The housing market is changing quickly. Alternative housing patterns have surfaced as creative answers to these problems as metropolitan areas continue to grow in population and housing costs rise. These unconventional housing alternatives, which vary from small dwellings to co-living arrangements, are becoming more and more popular, especially among younger generations who are looking for flexibility and cost.
But these new housing models also bring with them complicated tax issues that many residents, investors, and property owners might not completely comprehend. There are ambiguities around these other living arrangements because the tax legislation was primarily drafted with conventional single-family residences and typical rental agreements in mind.
Whether you’re a resident, property owner, or investor, we’ll assist you navigate this complex environment by examining the tax ramifications of many alternative housing types in this post.
Cohabitation: An Analysis from a Tax Point of View
What Does “Co-Living” Mean in Taxes?
One of the alternative housing market categories with the quickest rate of growth is co-living residences. Private bedrooms are usually included in these setups, along with communal living areas, kitchens, and occasionally bathrooms. However, what is the IRS’s opinion of these properties?
Co-living arrangements are a bit of a grey area from a tax standpoint. Owners of real estate must decide if their cohabitation operation qualifies as:
- A typical rental home
- A lodging facility
- A hotel or short-term accommodation establishment
- A cooperative for shared housing
Tax ramifications, reporting obligations, and possible deductions vary depending on the categorisation. Properties that provide extremely brief stays, for example, may be categorised as temporary lodging and be liable to hotel taxes and other expenditure deduction regulations.
Tax Issues for Co-Owners of Real Estate
You should be aware of the following tax issues if you own or run co-living properties:
- Depreciation Schedules: Commercial property must be depreciated over 39 years, but residential rental property may typically be depreciated over 27.5 years according to IRS regulations. Which timetable applies will depend on your co-living property’s categorisation.
- Expense Allocation: When living in a co-living facility, you’ll need to keep a close eye on your spending and divide it between the communal and private sections. The percentage of expenditures that can be subtracted from rental income may change as a result of this discrepancy.
- State and Local Taxes: A lot of towns have started enacting laws or levies that are exclusive to co-living facilities. Certain cities levy occupancy taxes akin to those levied on hotels or need specific licenses.
- Part 199A Deductions: Section 199A of the tax code allows for a 20% deduction on company income, and depending on how your co-living business is set up, you may be eligible for this deduction.
Tax Issues for Residents in Co-Living Environments
The tax ramifications for co-living property occupants must also be carefully considered:
- Rent Deductions: Although the majority of personal rent payments are not tax deductible, co-residents who work from home and fulfil certain IRS conditions may be eligible for home office deductions.
- State Residency Issues: Determining state tax residency can be challenging for highly mobile people who move between co-living facilities in various states, perhaps resulting in filing requirements in many jurisdictions.
- 1099 Reporting: In return for amenities like community management, some co-living arrangements provide lower rent. These agreements can result in taxable income and 1099 reporting obligations.
Classification Issues for Alternative Dwellings and Tiny Homes
Since their categorisation isn’t always clear-cut, tiny residences pose special tax issues. A tiny home may fall under one of the following categories, depending on its construction, permanency, and local laws:
- Real estate, such as a conventional house
- Personal belongings (such as a mobile home or RV)
- A building on leased property
The tax consequences of each categorisation vary. For instance, tiny dwellings that are categorised as personal property usually do not qualify for mortgage interest deductions, while those that are categorised as real property may.
Considerations for Property Taxes
Jurisdictional differences in small house property tax assessments are significant. Tiny homes on foundations may be taxed at cheaper rates in certain places because of their modest size, while in others they are assessed similarly to conventional dwellings.
More variance exists with tiny houses on wheels since some counties do not impose property taxes on them at all because they consider them to be vehicles rather than homes. However, additional tax requirements like personal property taxes or car registration costs may result from this categorisation.
Owner-Occupied Multifamily Properties and Home Hacking
Buying a multifamily property, living in one unit, and renting out the others is known as “house hacking” and has gained popularity among real estate speculators. A hybrid tax position involving both personal dwelling and rental property components is produced by this arrangement.
Tax Benefits of House Hacking
- Mortgage Interest Deductions: If an owner-occupant itemises their deductions, they may usually deduct mortgage interest on the personal home section of Schedule A, while Schedule E is used to deduct interest on the rental component.
- Depreciation: While your own living area is not eligible for depreciation deductions, the portion of the property used for rental purposes is.
- Expense Allocation: Using a reasonable approach, usually square footage or number of units, expenses must be divided between personal and rental usage.
- Capital Gains Exclusion: Up to $250,000 ($500,000 for married couples) in capital gains on the personal home part may be excluded if you lived in the property for at least two of the five years prior to selling.
Short-Term Rentals and Their Effect on Taxes
Property owners now find it simpler to rent out their properties for a brief period of time thanks to the growth of websites like VRBO and Airbnb. There are unique tax implications associated with these arrangements:
The 14-Day Rule
For occasional short-term landlords, one of the most advantageous tax laws is the so-called “14-day rule” or “Masters exemption.” Your rental income is tax-free and does not even need to be reported on your tax return if you rent your home for 14 days or less during the year.
All rental revenue, however, becomes taxable and must be reported on Schedule E if you rent for even a single day more than 14 days.
Investment vs. Business Activity
The IRS may categorise property owners who rent their assets more frequently as either:
- An investing activity that is passive
- A thriving company
This categorisation has an impact on business deduction eligibility, self-employment tax liabilities, and the way losses may be written off. In general, the IRS is more likely to consider your operation as a company than an investment if you offer significant services to visitors (like a hotel).
Housing Cooperatives and Community Land Trusts
Community Ownership Models’ Tax Benefits
Alternative ownership structures that may give tax benefits include housing cooperatives and community land trusts.
- Property Tax discounts: Because of their commitment to affordable housing, several jurisdictions provide property tax discounts for community land trusts.
- Interest Deductions for Co-op Residents: In most cases, members of housing cooperatives are able to deduct their portion of the cooperative’s property taxes and mortgage interest.
- Non-Profit Status: A lot of community land trusts are 501(c)(3) organisations, which enables them to avoid income taxes on certain activities and accept donations that are tax deductible.
Strategies for Tax Planning in Alternative Housing Models
Considerations for Entity Structure
Your tax status may be greatly impacted by the legal entity you use to own or run alternative housing:
- LLC vs. Corporation: LLCs offer flexibility and pass-through taxes, but corporations may offer higher tax rates but superior liability protection.
- REIT Structures: A Real Estate Investment Trust form may provide tax benefits for bigger alternative housing businesses, especially for co-living facilities with several sites.
- Non-Profit Models: Non-profit organisations may be able to collect tax-deductible contributions and provide exemptions from property taxes for housing developments with a communal focus.
Documentation Requirements
Compared to conventional rental houses, alternative housing options may need for more thorough record-keeping:
- Documentation of Space Allocation: Keep track of time-of-use logs and square footage allocations for properties that are used for both personal and rental purposes.
- Service vs. Rent Documentation: Clearly state the value of services and rent reductions in co-living situations where residents offer services in return for lower rent.
- Improvement Tracking: Keep separate records of changes made to private and shared areas since they can be treated differently by the tax code.
Future Alternative Housing Tax Considerations
Alternative housing models may be impacted by a number of possible changes to the tax law, which is always changing:
- Local Tax Changes: More jurisdictions are enacting targeted tax incentives for affordable housing options, including some alternative models, as cities struggle with housing shortages.
- Impact of Zoning Reform: Modifications to zoning regulations are facilitating the construction of auxiliary dwelling units (ADUs) and the conversion of single-family homes into multi-unit residences, which may open up new avenues for tax planning.
- Environmental Incentives: Many alternative dwelling types that prioritise energy efficiency and smaller environmental footprints may profit from the growing availability of tax credits for sustainable building methods.