Your guide to short term rentals
In the past few years, short term rental platforms like Airbnb and Vrbo have gained immense popularity.
It makes sense; Short term rentals (STRs) can be cheaper than hotels, they offer plenty of space, and are often much more conveniently located. In fact, many vacationers these days skip the search for a hotel entirely and use only one of these platforms.
Especially during this time, many people feel safer renting a short term rental with strict cleaning protocols than staying in a larger hotel with a bunch of other people.
This is great for the consumer (you might even have booked an Airbnb or two yourself). But are STRs a great opportunity for investors too?
Well, as with anything, there are many factors to consider. However, investing in STRs offers some significant advantages – even over traditional long-term rentals. Perhaps surprisingly, one of the biggest benefits is the fact that you’ve considered some major tax breaks.
Let’s get right into why a short-term rental is just the thing for your portfolio.
Why should you consider short term rentals?
The type of short term rental means that what you charge in “rent” is much more flexible.
While traditional long term rentals (like single family homes) offer consistent monthly cash flow, deciding how much rent to charge depends on many factors, including the local market average.
However, with a short term rental, most people understand and are willing to pay a premium price for a shorter stay. This means that potentially one or two tenants per month can bring in more profit than a traditional monthly rent payment.
Say you have a rental property within an hour’s drive of a national park. While a traditional lease can bring in $ 1,500 monthly rent, you can get as much out of a single 5 night stay when listed on Airbnb.
The same goes for cities with popular college football teams, tourist attractions, or just places with good weather all year round.
The downside is, of course, that while you make more money with a single tenant, your rental property can stand empty for days – even weeks. This can potentially lead to these gains quite quickly.
As you may have guessed, this means that doing a short-term rental requires more practical management than a traditional rental. Some people keep it between marketing (like customer reviews), property management, and cleaning services for more than it’s worth.
On the other side of the spectrum, many people enjoy the time and effort they put into making a property irresistible to potential renters. And with the right location, short-term letting can be far more lucrative than comparatively long-term letting.
With a long-term rental, most tenants are allowed to make small but effective changes to the property. This can include things like painting the walls, putting TVs on, adding a play set to that backyard … you got the idea.
With a short term rental, you have complete control over the property – including its appearance. The tenants do not make any changes (except occasionally) Horror story, Tenants make little influence, if any) or additions.
For some, knowing that you are in control provides a measure of security. For others, however, it means a bit more pressure to make sure everything is always up to date and thoroughly checked after each tenant leaves.
If you own rental property, you probably know how confusing taxes can be. When used properly, real estate can offer fantastic tax breaks, but there is one area where it gets pretty tough: using depreciation to offset income taxes.
Ordinarily, high-income workers cannot offset their W2 income by depreciating their rental properties thanks to IRC Section 469 of the Tax Reform Act. That is, unless they achieve the status of “real estate professional” (read more about it Here).
In other words, passive losses can only be used to offset passive income, and active income can only be offset through active losses.
Many high income earners strive for professional real estate status because if you can offset the income from your day-to-day work with depreciation on your rental property, you can effectively lower the total amount of taxes you pay and even fall into a lower tax bracket. The problem is, this is much easier said than done, and often it’s not worth the effort.
Short-term rentals, on the other hand, are the exception to the rule. It says in IRC section 469 that an activity is not considered a “rental activity” if the average length of stay is seven days or less. What does that mean exactly?
Well, it means that with a STR you can deduct rental losses as non-passive, which allows you to offset income from your day-to-day work without attaining real estate professional status.
For high-income people like doctors, this is of course a great advantage. We don’t usually have many options for reducing our taxable income. In tax time, being able to deduct depreciation on your property means you will likely pay Uncle Sam significantly less.
As a quick side note, the downside to this benefit is that you cannot count short-term rental hours towards your real estate professional status. If this is a destination for you, STRs are not a great way to help you get there.
Is a STR Right For You?
Like any investment, short-term rental properties are not without risk. The biggest one has to do with the economy. After all, most people look for STRs for vacation, and when people lose their jobs or otherwise run out of money, vacations are usually the first thing on the budget.
And of course, if you can’t fill your property with tenants, you can lose money.
Between the substantial tax breaks and fantastic profits, short term rentals can be a really lucrative addition to your portfolio.
Also, I usually don’t recommend doctors and busy professionals manage these types of places on their own. In my opinion, your time is worth far more than the effort. So you need to include administrative costs in the numbers.
To make the best decision, ask yourself how well you are familiar with this risk and how practical you want to be. Because when it comes down to it, STRs, while requiring more attention, can be equally rewarding.
Have you ever thought about a short term rental property? If so, did you decide against it or did you choose to do so? Let me know in the comments; I would love to hear about your experience.