US Short-Term Rental Tax FAQs

In this episode of the Hospitable Hosts podcast, our special guest is Jeff Cottle, a Senior Attorney at Anderson Business Advisors. Jeff is a transactional attorney specializing in strategic planning for real estate investors and business owners, focusing on asset protection and tax planning.

The conversation covers many topics, from choosing the proper structure for your US short-term rental business to tax deductions to maintaining compliance. Jeff explains complex legal principles and complicated vacation rental tax rules in simple terms. He provides examples illustrating the most common scenarios for real estate investors, property managers, and STR hosts.

Press Play now to learn about tax benefits available for LLCs and corporations, top legal pitfalls for STR hosts, and the role of estate planning in safeguarding short-term rental investments.

Do you prefer to read the highlights? We've got a summary of the key takeaways below.

Why Do You Need a Business Entity?

Jeff emphasizes that having a business entity is the most essential thing he discusses with every client, whether they are business owners, real estate investors, hosts, or property managers.

Operating a short-term rental comes with personal liability risks, so the main thing is to separate yourself from your business and protect your personal assets and other investments from legal action. Jeff recommends that, at the very least, you should put your property into an LLC, which stands for a limited liability company.

"Registered with your local state, the limited liability company, as the name implies, limits your liability so that if something happens related to the property, it doesn't impact you," he explains. Moreover, managing STR properties through a business entity "allows us to do some tax planning."

What Is the Best Business Structure?

Jeff says that their first and primary recommendation for real estate property owners is to form an LLC, and sometimes, they recommend a land trust. "You own the property in an LLC, that LLC will more than likely either be disregarded tax-wise, meaning it doesn't file any taxes, which is nice because it doesn't add to your tax return burden at the end of the tax year, or the beginning of the following year. Or it will be taxed as a partnership," Jeff explains.

Jeff recommends you use a corporation if you manage properties owned by somebody else. "If it's your primary source of income, and you're taking money out anyways just to pay for groceries and ordinary expenses, we use an S corporation. You get tax benefits. If this is not your primary source of income and it's more of a side hustle, we may recommend a C corporation instead. It has more deductions, and you're not forced to take out the money to get tax benefits," he clarifies.

If you are both managing your own properties and other people's properties, you may have an LLC for each of your properties and a corporation for all of your management activities. And you may even have a parent company underneath.

Legal Ways to Maximize Your Tax Deductions

Jeff points out that it depends on what your objective is. Suppose you're managing your own properties with individual LLCs for each of them and a few properties owned by others through a corporation, and it's not your primary source of income. In that case, you want to funnel as much money into the corporation as possible.

That's because both C and S corporations have more deductions allowed to them than ordinary LLCs. For example, a C corporation can pay for your healthcare expenses or education expenses tax-free as a deduction. Jeff explains that you reimburse yourself for these expenses and reduce your taxable income. "Reimbursing so it's tax-free, that's not income. And then you lower your taxable income, so you pay less taxes but still keep all that money."

Jeff also explains how a corporation can allow you to change the nature of your income from active to passive if you use a lease agreement between a corporation and your own properties with LLCs. Passive income is taxed less—it's not subject to Social Security payroll tax and other withholdings.

"If you funnel it through a corporation first, we can remove those withholdings from the income and then just pay it out to your LLCs as if it were passive income, which it is, and then you save taxes on that too."

For example, you can use a short-term rental to offset taxes from your W-2 income if you spend money on repairs. Still, you must personally manage your property and meet the material participation requirements.

Maintaining Compliance Managing Properties Across Different States

Jeff emphasizes that you must know each state's and localitiy’s short-term rental rules. You also need to use a business entity and ensure you're properly registered in each state—you need to foreign file your management company in each state to do business there.

Jeff recommends you not keep many assets in your management company because every time we foreign file an LLC or a corporation to a different state, we add some liability. "Continue paying yourself regularly, reinvesting the money elsewhere. If something goes wrong with the property management, they can look at your management company, but you don't have any assets or very little. So again, it cuts off that liability. All of your other investments or activities are protected that way."

Each situation is unique when setting up a business entity and maintaining compliance, so Jeff thinks it's a mistake to try to do it yourself without consulting an experienced investor, an attorney, or a CPA familiar with the STR industry. "Talk with a professional, talk with somebody who knows what they're doing because you want to be pretty exact about how we put them into place. If not, it creates a lot more trouble down the road."

Listen to the full episode of the Hospitable Hosts podcast to get more insights from Jeff and discover effective tax and asset-protecting strategies.