to report the rental income or complete the Schedule E. Just make sure you keep good records of the dates of the rental use and your personal use.
If you rent your residence for more than 15 days, you'll have to file Schedule E with your tax return. On it, you'll report the number of rental days and personal-use days. The gross rental income you received is reported on line 3. You'll also be allowed to deduct rental-related expenses for things such as advertising, travel costs, cleaning and maintenance, etc. on lines 5 through 19. In this section, you can claim two types of rental expense deductions: direct and general.
Direct rental expenses are the costs you would not have incurred "but for" the fact that you were renting your residence. The clearest example is the commission you paid to the rental service. Say you received $10,000 in gross rental income and paid $700 in commissions. In that case, the commission paid is 100 percent deductible.
Other examples of direct rental expenses include advertising, credit background checks on renters, rental insurance, cleaning, repairs and maintenance of the rental space, and travel costs directly related and solely incurred due to the rental activity.
General rental expenses are costs you incur to maintain the residence, and while these cost are directly related to the residence, they aren't directly related to the rental activity. The expenses include things like rent, maintenance, mortgage interest, real estate taxes, cleaning, utilities, heating fuel, security, Internet and cable TV, etc.
There's a catch. To come up with the amount expenses that can be deducted from your rental income, you have to prorate them by the number of days of rental use as a percentage of personal use. So, if you rented your apartment for 55 days and used it personally for 315 days, then 15 percent (55 divided by 315) of your general expenses would be deductible.
If you rented only 20 percent of your home (by number of rooms or by square footage), then you'd have to further limit this amount by 20 percent to come up with the deductible amount. After deducting the applicable expenses from your gross rental income, you'll report the net income from rental on the front of your tax return.
Renters in the new sharing economy may also face additional tax and legal issues. If you rent a leased or rented apartment, you should check your rental or lease agreement to ensure it allows subletting. If not and your landlord becomes aware, that may be grounds to terminate your lease. And some states and localities may impose an occupancy tax, lodging tax, room tax or other such "hotel" taxes. It's your responsibility to know and follow the applicable regulations and rules.