When to Include Short-Term Rental Income in Net Earnings Self-Employment (NESE) Income1
The short-term rental industry is booming. With rental services like AirBnB and VRBO, practically anyone can become a short-term rental landlord. So, if you are making some income on the side with short-term rentals, how do you report it to the IRS? There are a couple of possibilities, but in this blog, we will answer the question, “Should short-term rental income be treated like business income or like traditional rental income?”
Net Earnings from Self-Employment
Sec. 1401(a) of the IRS code imposes a tax on an individual’s net earnings self-employment (NESE) income. Under this rule “net rental income,” generally isn’t included in NESE, unless
- The income is received by a “real estate dealer,” or
- The rent includes substantial services provided to the occupant for the occupants’ convenience.
Examples of rentals where substantial services are rendered for the occupants’ convenience include hotels, boarding houses, warehouses, and storage garages. (Reg. §1.1402(a)-4(c)(2))
Consider these Examples
Example one: An individual, not a real estate dealer, owns a vacation property that he runs as a business. It’s a fully furnished property listed with various online vacation rental websites. The individual provides daily cleaning service, dedicated Wi-Fi, recreational equipment such as bicycles for renters’ use, and prepaid vouchers for local services.
Because the property is rented, on average, for seven days, it is not considered a rental activity for purposes of the passive activity loss rules in Code Sec. 469. In this example, the services provided are clearly not required to maintain the property for occupancy but are of such a substantial nature that the compensation for those services constitutes a material portion of the rent.
Thus, the net rental income is included in NESE. Practically, this income would be reported on a Schedule C for an individual rather than a Schedule E.
Example two: An individual, not a real estate dealer, rents a fully furnished bedroom and bathroom in his home by listing it on various online vacation rental websites. Renters may use the bedroom, bathroom, and only other rooms that are designated as common areas of the home. After every rental, the taxpayer cleans the bedroom and bathroom.
As in example one, the property is rented, on average, for seven days, and therefore is not considered a rental activity for purposes of the passive activity loss rules in Code Sec. 469. In this example, the taxpayer’s net income from the rentals is excluded from NESE because the cleaning service is not actually rendered for the convenience of the rental occupants but to maintain the property for occupancy.
Tax-Free Rental Income for Short-Term 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 receive. In fact, you don’t even have to report the income to the IRS.
1Chief Counsel Advice 202151005