In late 2021, the IRS issued Chief Counsel Advice 202151005 (“CCA”) to provide commentary on short-term rental property and the linkage with self-employment income. Generally, under Internal Revenue Code (“IRC”) 469, rental activity that averages seven days or less is not subject to the passive loss activity limitations.
Regulation Section 1.1402(a)-4(c)(2) states when services are rendered to the rental occupant, income can be deemed as net earnings from self-employment. Generally, income from rental services is considered income from self-employment if it is primarily for the convenience of the occupant and is other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only. Examples include services provided by hotels, boarding homes, warehouses and storage garages. In determining if the income from short-term rentals is subject to self-employment tax, the US Tax Court has reasoned that this occurs when the owner has been said to provide substantial services beyond the mere requirement of maintaining the space in a condition suitable for occupation.
The IRS provided a pair of examples in the CCA:
An individual who is not a real estate dealer has a business renting a fully furnished vacation property via an online rental marketplace. This individual provides daily maid services, access to dedicated Wi-Fi, a beach and recreational equipment for occupants’ use during their stay, and prepaid vouchers for ride-share services between the property and the nearest business district.
For the year at issue, customers used the vacation property on average for seven days. Therefore, the activity is not considered a rental activity for purposes of the passive activity loss rules under IRC 469. The taxpayer materially participates in the activity and, therefore, the activity is not considered passive.
In this example, IRS Chief Counsel notes that the taxpayer provides services for occupants that (1) exceed the requirements to maintain the space in a condition for occupancy; and (2) are of such a substantial nature that the compensation for those services constitutes a material portion of the rent. Thus, their net rental income is included in self-employment income.
An individual who is not a real estate dealer has a business renting a fully furnished room and bathroom in a dwelling via an online rental marketplace. Renters only have access to the common areas of the home to enter and exit the room and bathroom and have no access to other common areas such as the kitchen and laundry room. The taxpayer cleans the room and bathroom in between each occupant’s stay.
For the year at issue, the average period of customer use of the vacation property is seven days, and the taxpayer materially participates in the activity. Therefore, the activity is not a rental activity for purposes of the passive activity loss rules and the activity is not considered passive.
In this situation, the taxpayer’s net income from renting living quarters is excluded from self-employment income because the taxpayer does not provide substantial services beyond those required to maintain the space in a condition suitable for occupancy. The taxpayer cleans and maintains the property so that it remains suitable for occupancy; these services are not furnished primarily for the residents’ convenience.