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Home | Airbnb Lawsuits, Short-Term Rentals, and Real Estate Investors

You may have heard about the lawsuits involving Airbnb in San Francisco and New York City.  Although such lawsuits involve, in part, the question of whether Airbnb can list on their website those properties that have not been duly registered with the local municipality, these cases highlight the importance of knowing the local rules that govern short-term rentals, as discussed below.
The issues surrounding short-term rentals are becoming more prevalent as many clients are constantly looking to add a vacation rental to their existing portfolio of real estate investments, or to convert a “long-term” rental to a vacation rental.  The prospect of owning a property that provides income and a place to get away every now and again is pretty great, but if you are thinking about acquiring a vacation property / short-term rental, here are a few tips to keep in mind:

  1. Comply with the local rules and ordinances of the municipality where your rental is located. I won’t bore you with details of the Airbnb case v. San Francisco, but in short, there is a local law that provides that you cannot operate a short-term/vacation rental unless you are a resident of San Francisco and unless you register the property with the city.  So before you convert a traditional rental to a vacation rental, or add a vacation rental to your real estate portfolio, check with the local laws to find out if there are any restrictions and to what extent registration of the property is required.
  1. Obtain a business license where appropriate. If you are operating a vacation rental, this can, depending on your circumstances, be comparable to a hotel as opposed to a tenant with a long-term tenant.  If your vacation property is like a hotel in which services are provided to the guests, then it is an operating business, and would likely require a business license.  Contrast that scenario with rental properties with long-term tenants, particularly residential.  Although it depends on the jurisdiction, typically a business license is not required for a residential rental property with a long-term tenant, however, it is becoming more common for municipalities to enact ordinances that specifically provide that collecting rental income via residential real estate rises to the level of activity that requires a business license.
  1. Understand the tax implications of operating a short-term rental / vacation property as opposed to a “traditional” or long-term rental. Rental income is typically not subject to self-employment tax.  However, rental income that is received in connection with services performed could subject such income to self-employment tax.  It is much more likely that services would be performed in a short-term rental / vacation property scenario than a rental situation with a long-term tenant.  One example would be a cleaning service while the property is occupied, bed and breakfast, or any other services that are “hotel-like”.  If you’re planning to provide those types of services to the guests of your vacation rental, be prepared as you’re likely going to be subject to self-employment tax.
  1. Consider setting up a business entity for liability protection. It is almost always a good idea to setup a business entity that limits the liability of the entity owners to own the rental property, whether it is a long-term rental or a vacation rental.    Your particular situation will determine the type of business entity to setup, including how the rental income is taxed.  Remember that using a business entity to own a rental property should be a supplement to placing appropriate insurance on the property.
  1. Do not evict a long-term tenant simply to convert a rental into a vacation property. Assuming you own a rental in an area where there is a market for vacation rentals, you may be tempted to kick out your tenant so you can begin marketing the property as a vacation rental.  This is happening more and more but I advise you to read carefully the terms of your rental agreement and applicable law and do not evict a long-term tenant simply to expedite the process of converting a property to a vacation rental.  However, you could always work out an agreement with the long-term tenant to entice them to voluntarily terminate the contract. So called “cash for keys” where you give the tenant cash to move out early usually does the trick. However, make sure you get that agreement to terminate the lease early in writing. Also, use a check you can show they deposited and not actual cash.
  1. No personal use of the vacation rental if using a self-directed IRA/401k. We have many clients who use a self-directed retirement account to invest in real estate.  If you’re planning to acquire a vacation property with a self-directed IRA or similar retirement account, you, or any other disqualified persons, cannot stay on the property, even for a weekend.  I know, that is one of the main reasons to own a vacation rental, but if the owner of the property is your self-directed IRA, you can’t do it. It’s a prohibited transaction as you cannot have personal use of IRA owned assets.

In sum, there is a lot of appeal to vacation rentals, but there are many issues to consider.  As the Airbnb lawsuits highlight, it is important for a real estate investor to know the local rules that govern short-term rentals.  There are many other tax and legal issues to consider, a few of which have been mentioned in this article.  If you are planning to acquire a vacation rental property and have tax or legal questions, please contact our office.

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