WHEN INCOME FROM SHORT-TERM RENTALS IS SELF-EMPLOYMENT INCOME
The IRS released Chief Counsel Advice 202151005 in late 2021. The advice addresses when short-term rental income is subject to self-employment taxes.
Code Section 1401 imposes a tax on an individual’s net earnings from self-employment. However, net income from rental property is generally not included in the calculation of self-employment income, unless:
• The income is received by a real estate dealer, or
• The rent includes substantial services provided to the occupant for the occupants’ convenience and is rented for more than 30 days.
Examples of rentals where substantial services are rendered for the occupants’ convenience include hotels, boarding houses, warehouses, and storage garages.
For purposes of the passive activity rules (Section 469 and regulation 1.469-1T), a rental activity is not a passive activity if the average period of customer use of the property is seven days or less. In addition, a rental activity isn’t passive if the taxpayer materially participates in the activity. Under the regulations however, the rules concerning passive activity only apply to determining whether the activity is passive or not.
The Chief Counsel Advice memo has determined that even though an activity may be passive for purposes of section 469, it still may be subject to self-employment taxes. The following examples are given in the memo.
An individual, who is not a real estate dealer, has a business renting a fully furnished vacation property via an online rental marketplace. The individual provides daily maid service, access to dedicated Wi-Fi, a beach and recreational equipment for occupants’ use during their stay and prepaid vouchers for ride-share services between the property and the nearest business district. For the year at issue, customers used the vacation property on average for seven days.
Under the regulations for section 469, the activity is not considered a rental activity for purposes of the passive activity loss rules. In this example, Chief Counsel notes that the taxpayer provides services for occupants that
1. Are not clearly required to maintain the space in a condition for occupancy, and
2. 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 taxpayer’s net earnings from self-employment.
An individual, who is not a real estate dealer, has a business renting a fully furnished room and bathroom in a dwelling via an online rental marketplace. Renters only have access to the common areas of the home to enter and exit the room and bathroom and have no access to other common areas such as the kitchen and laundry room. The taxpayer cleans the room and bathroom in between each occupant’s stay.
For the year at issue, the average period of customer use of the vacation property is seven days and the taxpayer materially participates in the activity. Therefore, the activity is not a passive activity for purposes of the passive activity loss rules.
In this example, the taxpayer’s net income from renting living quarters is excluded from net earnings from self-employment because no services are rendered to the occupants. The taxpayer cleans and maintains the property so that it remains suitable for occupancy. Therefore, these services are not furnished primarily for the occupants’ convenience.
If you have any questions concerning the rental of property, contact Stanfield + O’Dell.