Personal Finance

Here's one of the simplest ways to qualify for the "pass-through" deduction

Key Points
  • Renting out a spare room of your apartment or house (or the entire place) will now qualify you for a 20 percent deduction on business income.
  • Plus, it could help you recoup some of the losses from the deduction curtailments to state, local and property taxes and mortgage interest.
The Honeymoon Cottage

If you've been following tax news at all, you've probably heard about the new 20 percent break for "pass-through" businesses.

Perhaps you've wondered: How can I get in?

Starting a business, however — yes, even if it's just a "side hustle" — can seem like a time-consuming and complicated endeavor.

But there's a relatively painless way: Rent out a spare room of your house or apartment. Landlords of all stripes could be eligible for this deduction.

We've had a huge surge in the number of Airbnb hosts who've become LLCs. 
Miguel Centeno
Partner at Shared Economy CPA

"If you have the housing, you're taking advantage of assets you already have to get into a business," said Mark Luscombe, principal federal tax analyst at Wolters Kluwer Tax & Accounting.

Pass-through entities are businesses that don't pay the corporate income tax. Instead, the profits are passed through to the business owner, who reports that income on their individual returns.

People are already realizing this opportunity, said Miguel Centeno of Shared Economy CPA, a firm that specializes in taxpayers who are independent contractors.

"Our doors are getting knocked down here," Centeno said. "We've had a huge surge in the number of Airbnb hosts who've become LLCs."

(An LLC, or limited liability company, is a business structure in which the owner is taxed at his or her individual income rate yet is also covered by a corporation's limited liability).

However, you don't need to incorporate to qualify for the pass-through deduction — although Centeno said it provides some additional benefits.

"If someone slips and falls, the worst scenario is they're going after your home," he said. "The LLC is a veil between the business and your asset."

To qualify all you need to do is report all of your rental business income and expenses on either Schedule C or Schedule E of your tax forms (watch out for guidance from the IRS on which one). The IRS is also expected to issue a new pass-through form sometime this year.

Taking advantage of the pass-through deduction by becoming a landlord might be especially enticing to those expecting a higher tax bill, thanks to the new curtailments on state, local and property taxes ($10,000) as well as mortgage interest ($750,000 for homes purchased after Dec. 15, 2017).

"Having an Airbnb can help you maintain some of those deductions by transferring them to the business side," Luscombe said — because businesses aren't subject to the caps.

Airbnb hosts also make more money, on average, than users of other platforms, according to technology finance company Earnest.

And now it might get even better.

"This pass-through change is revolutionary," said Stephen Fishman, author of "Tax Guide for Short-Term Rentals."

Here are some tips from experts on managing your rental business.

1) Track your expenses

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You should separate your rental-business finances from your personal ones, Fishman said.

"It's really good to have a bank account for all the business expenses," he said.

Fishman also recommends using special landlord software — such as Quicken or the free app Hurdlr — to help you manage all of your rental business transactions.

"If you buy something, you can just use the record keeping function to categorize it online," he said. "So when you do your taxes, it's all right there."

If you're using Airbnb, you can access a transaction history, for information on your earnings. You can export this report into a spreadsheet for even clearer reporting.

2) Know what is deductible 

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The list of expenses you can deduct for being a rental landlord is long.

Some of the more straightforward ones include any fees Airbnb charges you, home or landlord insurance, marketing for your property and gifts for guests such as wine or flowers.

Other deductions are more complicated. If you're a renter, for example, you can't deduct depreciation of the property (where you write off the value an asset has lost over time).

You can, however, deduct your rent — or a portion of it. Let's say your apartment's rent is $2,000 a month. If you rent out the entire place for 2 weeks, you can deduct $1,000. If you rent out only a room, you'll have to do a square-footage equation.

As mentioned, you can also deduct a portion of your property taxes and mortgage interest, also by using an equation to figure out how much of your property was used for the business. This chart from Fishman's book shows an example of such a breakdown.

3) Get the right insurance

You should check with your home insurance provider about any additional precautions you might need for being a landlord. In some cases, a special endorsement is needed. Hosts might also want to look into landlord insurance.

Airbnb offers a "Host Guarantee," for up to $1,000,000 in damages (well, certain damages).

4) Rules and considerations

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If you're a renter yourself, get permission from your landlord to sublet your house or apartment.

You should also check your city or county's rules around short-term rentals.

Chicago has a "prohibited housing list" of buildings restricting Airbnb rentals. In San Francisco, you can rent out your entire property for no more than 90 days a year.

These bans are in large part because residents and housing advocates have seen the rise of Airbnb push up housing costs. A report that came out at the end of January found that Airbnb had increased median rents around $300, and eliminated up to 13,500 long-term rental units in New York City.

In addition to learning the rules, Craig Smith, chair of ethics and social responsibility at business school Insead, said hosts should make an effort to be good neighbors.

Remind guests to be considerate, he said, by asking them to turn down the television or music by a certain time. He also recommended that hosts set up some type of interview with their guests beforehand, to catch potential problems.

"They should be careful," Smith said. "But not careful to the point of screening out people who have different identities or sexual preferences from themselves."

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