Airbnb Material Participation Startup Costs

[david3]

I have another H&W client with an short term rental -  out of state Airbnb with less than 7 days average rental period.

They purchased the property mid-October 2023 and began renting in December. I can't find anything in my research that discusses how the more than 100 hours test is applied when a short term rental is purchased late in the year.

Is the more than 100 hours still applied for 2023, or are the 100 hours prorated?

If it is a hard 100 hours no matter when the property was purchased, then maybe they will be able to meet the substantially all hours participation test.

If they meet the material participation test, which causes the property to be taxed as a business, will they be able to expense $5,000 of start up cost for expenses to get the property ready to rent? These are expenses such as cleaning, supplies, travel, repairs and maintenance that are not major remodel or improvements but they total $6K.

I am reading conflicting information regarding the treatment of startup costs. Some are saying sec. 195 doesn't apply to short term rentals, others say it does.

If these costs can't be expensed as startup costs, then I guess they are included in the cost basis of the property and depreciated over 39 years - correct?

Thanks for your help.

[TaxGuyBill]

Although it seems logical to prorate it, I've never seen anything that allows that to be done.

Material participation doesn't automatically make it a business; material participation it makes it non-passive.

Startup costs are for an "active trade or business".  I suspect that many people view short-term rentals with Material Participation as an "active trade or business", but circumstances and opinions vary and I'm not aware of any 'solid' bright-line determination for that.

[david3]

Ok, so do all of the expenses incurred prior to the rental date get included in the cost of the property and depreciated?

Thank you.

[TaxMonkey]

Your posts covers a lot of ground, with several nuanced ideas.

First of all for material participation, the 100 days are not prorated for an activity that starts during the year. It is also not limited to the calendar year that the tax return covers.  It applies to the period of 365 days, from when the activity starts, even if that spans two calendar years.  The word "year" by itself does not mean "taxable year".  Unless, someone is participating more than your clients, it sounds like they would materially participate.

Meeting the material participation test, does not "cause the property to be taxed like a business".  In the case of a short term rental it merely means that the activity is not subject to passive activity loss limitations.  It is still not subject to self employment taxes unless "significant services" are provided

I googled around for people asserting that IRC 195 does not apply to rental activities, and was able to find a couple.  They made their determination based on the IRC 195 phrase "active trade or business" vs the IRC 469 phrase "passive activity" or a trade or business in which the taxpayer does not materially participate.

In my opinion, when IRC 195 uses the phrase active trade or business they are not using that to distinguish between a passive or non passive activity. Rather, they are using the word active to refer to a trade or business which has begun, and is not a "start up".  Therefore, IRC 195 applies to rental activities that are considered to be a trade or business.

As to whether a rental activity is considered to be a trade or business, this was a subject of broad conversation when IRC 199A came out, and I believe the case law on this subject sets a very low bar for the amount of involvement considered to be "regular and continuous" the necessary requirement to be considered a trade or business.

Consider this, have you ever applied the capital loss limitation of $3,000 to the sale of a rental property with a loss?  It is the same requirement, a IRC 1231 loss requires that the rental property be used in a trade or business otherwise the loss would be capped at $3,000 per IRC 1211.

In your situation, with roughly 6 weeks between purchase and rental as well as the low amount of actual expenses involved, I don't think I would apply the start up cost limits in this situation.  If it was a longer time frame, and more money involved I would apply IRC 195, and I would not capitalize them to basis in the property.

So in summary, after much consideration my opinion would be:

Yes, they materially participated

Yes, this is an active trade or business

No, I would not treat these as "start up" expense, just regular expenses.

If you are not comfortable treating them as regular expenses, then I would treat them as start up expenses.

[BobKamman]

I wonder how many of those opining on the "Schedule E vs Schedule C" question have ever booked an Airbnb.  After early opposition to the concept, in the last ten years I have accumulated a couple dozen stays, at least, at Airbnb listings -- about half of them domestic, half overseas.  Several immediate family members have as much or more experience.  

Before the Internet, a short-term rental involved placing a classified ad, or a sign out front.  Today, to run a successful Airbnb, you need expertise in marketing; customer relations (with prospective, current and former guests, from all over the world 24/7); and hiring such contractors as photographers, housekeepers and maintenance staff. 

One thing that increasingly is not required, is real estate ownership.  Many Airbnb vendors are leasing property long-term and then renting them short-term.  

So please, look at the facts and circumstances of each taxpayer.  If the question is, "What can I get away with?", then either Schedule C or Schedule E will probably work.  But if it's, "Doesn't this really look like a business?", then be open-minded and honest.

[david3]

So in summary, after much consideration my opinion would be:

Yes, they materially participated

Yes, this is an active trade or business

No, I would not treat these as "start up" expense, just regular expenses.

If you are not comfortable treating them as regular expenses, then I would treat them as start up expenses.

Thanks, TaxMonkey, for your help.

It would be good to treat the expenses incurred prior to when the property was held out for rental, as regular expenses. However, I thought those expenses couldn't be reported as regular expenses. Do you have a cite or authoritative support for doing so?

[TaxMonkey]

You are talking about a period of 6 weeks or so, that is something I would be willing to overlook and just assume the property was available to rent when it was purchased.  But feel free to amortize the $1k if you feel it is necessary.

[david3]

OK. Thanks for your help.