Short term rental - Schedule C or Schedule E?

[elizben]

I own a mixed use townhouse with a shop on the ground floor and a two bedroom flat above. The shop is rented out all year long, while I let out the flat on a short term basis via Airbnb between April to November. My family goes and stays at the flat from time to time during the remainder of the year.

I efiled my 2018 taxes which were accepted in March, but I have just received a letter from the IRS requesting a Schedule C. When I did my taxes online using Turbotax, my Airbnb income was declared as foreign earned income (I am a US citizen but live full time in Europe), but the system never asked me to fill out a Schedule C and so it was never submitted. I can fill one out now but I'm wondering if I should have declared the Airbnb income on Schedule E instead, next to my rental income from the ground floor shop. Can someone please shed some insight on this? And if I should have filled out the info on Schedule E, should I now amend my tax return or just submit Schedule C as IRS has requested?

You might need to know how much I materially participate in the Airbnb business. Since I don't have a full time job, my main work is the management of my Airbnb. I handle all the bookings/guest communications, purchase supplies, arrange for things to get fixed and do many of the turnarounds. I don't provide breakfast or daily maid service.

Any help would be greatly appreciated! Thank you very much.

[tagteam]

---

@elizben wrote:

...Can someone please shed some insight on this?...

---

You almost certainly received a request for a Schedule C because you reported the rental income as earned income. Had you reported it on Schedule E in the first instance, you would most likely not be facing this issue. In short and in sum, if I were in this predicament, I would file a Schedule E with a letter of explanation and hope that methodology would appease the IRS.

With respect to this entire issue, if you ask 3 different tax professionals you will get 5 different answers and the reason is simply because the Code, Regulations, Publications, and Instructions are vague, at best, and wide open to interpretation. 

Publication 527 states: 

If you provide substantial services that are primarily for your tenant's convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ.

Instructions for Schedule E state:

If you provided significant services to the renter, such as maid service, report the rental activity on Schedule C or C-EZ, not on Schedule E. Significant services do not include the furnishing of heat and light, cleaning of public areas, trash collection, or similar services.

I.R.C. §469(j)(8) states:

The term “rental activity” means any activity where payments are principally for the use of tangible property.

Treas Reg. §1.469-1T(e)(3)(ii)(A) states:

The use of tangible property is not a rental activity if, on the average, the period for which each customer uses the property is seven days or less. (paraphrased).

If you read the instructions, code section, and regulation above carefully, you will most likely come to the conclusion that the only possible obstacle to clearly reporting short(er)-term rental income on Schedule E (rather than Schedule C) would be the Treasury regulation taking average rental periods of customer use of seven days or less out of the definition of "rental activity".

However, note that the Internal Revenue Code (promulgated by Congress) absolutely takes precedence over Treasury regulations. Thus, solely in my opinion, where payments are principally for the use of tangible property and no significant or substantial services are provided for the tenant (renter), then the income should be reported on Schedule E.

 

[elizben]

Thank you for this very thorough explanation. I also think that I should correct the mistake and submit a Schedule E. Many thanks again!

[Carl]

You really need to seek professional help on this, instead of trying to fix this through us "armchair lawyers" in this public user-to-user forum. While the information provided by @tagteam is correct, there could be local laws or ordinances that have the potential to change things a bit. What sticks out to me is that you say you lease it out through AirB&B. So while it's perfectly possible this could be a SCH C business, it most definitely is not "foreign earned" income any way you look at it. With the rental property in the U.S., where you may live on the planet is irrelevant.

For the SCH E or SCH C question, I'll use my own location as an example. In my county, if in the city limits and you rent out a residential property for less than 30 days for any one period during the calendar year, then the property is considered a short term rental for the entire year. That's because short term rentals in the city limits have a $3 per night bed tax imposed by the city for each night the property is rented. (Thankfully, none of my properties are inside the city limits)

Then, as specified by tagteam, if you provide recurring services such as maid service, that does make it a SCH C business. That would mean the assets (such as the structure itself) is depreciated over 30 years (40 years if the business started before 2018). Whereas if you don't provide recurring services it's a SCH E business and the assets are depreciated over 27.5 years.

This can get complicated because you have a SCH C business on the ground floor that I'm guessing was established prior to 2018 and that part of the building is depreciated over 40 years. But the flat above if a SCH E business is depreciated over 27.5 years. But could be 30/40 years depending on the "in service" date for the upstairs.  It also depends on what entity is renting out the property too. You? Or the business? If done right that can make a really big difference on the tax front. But what's "right" for your specific and explicit situation depends on way to many factors to cover here.

Now to add more muck to the mix, if your state taxes personal income that makes things even more complicated and more prone to user error in tax reporting.

In a nutshell, you can ask your questions to 5 different people and get 6 different answers.... and none of those answers would necessarily be wrong either.  So seek professional help on this. As you can already see, doing things wrong can (and will!) be costly in the long run.

[elizben]

Hi Carl,

Thank you so much for taking the time to respond. I'm sorry but I should have explained things more clearly. My property is not in the states, but in a country in the EU, so the Airbnb income is generated abroad. Regarding the shop on the ground floor, I rent out the space personally (not through a business structure). The space is occupied by a long term tenant who has been there for years, and I do not provide anything aside from a broadband connection. But you're absolutely right about so many things and I ought to seek out a professional that specializes in US expat taxes. Many thanks again for taking the time to explain things to me!