What you should know about the short term rental business.
I own a second house in a popular coastal town. I’ve decided that this year I want to rent it out using Airbnb. What are the costs associated with this? What should I expect in terms of taxes? What about risk? Should I have an extra layer of insurance to cover any potential mishaps? Should I make all my guests sign a damage waiver?
There’s no doubt that the short-term and vacation rental business has exploded in recent years, thanks to easy-to-use sites like Airbnb, HomeAway, and VRBO.
Though it can be a great way to earn extra money and generate a passive income, renting out your home isn’t without its drawbacks. There are insurance costs to consider, the potential for a massive tax bill come April, even the cost of damage to your property, not to mention the fact that many cities are trying to more tightly regulate the industry.
We spoke to experts about some of the major issues to consider when renting out a second home: insurance, taxes, and protecting yourself from damage.
Make Sure You’re Covered
When renting out a second home, it’s important to note that a homeowners policy typically does not cover vacation or rental activities. So, you probably need to get a separate policy.
“From an insurance perspective there are risks, and purchasing the right type and amount of coverage is important, and it changes dependent on whether you’re keeping your vacation home for you or renting it out to others,” says Loretta Worters, vice president of media relations at the Insurance Information Institute (III).
If you plan to rent your home out to others, the cost of your homeowners insurance will probably increase, she notes, also suggesting that you may need to purchase additional coverage.
“Your insurance needs will depend on how often you rent out the property and for how long. For a one-time, short-term rental, you may be able to add a simple extension (an ‘endorsement’) to your existing homeowner’s policy,” Worters says.
“On the other hand, if you plan to regularly rent out your second home, you may need separate business coverage or a landlord policy. While some rental services, such as Airbnb and VRBO, offer coverage for homeowners, it’s important to read the fine print to determine limits and exclusions,” she explains.
Airbnb offers a Host Protection Policy, which protects hosts from liability claims, property damage, and bodily harm of up to $1 million. VRBO and HomeAway both offer their own affiliated policy, HomeAway Assure™, designed to replace your homeowner’s insurance and also to cover you if you choose to rent out your home for vacation rentals.
Renting out a second home can include more complex risks that you may not have considered, so it’s a good idea to talk with your insurance professional to make sure you’re covered, Worters notes.
Requiring guests to sign a damage waiver is also a good idea, experts note.
Consider Your Taxes
A major concern when renting out an additional home is what taxes you will owe.
“If you’re generating enough rental income, you’ll want to think about estimated tax payments,” says Julie Ford, CFP®, CPA, at Ford Financial Solutions, LLC. “A tax accountant can help you determine the right amount, but an easy way to start is to keep all of your rental income in a separate savings account. If this is a new and variable income stream, it’s wise to be conservative and think of this extra income as boosting your savings rather than extra income to cover your lifestyle.”
There are other options to manage the potential tax burden.
“If you’re a salaried employee, you can increase your withholdings and pay more income taxes out of your paycheck,” Ford notes. “Otherwise, you can make one-off quarterly tax payments.”
However, there are a few hard and fast tax rules to keep in mind. For example, the 14-day rule, which says that if you rent your home for no more than 14 days per year and use the vacation house yourself for 14 days or more during the year (or at least 10 percent of the days you rent to others), you don’t have to pay taxes on what you earn from renting out the home.
You can also deduct business expenses to run your rental business. But keep in mind that many cities charge an occupancy tax on short-term rentals. This varies by state and town, so be sure to check your local requirements.
You can find more information on taxes and your vacation rental property here.
You should also expect wear and tear on your property, Ford notes.
“Expect the unexpected. Your property will experience more wear and tear, which means you need a larger savings buffer to quickly respond to repairs and maintenance,” she says.
And be sure to track any assets you store in your rental property.
“When insuring a vacation home you might keep clothing and equipment there to use when you visit,” Worters says. “To help keep track of your possessions and file an insurance claim if necessary, create a home inventory with all of the items you’ll be keeping in the house. The III provides a free Web- and app-based inventory tool, Know Your Stuff®, which makes it easy to store information and photos of your possessions, all in one place. The tool also allows you to set up various homes, each with its own inventory, and move items from one to the other.”
Ford also advises potential rentees to consider the following: “Do you have time to manage a rental property? If not, what will a property manager cost? How much will a cleaning service cost if you can’t do it yourself? Do you need to make any major or minor modifications to the property to make it more marketable for your rental market? What kind of restrictions do you want to put in place for any renters like pets, smoking, guests, age?”
When renting out a property, it’s best to make sure all your ducks are in a row before opening up your home.
“Get your taxes in order. Make sure you’re appropriately covered with the right insurance policies and riders,” Ford says. “Have a professional review your contracts and waivers that each renter will sign.”
And at the end of the day, you should consider all aspects of renting your second home before making the leap, she notes. “Think about whether or not the time and effort put into this new stream of income will be worth it.”