Short Term Rentals: Passive or Non-Passive

Many tax professionals mistakenly apply the §469 passive loss rules to tax law determinations where they don’t belong. It’s essential to remember that §469 only helps determine whether an activity is passive or nonpassive—it has no effect on other tax provisions unless explicitly mentioned.

Here are two common misconceptions: 

1. Misconception: A passive activity under §469 doesn’t qualify for the §199A deduction.

   1. Clarification: Under §199A, an activity qualifies as long as it is a §162 trade or business. It’s possible for an activity to be both a §162 trade or business and passive for the owner under §469. 
      

2. Misconception: Nonpassive rental income is subject to self-employment tax.

   1. Clarification: Whether an activity is passive under §469 has no bearing on whether the income is subject to self-employment tax, as this is determined under §§1401-1402. 

The IRS addressed the second misconception in Chief Counsel Advice 202151005, particularly concerning short-term rentals. The IRS clarified that short-term rental activities where the average stay is seven days or less are not automatically passive rental activities under §469. Instead, they are considered passive only if the taxpayer fails to materially participate. Therefore, most short-term rental activities, like Airbnb and VRBO rentals, are nonpassive. 

There is often confusion among tax professionals about when short-term rental income is subject to self-employment tax and reported on Schedule C instead of Schedule E. The general rule is that rental income is exempt from self-employment tax. However, if services are provided alongside the rental, the income may be subject to self-employment tax, regardless of the average length of stay. 

In Chief Counsel Advice 202151005, the IRS made two key rulings: 

1. Whether a rental activity is passive under §469 has no impact on self-employment tax liability, as they are separate determinations. 

2. Net rental income from living quarters is exempt from self-employment tax when no services are provided. If substantial services are rendered that go beyond maintaining the property for occupancy, the net rental income is subject to self-employment tax. 

   
   

The IRS offered two examples to clarify this: 

1. Example 1: A taxpayer rents out a fully furnished vacation property via an online platform. The taxpayer provides daily maid services, toiletries, dedicated Wi-Fi, recreational equipment, and ride-share vouchers. The average rental stay is seven days, and the taxpayer materially participates in the rental activity. 

   1. IRS Conclusion: The net rental income is subject to self-employment tax because the taxpayer provides substantial services beyond what’s required to maintain the property.
      

2. Example 2: A taxpayer rents out a room and bathroom in a dwelling via an online platform. The only services provided are cleaning the room and bathroom between stays. The average rental stay is seven days, and the taxpayer materially participates in the rental activity. 

   1. IRS Conclusion: The net rental income is not subject to self-employment tax because the services provided are minimal and only for maintaining the space for occupancy. 

      
      

The bottom line is short term rental activities may be treated differently depending on the facts and circumstances and it’s also best to seek guidance from an experienced accounting team.