Safe Harbor sounds like the name of a vacation rental property. It evokes images of peaceful water and making memories with family and friends. It’s a place where you can go and be your best self, away from the day-to-day issues of the real world.
One could argue that a safe harbor in terms of tax law gives similar feel-good vibes. Generally speaking, a safe harbor is a legal provision to sidestep or eliminate legal or regulatory liability in certain situations, provided that certain conditions are met. Several areas of law utilize safe harbors including environmental law and copyright law, among many others. Here, we’ll discuss how safe harbor laws impact taxes for vacation rental property owners.
Tangible Property Regulations
Before we can get into the fundamentals of safe harbor laws, it’s important to understand the overarching regulations surrounding tangible property. For vacation rental property owners, tangible property is the actual home, condo, or other property you’re renting out for others to utilize.
The Internal Revenue Code (IRC) section 162 states that tangible property owners may deduct expenses for materials, supplies, repairs, and maintenance of said property. IRC section 263(a), on the other hand, states that tangible property owners must capitalize the cost of acquiring, producing, and improving the tangible property.
In short, these sections mean that tangible property owners must determine which expenses can be considered deductible business expenses, and which are non-deductible capital expenses.
Confused yet? It’s ok. Tax law is complex and sometimes conflicting with case law and administrative rulings, which is why final tangibles regulations have been determined. When combined with safe harbors, final tangibles regulations can help vacation rental property owners better determine which expenses can be deducted and which cannot.
Note that final tangibles regulations are rules for anyone who pays or incurs amounts to acquire, produce, or improve tangible real or personal property. This is required whether you are listed as a corporation, S corporation, partnership, LLC, or an individual filing a Form 1040 or 1040-SR with a Schedule C, E, or F.
It’s best to check-in with your CPA to determine what expenditures you can deduct, and which you cannot.
What is a Safe Harbor for Vacation Rental Property Owners?
In terms of tax law and income tax reporting for vacation rental property owners and others classified as real estate landlords, there are two safe harbors that you must know about. Safe harbor laws are designed to give property owners the ability to demonstrate good faith to reduce or eliminate liability.
Think of it this way: In good faith, you did your best to comply with the tax law, but you were unable to do so because of circumstance or complexity. Safe harbors will protect you from being held liable, or reduce your potential for being held liable.
De Minimis Safe Harbor
According to the IRS, de minimis safe harbor is an administrative convenience that generally allows you to elect to deduct small-dollar expenditures for the acquisition or production of property that otherwise must be capitalized under the general rules. While there is no maximum that you can deduct using the de minimis safe harbor, there are some guidelines to help vacation rental property owners determine what could be deducted under this election. Usually, if you have an applicable financial statement (AFS), you could deduct up to $5,000 per invoice or item. If you don’t have an AFS, you could possibly deduct up to $2,500 per invoice or item. The point of the de minimis safe harbor is to minimize the burden of figuring out which small-dollar expenditure is deductible or capitalizable. You may not use the de minimis safe harbor for the acquisition or production of tangible property that exceed the aforementioned $5,000 or $2,500 amounts.
Safe Harbor Election for Small Taxpayers
Safe Harbor Election for Small Taxpayers. This safe harbor applies to those who own or lease buildings and engage in repairs, maintenance, or improvements that may not be required to capitalize as an improvement. Requirements for this safe harbor include: average annual gross receipts of $10 million or less; the building property has an unadjusted basis of less than $1 million; and the total annual repairs, maintenance, or improvements don’t exceed two percent of the unadjusted basis OR $10,000; choose the lesser of the two.
Do You Qualify to Elect to Use a Safe Harbor?
CPAs are the best resource to determine if you, as a vacation rental property owner, qualifies for safe harbor election. Keeping your records straight is paramount to untangling what you can deduct and what you must capitalize when tax time rolls around. Perch helps vacation rental property owners keep track of all essential materials by taking in payout reports and bank feeds, conducting deductions, and producing all the forms your CPA needs to file your taxes.
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