Owning a Vacation Rental: Tracking and Reporting Income and Expenses

Date July 20, 2022
Categories
Article Authors
Owen Hasenauer
HBK CPAs & Consultants

While many summer vacationers continue to make reservations at traditional resorts and hotels, many others seeking the “comforts of home” or looking to “live like a local” are booking short-term rentals through online marketplaces like VRBO and Airbnb. The trend is making short-term rental properties an increasingly attractive investment.

Owning a short-term rental can be a great way to generate passive income, as well as benefit from the appreciation in value common to many types of real estate investments. However, with the extra income comes the need to consider the potential tax reporting requirements, and the rules governing the taxation of rental income and determination of allowable expenses can be difficult to navigate.

Many vacation-home owners seeking to rent their property use third parties, like the online marketplaces, to manage their listings. Those companies will list your rental on their websites and collect the rental income from your tenants for a percentage of the rent, then pay you the net rental income. Effective January 1, 2022, the IRS requires those U.S. third parties to report gross earnings for U.S. hosts earning more than $600 in a calendar year. If your rental income exceeds the threshold you will receive a Form 1099-K from the listing company showing the income you earned for that year. These forms are useful in reporting income from a rental property to the IRS; still, you should track and maintain detailed records of all rental income earned for the year.

Keeping expense records

In addition to tracking and reporting income, there are many expenses that may qualify for a deduction on your tax return. These expenses, along with your rental income, are generally reported on Schedule E of Form 1040. In general, expenses are allowed to be deducted when they are ordinary and necessary for managing, conserving, or maintaining the property. Ordinary and necessary expenses are those that are common and would be expected when maintaining a rental property. A few examples of items that are listed on Schedule E include cleaning and maintenance, management fees, repairs, and utilities.

You should maintain detailed records, including invoices and receipts, that demonstrate the type of expenses and when they were incurred. Keeping adequate records is important in case your return is audited by the IRS. If you report deductions on your return but do not have records to back them up, those expenses could be disallowed; you also could be subject to penalties and interest.

IRS rules for reporting

Whether your piece of paradise is in the mountains or at the shore, there are special rules for reporting expenses for rental properties, which are based on how the property is used and classified by the IRS. If an owner does not personally use the property, the reporting is fairly straightforward. It is treated as a rental property and all income and expenses are reported on Schedule E. But when there is both personal and rental use, the property will fall into one of the following categories:

  • Personal residence: If personal use is more than 14 days or 10 percent of the rental days, whichever is greater, and the property is rented less than 15 days, you generally are not required to report rental income and expenses on your return. You might be able to deduct mortgage interest and real estate taxes as an itemized deduction on Schedule A.
  • Rental property with personal use: If personal use is less than 14 days or 10 percent of the rental days, whichever is greater, and the property was rented, or held out for rent, during the year, all rental income is reported on Schedule E, and expenses are prorated between personal and rental use. The personal portion of any real estate taxes can be included on Schedule A as an itemized deduction. Because the property is considered a rental property, mortgage interest allocable to personal use is considered personal interest and is not deductible.
  • Dwelling unit used as a home: If personal use is more than 14 days or 10 percent of the rental days, whichever is greater, and the property is rented for more than 15 days, all rental income is reported on Schedule E and expenses are prorated between personal and rental use. However, certain rental deductions are limited to the gross income from the property. The personal portion of mortgage interest and real estate taxes may be deductible on Schedule A as an itemized deduction.

Ordering rules – Dwelling unit used as a home

Not only are expenses for rental property classified as a dwelling unit used as a home limited in terms of being tax deductible, they are also subject to ordering rules. The rental portion of mortgage interest, real estate taxes, and casualty and theft losses—items that would be deductible on Schedule A if the property had not been rented—are deducted first. If these expenses do not offset all of the income, the remaining operating expenses can be deducted up to the amount of income. As well, depreciation can be deducted if income still is in excess of operating expenses. Operating expenses and depreciation cannot produce a loss, but any expenses not allowed in the current year can be carried forward to future years until there is sufficient income to use them as deductions.

Conclusion

These and other IRS rules can make reporting income related to the rental of a vacation home challenging. There are many factors to consider if you are purchasing a vacation home or using an existing vacation home for rental income. The team of professionals at HBK CPAs & Consultants is experienced in planning for these issues and can guide you through the process.

For questions regarding tracking and reporting income and expenses, please contact your HBK representative.

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Cryptocurrency and Taxes

Date February 25, 2022
Categories
Article Authors

Cryptocurrency has moved from the realm of shadowy internet message boards to front stage financial news. Crypto and NFTs are just as much a part of news network discussions as the stock market is -stealing headlines, talking time and pageviews from its more traditional predecessors. However, along with the increased attention to those new financial vehicles comes updated tax considerations. Below is a primer for cryptocurrency tax considerations, and is by no means a full discussion:

I have been mining cryptocurrency and have started to receive coins from this activity – is this taxable?

Yes – IRS Notice 2014-21 states that successfully “mining” cryptocurrency will create income for the taxpayer. The amount of gross income includible to the taxpayer is the fair market value of the cryptocurrency at the time of receipt.

Where do I report this income on my tax return?

How to report this income is dependent on the purpose/nature of your activity. If you are pursuing this purely as a hobby, any income would be included on 1040 Schedule 1 Line 8 Other Income. These amounts are not subject to self-employment taxes however, you are unable to take deductions against this income as hobby-related expenses are not allowed. Alternatively, if your activity would be regarded as business activity, you likely will need to report the income on Schedule C. Additionally, you can take ordinary and necessary business expenses against this income – however, you may also be subject to self-employment taxes.

What happens if I later sell the cryptocurrency that I have mined?

The IRS views virtual currency as property, and as such general rules around property apply. The basis of your mined coins would be the fair market value as of the time of receipt – since you are required to include that as income as discussed above. If the property is a capital asset (think stocks for most taxpayers as an example), then capital gain or loss would result from a sale. Whether gains or losses are categorized as long-term or short-term will depend on how long you have held the coin for, similar to a sale of stock. Long-term treatment would apply if held for over a year, short-term if held for less than a year.

If the property is not a capital asset, ordinary income or losses would result. Common examples here would be items like inventory or items held for sale directly to customers are typical areas where this treatment would apply.

I did not mine any cryptocurrency, but I did purchase some this year. Do I have to pay tax on my purchase? Do I need to check that box about crypto transactions on the 1040?

If you only purchased crypto during the year and had no other transactions (sale, using it to purchase other goods/services, etc) then there are no further tax consequences for the year. Additionally, you are not required to check the box regarding crypto transactions.

When I sell cryptocurrency – does it matter which specific coin I sell? It can matter a lot! The IRS allows taxpayers to specifically identify units of virtual currency, granted that you meet documentation requirements. Those requirements are (1) the date and time each unit was acquired, (2) your basis and the fair market value of each unit at the time of acquisition (3) the date and time each unit was sold, exchanged, or otherwise disposed of, and (4) the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit. These requirements are met by several popular wallets, and this is a great area to utilize tax planning strategies, as selling coins that you have held for over a year with a high basis would have a different tax impact than coins recently purchased with low basis. Donating virtual currency can also be a viable tax planning strategy. Please consult with an HBK Tax professional first before using this as a tax planning strategy.

What if my wallet doesn’t provide that type of documentation and I have not kept the records either?

If you do not use specific identification related to sales and exchanges, the IRS deems that you are disposing of them in chronological order – starting with your earliest unit. This would be first-in, first-out basis, or FIFO. I didn’t receive any type of 1099 or official-looking document when I made my sales – do I still need to report this on my tax return? Yes! Any income, gain or loss from virtual currency needs to be reported on your tax return, whether you received a statement or not.

What about forks?

The taxability of a fork depends on which type – soft or hard. A soft fork is a change of the protocol of the software that can be backward compatible. This can be used to implement new features for a coin = but, importantly, it is still the same coin. It is not creating a new coin. Soft forks are not a taxable event, since you are still holding the same original coin.

Hard forks are different – these are software upgrades that are not backward compatible, and all users must upgrade to the new software to continue participating. This is a permanent divergence from the original chain, which can potentially create a new coin. It is possible to have a taxable event after a hard fork, if a user ends up possessing both the original cryptocurrency and a new cryptocurrency, via either the hard fork or airdrop. Speak to an HBK tax advisor for further information.

What about staking?

Staking is essentially lending your crypto – by lending your crypto, you are helping to secure and validate a given chain. In return, you have the potential to earn more crypto, similar to an interest payment. The more crypto that you are lending, the higher your chances of earning are. The taxability of this is still waiting for further clarification. As recently as December 21, 2021 the IRS released guidance that defined a “transaction involving currency” to include “receipt of new virtual currency as a result of mining and staking activities.” However, in the case Jarrett et al v. United States, the position is being taken that any coins gained through proof of stake should be considered new property that was created by the taxpayer. The IRS declared that it was refunding money to the Jarrets as a result of this case. IRS clarification or further court cases may provide further insight as to the taxability of these transactions.

This is by no means a full deep dive into the world of cryptocurrency taxation – new vehicles, methods and transactions are being created all the time. Hopefully, this primer has helped to understand some of the basics around taxation as it relates to cryptocurrencies. As with other areas of tax, please consult with your HBK tax advisor regarding these types of transactions.

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Decoding the 2018 Tax Form Makeover

Date December 21, 2018
Article Authors
HBK CPAs & Consultants

The passage of the Tax Cuts and Jobs Act (TCJA) resulted in a complete makeover of the forms used to prepare individual income tax returns. Apparently “filing on a post card” is possible; for some, the new Individual Income Tax Return will indeed be as simple and straightforward as filling out a two-sided post card-sized form. For many others, however, the new form will be accompanied by one or more of six new schedules.

The first page of the new form is informational. It lists the taxpayer’s filing status, name, address, social security number and dependents. It also includes a signature area for the taxpayers and the tax preparer.

The second page of the new form contains the information used to compute the tax due for the year; it has been significantly simplified from prior year forms. If additional information needs to be reported, the TCJA has provided the following schedules to be used:

  • Schedule 1 should be included in any tax return where the taxpayer receives income from capital gains (reported on Schedule D), ordinary gains (reported on Form 4797), business income (reported on Schedule C), rental and pass through income (reported on Schedule E), or any other type of income typically referred to as “Other Income.” This form will also report any adjustments to income, such as the deductible part of self-employment tax (reported on Schedule SE), the self-employed health insurance deduction, the deduction for contributions to an IRA and the student loan interest deduction.
  • Schedule 2 will be included in any tax return where the taxpayer is subject to the Alternative Minimum Tax (reported on Form 6251) or needs to make an excess advance premium tax credit repayment.
  • Schedule 3 will be used to claim nonrefundable credits such as the foreign tax credit (reported on Form 1116), any residential energy credits, general business credits or child and dependent care expenses.
  • Schedule 4 will be used to compute other taxes such as self-employment taxes (reported on Form SE), additional taxes on IRAs, net investment income taxes (reported on Form 8960), household employment taxes (reported on Schedule H) and any Section 965 taxes due.
  • Schedule 5 will be used to report any estimated tax payments as well as any payments made with an extension. This schedule will also be used to claim any refundable credits that the taxpayer is entitled to other than the earned income credit, such as the American opportunity credit or the additional child tax credit.
  • Schedule 6 should be included for any taxpayers who have a foreign address or wish to designate a third- party designee to discuss their return with the IRS.

In addition to these new schedules, taxpayers should be prepared to fill out many of the standard, familiar forms and schedules when completing 2018 returns.

Taxes can be complex, and it is important to understand how these changes might affect filings. The examples included in this article are not all-inclusive and not intended as a substitute for the value and knowledge of consulting with a tax specialist. Please contact a member of the HBK Tax Advisory Group with your questions and concerns. We’re here to help.

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