The IRS, in recent guidance, concluded that the “rents” from many short-term rental arrangements are subject to U.S. self-employment taxes (“SE Tax”). In this guidance, the IRS ruled that a taxpayer was subject to SE Tax in the following situation.
The taxpayer (i) purchased real estate located near a beach, (ii) rented it to third parties., (iii) average rental was less than seven days; and (iv) materially participated in the rental activity (i.e., it was not operated by a management company). The rental was a fully furnished vacation property. They provided (i) linens and kitchen utensils, (ii) daily maid services, including delivery of individual use toiletries, (iii) access to dedicated Wi-Fi service, (iv) access to beach and other recreational equipment, and (v) prepaid vouchers for ride-share services to the nearest business district.
The IRS ruled that only payments for use of space and the services required to maintain the space for occupancy are excluded from self-employment income. If the owner performs substantial services such that compensation for services can be said to constitute a material part of the payment made by the tenant, the income is subject to SE Tax. Here the IRS determined that the exception did not apply because the owner rendered substantial services to the occupants.
A strategy for reducing (but not completely eliminating) the SE Tax in this situation may be to provide management services to your property company through an S corporation management company. By doing this, you can separate the service income from the rental income so that the rental income is not subject to SE Tax. In addition, depending on the facts, it may be possible to take only a portion of the earnings of the S corp as compensation subject to employment tax and then take the rest as dividends (not subject
to SE Tax).
Bottom Line: If you are managing your own short-term rental, be sure to consult your tax professional about reducing your SE Tax exposure.
“Accept who you are. Unless you’re a serial killer.” – Ellen DeGeneres.