[The following conversation with a licensed Texas CPA is for illustrative purposes. It does not constitute legal or tax advice and readers are encouraged to consult with their own professional service providers should they chose to further investigate the opinions expressed here]
It’s tax time, so I recently sat down with CPA and vacation rental owner Stephanie Ball to discuss finance and tax issues that affect vacation rental owners.
What are some of the biggest mistakes that vacation rental owners make when they first get started?
One of the biggest mistakes I see is that people spend too much money; they generate big losses in the beginning. A client of mine was piling up big losses that she wasn’t able to write-off on her tax return and I said, “you need to quit buying more furniture, more towels, more beds, etc. It’s nice enough, just make some money.”
From a tax perspective your goal is to keep the income as rental income and not as Schedule C self-employment income. If it’s a Schedule C business you’re going to have to pay the 15.3% self-employment tax. But keep in mind that even if the income is rental income, if your adjusted gross income is over $150,000 then you won’t get to take any losses even if you self-manage. So my advice to my clients is make the adjustments needed so that your income is rental income, and then stop piling up losses. Again, get it listed and start making some profit.
That’s great advice. As owners are getting started, what are some of the best practices you recommend for bookkeeping and the treatment of their business?
I think they should definitely set up a Quickbooks (software) account or something similar and keep a really tight watch on how much they’re spending to be sure they’re making a profit. I think a lot of people think “I brought in $325 a night” or “I got $2000 for that week” and those dollar figures sound big but they are actually losing money. I have one client who was excited about renting their home and then they did it for a few years and realized they weren’t making money because they weren’t effectively controlling their expenses – she was buying sheets after every six guests. This can be a lucrative business but you need to manage it like a business. Plan for unexpected repairs, plan for taxes, To be successful you need to keep a really close eye on how much you’re actually spending.
What is the most surprising write-off that a vacation rental owner can take advantage of?
I’m not sure if it’s a surprise but I don’t hesitate to endorse expensing travel any time I stay in vacation rentals because it’s legitimately research. I’m checking out how they run their rentals, from the booking to payment to the pre and post-instructions to how they set up the house and everything in between. I will borrow good ideas whenever I find them, and equally valuable is learning what not to do. I may be out there enjoying the sunshine, but I chose to stay in a rental property as opposed to a hotel because I am learning things for my business. For reporting purposes I don’t include the airfare or meals. Now whether that would hold up in an audit or not hasn’t been tested yet. I’ve had pretty good audit results with my clients, and almost everyone so far has had either no change or has received a refund. I’m conservative, so I tell my clients if I approve your expenses, in all likelihood the IRS will accept them as well. But of course the professional side of me has to qualify that by saying that there is always the possibility that a specific revenue agent may take issue with any particular deduction so the best policy is to be conservative in your deductions, be diligent in your record keeping, and be flexible in the event that your return is ever selected for examination. If you DO get audited, it can help in the negotiations with the auditor if you can show that you thought about what was fair. For instance, if you travelled with others, you could prorate your portion of the housing costs – deduct only 50% if you travelled with another party, etc. But with all of those caveats, I personally feel that this is a pretty safe business expense deduction.
Any parting thoughts?
I think the main tax issue is keeping your property income designated as rental income so you don’t have the self-employment tax. The key for having something designated as rental income, and not schedule C income, is how much time and effort is involved. B&B’s are Schedule C so there is your fine line – just making breakfast you are considered self-employed. So I advise my clients that they’re selling space and time, not services rendered. Keep the lines completely clean and there should be no problem showing that the rental income is for passive activities only.
About the Author:
Joel Rasmussen: Internationally recognized speaker, writer, and filmmaker Joel Rasmussen is the President and founder of the Austin Rental Alliance, the largest non-profit vacation rental owners association in North America. A frequent speaker for HomeAway, Mr. Rasmussen is the author of the Vacation Rental Success series. He has been interviewed or featured in New York Times, CNN, USA Today, Fox Business News, Washington Post, and The Wall Street Journal.