I was looking at a tax return recently. There was an
issue there that I did not immediately recognize.
Let’s go over it.
The client is a new venue for cocktail parties, formal
dinners, corporate meetings, bridal showers, wedding rehearsals and receptions,
and other such occasions.
The client will configure the space as you wish, but
you will have to use a preselected list of caterers should you want food. There
is a bar, but you will have to provide your own bartender. You can decorate,
but there are strict rules on affixing decorations to walls, fixtures, and
such. Nonroutine decorations must be approved in advance. You will have to
bring your own sound system should you want music, as no system exists. The
client will clean the space at the end of the event, but you must first remove
all personal items from the property.
Somewhat specialized and not a business I would pursue, but I gave it no further thought.
The question came up: is this ordinary business income
or rental income?
Another way to phrase the question is whether the
income would or would not be subject to self-employment tax.
Let’s say you have a duplex. One would be hard pressed
to think of a reasonable scenario where you would be paying self-employment tax,
as rental income from real estate is generally excepted from self-employment
income.
Let’s change the facts. You own a Hyatt Hotel. Yes, it
is real estate. Yes, there is rental income. This income, however, will be
subject to self-employment tax.
What is the difference? Well, the scale of the
activity is one, obviously. Another is the provision of additional services.
You may bring in a repairman if there were a problem at the duplex, but you are
not going into the unit to wash dishes, vacuum carpets, change bed linens or
provide fresh towels. There is a limit. On the other hand, who knows what concierge
services at a high-end hotel might be able to provide or arrange.
We are on a spectrum, it appears. It would help to
have some clarification on which services are innocuous and which are taunting
the bull.
IRS Chief Counsel Advice 202151005 addressed the
spectrum in the context of residential rental property.
First a warning. A CCA provides insight into IRS
thinking on a topic, but that thinking is not considered precedent, nor does it
constitute substantial authority in case of litigation. That is fine for us, as
we have no intention of litigating anything or having a tax doctrine named
after us.
Here is scenario one from the CCA:
· You
are not a real estate dealer.
· You
rent beachfront property via online marketplaces (think Airbnb).
· You
provide kitchen items, Wi-Fi, recreational equipment, prepaid ride-share
vouchers to the business district and daily maid service.
Here is scenario two:
· You
are not a real estate dealer.
· You
rent out a bedroom and bathroom in your home via online marketplaces.
· A
renter has access to common areas only to enter and exit.
· You
clean the bedroom and bathroom after each renter’s stay.
I am not overwhelmed by either scenario. Scenario one
offers a little more than scenario two, but neither is a stay at the Hotel
Jerome.
Here is the CCA walkthrough:
· Tax
law considers rental income collected by a non-dealer to be non-self- employment
income.
· However,
the law says nothing about providing services.
· Allowable
services include:
o
Those clearly required to maintain the
property in condition for occupancy, and
o
Are a sufficiently insubstantial portion
of the rent.
· Nonallowable
services include:
o
Those not clearly required to maintain the
property in condition for occupancy, and
o
Are so substantial as to comprise a
material portion of the rent.
The CCA considered scenario two to be fine.
COMMENT: I would think so. The services are minimal unless you consider ingress and egress to be substantial services.
The CCA considered scenario one not to be fine.
Why not?
· The
services are for the convenience of the occupants.
· The
services are beyond those necessary to maintain the space for occupancy.
· The
services are sufficient to constitute a material portion of the rent.
I get the big picture: the closer you get to hotel accommodations
the more likely you are to be subject to self-employment tax. I am instead having
trouble with the smaller picture – the details a tax practitioner is looking
for – and which signal one’s location on the spectrum.
· Is
the IRS saying that services beyond the mere availability of a bed and bathroom
are the path to the dark side?
· IRS
Regulations refer to services customarily provided.
o
How is one to test customarily: with
reference to nearby full-service hotels or only with other nearby online rentals?
o
In truth, did the IRS look at any nearby
services in scenario one?
· What
does material portion mean?
o
Would the provision of services at a lower
rent situs (say Athens, Georgia) result in a different answer from the
provision of comparable services at a higher rent situs (say Aspen, Colorado)?
o
What about a different time of year? Can one
provide more services during a peak rental period (say the NCAA Tournament) and
not run afoul of the material portion requirement??
One wonders how much this CCA has reinforced online
rental policies such as running-the-dishwasher and take-out-the-trash-when-you-leave.
There is no question that I would advise an Airbnb client not to provide daily
services, whatever they may be.
I also suspect why our client set up their venue the
way they did.
