Short-term Rental Properties: Tax Considerations and Updates
Short-term rental properties, such as Airbnbs and VRBOs, have become an increasingly popular way for property investors and homeowners to utilize their properties. When entering the short-term rental market, taxpayers need to be aware of several tax and licensing factors, both at the federal and state level. This article focuses primarily on requirements in Tennessee, so you may be subject to different taxes and requirements depending on your location.
Are all short-term rentals deemed to constitute self-employment income? The Chief Counsel Office addressed this issue in CCA 20215100. It reiterates that short-term rentals are not deemed, per se, self-employment (SE) income. Therefore, that leaves an opening for escaping the SE tax of 15.3% in some instances. It really depends on if the owner is engaged in the activity as part of their real estate dealer activities in operating the short-term rentals. If the owner would not be deemed to be a dealer, then Treas Reg 1.1402(a) provides an out from SE tax.
However, please note that this is contingent on not providing material services along with the short-term rentals. The CCA indicates that the services need to be rendered to maintain the space in a condition for occupancy, not services that would be deemed to generate a material part of the rental fee due to the services being provided. It was interesting to note that in the example which included daily maid services, the activity was classified as subject to SE tax. On the other hand, in an example where the only cleaning services provided were those between guest stays, those rentals were not deemed to be subject to SE taxation.
In trying to clarify what activities result in classification of being a dealer for self-employment tax implications, let’s look directly at an excerpt from the Reg. § 1.1402(a)-4 Rentals from real estate.
(a) ……… In general, an individual who is engaged in the business of selling real estate to customers with a view to the gains and profits that may be derived from such sales is a real estate dealer. On the other hand, an individual who merely holds real estate for investment or speculation and receives rentals therefrom is not considered a real estate dealer. Where a real estate dealer holds real estate for investment or speculation in addition to real estate held for sale to customers in the ordinary course of his trade or business as a real estate dealer, only the rentals from the real estate held for sale to customers in the ordinary course of his trade or business as a real estate dealer, and the deductions attributable thereto, are included in determining net earnings from self-employment; Thus, it is extremely important to really understand your business model and establish your services in conjunction with your rentals from the start to avoid income being recharacterized during a possible examination.
The state of Tennessee does not have any specific licensing requirements for the operation of a short-term rental. However, T.C.A. § 13-7-604 gives municipal governments the power to put in place a permitting or application process for short-term rentals. This act does include a legacy clause that allows properties being used as short-term rentals before any such local requirement was passed to continue operating. The unit is protected under this clause until it is sold, transferred, ceases to be used as a short-term rental for 30 consecutive months, or found to be in violation of local laws at least three times.
As an example of local requirements, the city of Chattanooga passed ordinance 13981 in May of 2023 to update the city’s regulations. Owners of short-term rentals must pay an annual fee and submit an application for a short-term vacation rental certificate, with varying requirements for owner occupied versus non-owner occupied (absentee) properties. Absentee properties will also be subject to an inspection to ensure the property meets all local and state requirements. Hamilton County has similar requirements for properties in unincorporated areas.
The city of Chattanooga also enacted an opposition process for absentee rentals. Residents near the proposed rental property can file letters of objection. If enough objection letters are received, the city will take this into consideration when deciding whether or not to grant the applicant a permit.
While owners of short-term rental properties are not required to get licensing at the state level in Tennessee, they are required to register with both their county and city for a business tax license. Taxpayers must file a business tax return for each jurisdiction in which they rent out properties.
Business tax applies to the gross sales for the taxpayer, including non-refundable deposits, cleaning fees, etc. However, business tax is only charged if gross sales exceed $100,000 for the year. Unlike other Tennessee taxes, all sales are attributable to the taxpayer for business tax services, regardless of if a marketplace facilitator was used.
Franchise and Excise Tax
If an individual personally owns and rents out a short-term rental unit, they will not be subject to franchise and excise tax. However, if the unit is owned by a separate entity, such as an LLC, limited partnership, or corporation, that entity will be subject to franchise and excise tax at the state level. Like business tax, marketplace facilitators are not subject to this tax on the short-term rental units but may be subject to the tax on their own business.
As noted above, short-term rentals are not necessarily considered self-employment income. If the income is determined to be subject to self-employment tax at the federal level, taxpayers can exclude it from their income subject to excise tax, lowering their tax due at the Tennessee level.
Taxpayers may be eligible for exemption from franchise and excise tax as an obligated member entity (OME) or a family-owned noncorporate entity (FONCE). In order to be an OME, the entity must be an LLC, LP, or LLP and all members/partners must be fully liable for all debts and liabilities of the entity. A FONCE must be at least 95% owned by members of the family, and the entity’s income must be at least 67% passive investment income. Exemptions of either type must be filed with the TN DOR annually in lieu of a franchise and excise tax return.
Tennessee sales tax applies to rentals of rooms, lodgings, and accommodations for less than 90 days per guest. Any rental to the same guest for more than 90 consecutive days is not subject to sales tax. Both the state rate (7%) and local rates (1.5-2.75%, depending on the county) apply. Sales tax returns can be filed on the TNTAP website.
The property owner must collect and remit sales tax based on the sales price of the rental, including fees and deposits (excluding cancellation fees). If a marketplace facilitator, such as Airbnb or VRBO, is used, the facilitator is responsible for collecting and paying sales tax on the rental rather than the property owner. The owner must still collect and remit sales tax on any additional items they sell or rent to guests outside of the online platform.
In addition to sales tax, short-term rental owners are required to collect occupancy tax for rentals less than 30 continuous days. Similar to sales tax, marketplace facilitators are responsible for remitting occupancy tax on any sales made via their service. Unlike hotels, which pay occupancy tax to their local jurisdiction, short-term rentals pay occupancy tax directly to the state of Tennessee.
Tennessee has issued a manual on taxation of short-term rental units that provides additional guidance on these state taxes. You can also reach out to the professionals at HHM for guidance.