As we emerge from the pandemic, people want to know, what if I buy this property and turn it into an AirbNb. What are the tax effects. Short term rentals are rentals and thus the rent rules apply to the property including the passive loss rules.
If the property is considered a rental. Taxpayers are allowed to deduct up to $25,000 in losses each year if 1040 MAGI income is under $100,000. MAGI is computed as follows:
• Student loan Interest
• One-half of self-employment tax
• Qualified tuition expenses
• Tuition and fees deduction
• Passive loss or passive income
• IRA contributions
• Taxable social security payments
• The exclusion for income from U.S. savings bonds
• Foreign earned income exclusion
• Foreign housing exclusion or deduction
• The exclusion under 137 for adoption expenses
• Rental losses
• Any overall loss from a publicly traded partnership
After you go above $100,000 you lose $1 for every $2 above. Thus it phases out completely at $150,000. Also, if you use rental property more than 14 days (excluding work days) it reduces losses pro-rata, days used/total days used and rented. Still it shelters the income from rentals. And losses are indefinitely carried forward for when you sell the property.
For example: Assume: Couple with $200,000 MAGI and $5,000 of rental income.
Expenses:
Taxes $4,000
Insurance: $1,000
Interest on Mortgage (200k@5.75%) = $10,433
Rental fees: $500
Repairs: $1,000
Building value at purchase $200,000.
Improvements: $50,000
Land: $200,000
Depreciation allowable is: $9,090/year.
LLC annual fee $100.
The total expenses are: $25,733. $5,000 income is tax free, but the $20,733 of losses are suspended.
If you spend 750 hours per year on this (keeping a log) and other real estate ventures then you can become a professional. Then all losses are deductible annually.
Farm: For farming, losses are unlimited. Thus if a portion of the property is used for farming activities: orchards, cattle, sheep, pigs, then the value of that stand alone portion divided by the entire value of the property can sustain losses.
For example: Imagine a one hundred acre parcel. House on 1 acre, cattle and barns on other 99 acres. 99 acres are worth $198,000 and house and lot are worth $252,000. Thus 44% of each expense is allowable against farming income (not depreciation unless you have a separate farm building) = $5,123 using numbers above. Say then you have another $10,000 of vet expenses and feed and transport. So, you can take a $15,123 loss on the farming portion. But of course, then you sell the cows and that will reduce your farm loss.