Tax reform made many changes in the tax treatment of wealthy clients’ vacation and second homes. But vacation rental property brings a number of taxes many owners might not know about—and upcoming ballot initiatives in this fall’s voting may further alter how these rentals are regulated, managed and taxed.

Many owners of vacation rental property don’t know what they owe. “Many clients think there will be many tax write-offs related to vacation rental properties. Depending on the situation, the only available write-offs may be mortgage interest and real estate taxes. Even these deductions have been severely limited with the new tax law,” said Lynn Conover, a CPA with the Curchin Group in Red Bank, N.J.

“Also, personal use of rental properties is not limited to the taxpayer [but] also includes members of their family, including siblings, spouses and other lineal descendants,” she said.

“'Short-term' is most often defined as rentals of less than 30 days, but it can be 90 days or 185 days in certain states,” added Rob Stephens, co-founder and general manager of Avalara MyLodgeTax. “Renting a property short term triggers transactional business tax requirements [and] the owner or operator must collect and remit the guest sales and lodging taxes.
 
“Everyone is familiar with income tax requirements,” Stephens said. “Vacation rentals are simply a different type of income-generating properties, often generating greater monetization and yields when compared to long-term rentals.”

Local tax compliance is a major factor in this market. In Broward County, Fla., voters will soon decide on a one percent increase in the county sales tax. Beginning Oct. 1, “transient rentals” (for periods of less than 90 days) in New Jersey became subject to the state’s 6.625 percent sales tax and 5 percent hotel occupancy fee, unless an occupancy tax already applies, as it does in certain municipalities, according to James McGrory, a CPA with Drucker & Scaccetti in Philadelphia.

“There are similar increases on the ballot in several states, including Colorado, Wyoming and California,” Stephens said. “While these increases go to voters, frequently city councils and county commissions can also mandate tax changes.

In Philadelphia, a high-net-worth client will need to apply for a commercial activity license and a business tax account, as well as need to file a business income and receipts tax return and a net profits return each year on rental income, McGrory said. “Also, many municipalities in Pennsylvania have a business privilege tax on gross receipts of a rental property. At the Jersey Shore, many localities impose their own unique compliance requirements,” he said.

Short-term rentals are mushrooming and easier to find and book through well-known online platforms. Location of your wealthy client’s property may also determine their tax experience. “The biggest debate is around regulations,” Stephens said. “How do communities regulate short-term rentals? How many rentals should be allowed and in what areas? How many rentals are too many and should they be allowed at all?”

“Registration is required with the state for tax purposes prior to collecting these taxes from guests,” McGrory added. “This increased regulation will require high-net-worth clients to collect all lodging taxes from guests, to file tax returns and to remit these taxes promptly. Penalties for noncompliance could be substantial.”

After such operating expenses as utilities, homeowners’ association fees, cleaning, maintenance, mortgage interest and especially depreciation are deducted against rental income, most properties are at a loss position for income taxes. “Sales and lodging taxes are a tax on the gross receipts (gross rent) generated by the property with no deductions,” Stephens said. “The typical lodging tax rate is 10 percent to 12 percent, charged against top line revenue. This is very different than how income taxes are calculated and the bottom line after expense deductions.

“If homeowners are unaware of the requirement to collect and remit these taxes ... they’re accruing thousands of dollars of tax liability each year,” he said.