When it comes to house hacking and vacation rental income, one of the more important considerations is how to handle short-term income tax. In my upcoming book, House Hacking: The only real estate investing strategy you need to build wealth, live for free (or almost free), and make money through homeownership, I address many aspects of utilizing vacation rentals as part of your House Hack. I see websites like AirBnB and VRBO as complete game-changers for house hackers!
I’ll save that content for when you get your hands on the book (in a few weeks). But, I will provide you with the foreword by my friend Brandon Hall, who is a CPA specializing in working with real estate investors.
I felt that it would be a good thing to have a CPA chime in, and Brandon upon review of the manuscript was kind enough to offer a foreword. Thank you, Brandon Hall!
***The following is an excerpt from the upcoming book as written by Brandon Hall, CPA.
Ben’s writing on JustAskBenWhy.com and on BiggerPockets.com has been fascinating me since 2014. I enjoy his style, one that challenges accepted norms in a direct way and makes people question their views. Ben draws his readers in and gets them emotionally invested in the story to the point of dropping their defenses enough to soak up the knowledge he dishes out.
There are many investing books on the market today, but few are truly actionable. And of those that are, most are either too bland in the storytelling department or too basic in the subject matter. In short, authors promise dreams that are not likely to be achieved.
HOUSE HACKING: The only real estate investing strategy you need to build wealth, live for free (or almost free), and make money through homeownership is different. Ben succeeds at providing us with a totally actionable blueprint for house hacking, perhaps one of the best strategies for today’s economic environment and real estate cycle. And you know it’s actionable because he is actually doing it right now, as this book is being published!
Do you guys know how rare this is? So many people want to write about things they did years ago, conveniently skirting the truth that those techniques are no longer viable. This book is truly unique in that it offers truly “real-time” and actionable advice.
Real Estate Investors and House Hacking
Whether you are a new investor or are boasting decades of experience, this book will help you minimize your monthly overhead without having to drastically change your quality of life. In fact, as Ben shows us, house hacking allows you to minimize your overhead and indeed amplify your quality of life. That, my friends, is what real estate investing is all about.
Ben asked me to write the foreward and explain some of the concepts you will see in Chapter 7. I am a CPA and run a tax and accounting firm that works solely with real estate investors, developers, and flippers. We service hundreds of clients across the U.S., and like Ben, I contribute frequently to the BiggerPockets.com blog and forums. Chapter 7 delves into some complicated tax topics, and Ben rightly wanted an expert to discuss the details. Allow me to clarify a few points. Thus, a few thoughts.
Ben describes short-term rental income, such as AirBnB, being subject to self-employment taxes. Self-employment taxes are another word for FICA taxes or payroll taxes. Social Security and Medicare make up 15.3% of FICA taxes. The Social Security portion is 12.4%, and the Medicare portion is 2.9%.
If you are employed, your employer withholds and pays half of the 15.3%. You, as the employee, pay the other half. But when you are self-employed, you pay the entire 15.3% on your self-employment income. Worst of all, this tax is levied before we even factor in your marginal tax rate.
Passive Income for Short-Term Rentals?
Why does this matter? After all, rental income is passive, right?
No, this is not true with short-term rental income. If your average rental period for the year is less than seven days, the income is considered BnB income and is subject to the 15.3% FICA tax. If your rental period is greater than seven days and less than thirty days, and you provide substantial services (like most short-term rental hosts), you will still be subject to the 15.3% tax. You will only avoid this tax if your average rental period is greater than 30 days.
So if your investment strategy includes being a BnB host where you will receive income from short-term rentals, should you resign to the tax code and fork up the 15.3% on each dollar you earn?
Absolutely not. The tax code is full of legal loopholes that you should explore with your CPA. In the case of avoiding the 15.3% self-employment tax, we could do a number of different things. The first option is to place the property generating short-term rental income into an S-Corporation. The second option is to create a management corporation which would siphon off the profits from the short term rental, thus avoiding the tax liability created therein.
Ben touches on the second option in Chapter 7, so that’s what I’ll explain. Option one can get a tad complicated, and I don’t want to bore you in the foreward before you even get to the gold of this book!
If you receive short-term rental income, the net income is subject to the entire 15.3% of self-employment taxes. When you move profits into an S-Corporation, you still pay taxes on the profits, but the entire profit is no longer subject to the 15.3% self-employment tax. Instead, the profits are paid out to you in the form of wages or cash dividends (distributions), and only the wages are subject to the self-employment taxes.
As an example, if you receive $10,000 net income from your short-term rental without using an S-Corporation, you will pay $1,530 in self-employment taxes. And then, assuming you are in the 25% tax bracket, you’ll pay an additional $2,500 in taxes, for a total of $4,030.
S-Corporation for Vacation Rental Income
If, instead, the S-Corporation manages your short-term rental property and thus receives management fees of $10,000, you may pay $5,000 of that $10,000 in wages to yourself. You will pay self-employment tax of 15.3% only on that $5,000. This amounts to $765. And then, assuming you are in the 25% tax bracket, you’ll pay an additional $2,500 in taxes, for a total of $3,265.
So in the above example, the S-Corporation saves you $765 in taxes. And the really cool thing is that you’ll realize those tax savings every single year. And your savings will scale as your income scales. It’s truly a great strategy for sheltering your income from taxes.
Your CPA may be able to get even more aggressive than this and shelter even more income for you. This does, however, illustrate the process…
What questions do you guys have on this? Hit me up in the comments below…