What running an Airbnb taught me about corporate taxes

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I’m in a truly lucky, and privileged position, to be able to afford and own a house in the Bay Area. A big part of the reason we bought the house we did was because of the way it was structured. It has three floors, and two entrances, and the bottom floor is essentially set up like an in-law suite, with a private entrance, bedroom, full bath, and a sizable laundry room. We saw an opportunity to augment our income with an Airbnb, and decided to jump into the deep end. (I’ll clarify that, because there’s not really a true kitchen, we’d likely never create a permanent rental unit out of this space).

I actually dragged my feet for a long time on getting it set up and listed. Like, a whole year. My wife put in a huge amount of effort to make the space stylish and Pinterest-worthy, and I made all these excuses for myself, because I was afraid no one would book it. Our house isn’t particularly close to public transportation (we’re about a mile away from the nearest BART stations), so I assumed it wasn’t going to be convenient for tourists (back before the pandemic when those existed) or business travelers. So for a whole year, my wife and I basically had a floor of our house that went untouched, except when we would pass through the space to go to our garage.

Eventually, however, after enough pressure from my wife, I took the plunge and put a listing up on Airbnb, and much to my surprise, it got booked! Rather quickly, actually. And it stayed booked, for the most part. There have been a few rare occasions where we’ve had some days actually pass by unbooked, but over the course of a year, we had fewer than 30 unbooked nights (that number ignores nights that we blocked to account for minimum stay lengths, nights when we didn’t want to host, etc.).

When all you have is a hammer, everything looks like a business expense

The craziest thing I discovered by starting an Airbnb is just how insanely tax-efficient you can get with a rental business. By operating an Airbnb out of our house, suddenly a lot of our everyday expenses become business expenses, and thus, tax-deductible. Now, to be clear, we can’t deduct things off of our personal income taxes -- we can deduct only as much income as we make through the Airbnb business, but we’re able to be extremely tax-efficient by generating “zero” profits. 

The bulk of our tax deductions come from the space in our house, itself. Because we have a well-defined space within our house that we utilize strictly for business purposes, we are able to claim a portion of our mortgage interest, property taxes, and homeowner’s insurance as deductible business expenses. To be fair, our homeowner’s policy is specifically designed for homes that are used as partial rentals, and costs us about two to three times more than it would if we had a standard policy. But these added deductions enable us to go pretty far beyond the standard SALT deductions for things like property taxes (it’s pretty trivial to blow through those if you own property in California, since property taxes are crazy high, at least on a dollar amount basis).

For clarification, we don’t get to claim all of our mortgage interest and property taxes. Tax law allows for us to deduct an amount that is proportional to the amount of our house that serves as a place of doing business. There’s a handful of methods you can use for determining that proportion. For example, you could measure the square footage of your home, and the square footage of the section that is used for business, and use that ratio. Alternatively, the rooms method allows you to divide the number of rooms for the business by the number of rooms in the house to get the proportion. In our case, the number ends up being in the 15% range, so we can deduct 15% of our interest and taxes. 

The deduction that will come back to bite us at some point, however, is depreciation. If you’re not familiar with depreciation, the basic idea is that your home is a business expense that degrades in value over time (obviously, in the case of real estate, values often increase over time, but whatever). For rental property specifically, the value is depreciated over 27.5 years, and so every year, I get 1/27.5 of the value of my home taken as a tax deduction. In theory, this would be total awesome sauce, but what they don’t tell you when you start depreciating is that the government eventually gets its pound of flesh, in the form of a depreciation recapture tax. When you sell a home that you’ve been using as rental property, you have to pay tax on all of that depreciation you’ve been claiming over the years. Also, you’re not allowed to say “I don’t want to depreciate this home.” You have to take the depreciation deduction. It’s not all bad, though, because depreciation recapture is taxed at personal income tax levels, but maxes out at 25%, and unless you’re retired when you sell the property, if you live in the Bay Area, there’s a good chance that 25% is a discount on your income taxes, anyway. Also, if you’re a really savvy Airbnber, you can defer all that depreciation recapture until later by trading your home out via a 1031 Exchange, though this makes things altogether more complex along the way.

So far, all of these deductions make reasonable sense, and where things get really nutty is that now we can start talking about all the other services that are required to run our Airbnb. Now our utilities -- electric, water, cable/internet -- become business expenses. As do the streaming services that we make available to guests, like Hulu, Netflix, and Disney+, and even our cell phone, since we use our data plans to communicate with guests through the Airbnb app. These all have to be deducted proportionally, as well, but over the course of a year, can end up amounting to north of $1000 of tax deductions for services that end up adding to our own enjoyment (and pandemic sanity) during the course of the year, as well.

Profits and losses

I’ve read lots of new stories about companies that book huge profits andpay nothing in corporate taxes. It only really started to click for me when I started running my own business, and realized how absurdly corporate taxes favor the businesses. There are a whole bunch of various taxes at play with an Airbnb: there are local taxes that get levied on the gross revenue, corporate income taxes on profits, local property taxes on the residence, and, in theory, payroll taxes for employers. 

In the case of my rental, most of the local taxes on revenue get paid by Airbnb to the municipality, and I also pay a small amount of tax on my gross revenue to the city, but it’s only around 1%. I certainly pay property taxes on my residence, but those taxes actually end up qualifying as business expenses! Living in the Bay Area, most folks rip through the $10,000 state and local tax deduction cap in an instant, and I’m actually able to capture more tax deductibility of my state and local taxes through Airbnb revenue. Also, since we’re running a single Airbnb out of our house, we don’t exactly require employees, and the business is structured as a sole proprietorship, so there’s no payroll taxes. 

Between all of our expenses to have an Airbnb listing (depreciation, property taxes, mortgage interest, insurance, utilities, etc.) and all the things we add to it to make it an attractive product (high-speed internet, streaming services, amenities, etc.) we have almost “zero” profit. To put this in stark contrast, in 2020, our Airbnb was occupied for 192 nights, and our profit in 2020 was less than $300. I’ll assure you we’re not listing our space for $1.50 per night, so when I look at that number, I can’t help but think “that’s insane.” 

Outside of some future depreciation recapture tax, nearly all of the income we receive from Airbnb stays untaxed after it hits our bank account. Granted, there are some expenses that are significantly higher than they would otherwise be if we weren’t running an Airbnb (our homeowner’s insurance is the obvious example), but all of the amenities and services we offer are things that we would otherwise be purchasing anyway. And outside of the periodic cleaning we have to do to reset the space for our next guests, it’s almost entirely turnkey.

Fringe benefits

The outcome of running an Airbnb out of our house is that:

1. We bring in a decent chunk of supplementary income.

2. We pay almost nothing in taxes on that supplementary income because all of the “profits” are negated by various business expenses that we’d be otherwise paying for by virtue of living in the same space and sharing the same services with the Airbnb space.

3. Many of the services that we use regularly for our own quality of life become partially tax deductible.

4. We are now running a business, and so I’m eligible to open business credit cards (if you’ve been reading my other posts, you’ll be aware of my love for credit card points).

5. I have excuses to learn about other parts of the tax code that I then write about here.

Sometime soon, I’ll write up some details about how we’ve set up and run, what I consider to be, a highly successful Airbnb. We’ve been superhosts for the past two years, have a 4.96 or so rating on Airbnb, and cover a substantial part of our mortgage, yet I probably only spend an hour per week on Airbnb-related activities. Till next time!