The answer to the question of is a Vacation Property rental subject to self-employment tax is that it depends!
Side 1 – Vacation Property Rental
The taxpayer owns a fully furnished vacation property that is rented to customers via an online rental marketplace. The taxpayer is not a real estate dealer. The taxpayer provides linens, kitchen utensils, and all other items to make the vacation property fully habitable for each occupant. The taxpayer also provides daily maid services, including delivery of individual use toiletries and other sundries, access to dedicated Wi-Fi service for the rental property, access to the beach and other recreational equipment for use during the stay, and prepaid vouchers for ride-share services between the rental property and the nearest business district.
The average period of customer use is seven days. Therefore, the activity is not considered a rental activity for purposes of the passive activity loss limitation rules under IRC section 469. The taxpayer materially participates in the activity, which also means the activity is not considered a passive activity under IRC section 469.
Regulation section 1.469-1T(d)(1)
Regulation section 1.469-1T(d)(1) provides that the characterization of items of income or deduction as passive activity gross income or passive activity deductions does not affect the treatment of items of income or deduction under any other provisions of the Internal Revenue Code. Therefore, whether income or losses are from a passive activity is not determinative of whether income or losses are self-employment income or losses under IRC section 1401. IRC section 1402(a)(1) excludes income or losses from rentals of real estate from the definition of self-employment income unless these amounts are received in the course of a trade or business as a real estate dealer.
Regulation section 1.1402(a)-4(c)(2)
However, Regulation section 1.1402(a)-4(c)(2) states that payments for the use or occupancy of rooms or other space where services are also rendered to the occupant are included in determining net earnings from self-employment. Generally, services are considered rendered if they are primarily for the convenience of the occupant and are other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only.
Examples of these types of services include services provided by hotels, boarding homes, warehouses, and storage garages.
Revenue Ruling 57-108
In Revenue Ruling 57-108, the IRS ruled that a landlord who rented furnished vacation beach dwellings and rendered services for the comfort and convenience of his guests in connection with their recreational activities, including maid services, swimming and fishing instruction, mail delivery, furnishing of bus schedules, and information about local churches, rendered services primarily for the occupants’ convenience. Consequently, the net rental income was subject to self-employment tax because the rental exclusion under IRC section 1402(a)(1) did not apply.
Tax Court Ruling
The Tax Court has ruled that IRC section 1402(a)(1) should be applied to exclude only payments for use of space, and, by implication, such services as are required to maintain the space in condition for occupancy. If the owner performs additional services of such substantial nature that compensation for them can be said to constitute a material part of the payment made by the tenant, the rent received then consists in part of income attributable to the performance of labor which is not incidental to the realization of return from passive investment.
Each case turns upon the facts presented and whether the services provided are services rendered for the convenience of the tenants as opposed to services required to maintain the space rented to tenants in a condition for occupancy. When determining whether a service is for the maintenance of the property, the courts have emphasized that the rental exclusion must be read narrowly and that any service not clearly required to maintain the property in condition for occupancy is considered work performed for the tenant.
In this case, the IRS explained that not treating the activity as a rental activity for purposes of the passive activity rules of IRC section 469 is not determinative of whether the activity is a rental activity for purposes of the exclusion from self-employment tax under IRC section 1402(a)(1). In situations where the taxpayer is not a real estate dealer, rentals from real estate, even when they are short-term rentals of seven days, are excluded from self-employment income when no services are rendered for the occupants.
However, because in this case, the taxpayer provides substantial services beyond those required to maintain the space in a condition suitable for occupancy, the income is not excluded from self-employment income under IRC section 1402(a)(1). The taxpayer in this case provides services that are for the convenience of the occupants. The services go beyond those clearly required to maintain the space in a condition for occupancy and are of such a substantial nature that the compensation for these services can be said to constitute a material portion of the rent.
Side 2 – Vacation Property Rental
In contrast, if the only services provided are cleaning services in between each occupant’s stay, the activity would be excluded from self-employment tax as a rental activity under IRC section 1402(a)(1), even though the activity is not a rental activity under IRC section 469 because it is a short term rental of seven days and the taxpayer materially participates.
If you have questions about Vacation Property Rentals, feel free to call me at 509-543-7600 or send a request HERE.
February 2022
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