As a real estate investor, you must decide whether your properties will be short- or long-term rentals. But if you’re new to rental property investing, how do you know which strategy is right for you? This decision can have a significant impact on your time, income, and tax liability, so it’s worth spending time on this choice. Don’t panic, though. REI Hub is here to help. Today, we’ll compare and contrast aspects of long- and short-term rentals so you can choose the investment strategy that works for you.
What Qualifies as Long or Short Term?
First, let’s get clear on what long- and short-term rentals are.
Traditionally, a short-term rental is any property rented for a period of less than six months. In the eyes of the IRS, a short-term rental and a vacation rental are the same. This is when you rent an entire property to someone else.
Therefore, the IRS does not count house hacking as the same as a short-term rental. With house hacking, you’re renting out part of your personal dwelling. It doesn’t matter whether you’re renting it to the same person for six days or six years. Either way, the IRS limits your losses to your income, and you allocate part of your home expenses to your rental activity. House hacking is a different investment strategy you can learn more about with this resource.
A long-term rental property lease is typically for six months or more. However, some property management companies and landlords consider anything over 30 days as a long-term lease. You’ll want to check your local laws and ordinances to see what terms count as long-term leases in your area.
Comparison of Long- and Short-Term Rentals
There are advantages and drawbacks no matter how long your rental terms are. We’ve pulled together the most important factors for you to consider as you decide which strategy is best for you.
Budgeting
- Demand and rents can fluctuate by season with short-term rentals, and this inconsistency can cause cash flow issues if property owners aren’t careful with their budgets.
- The terms of long-term leases make it easier to budget and forecast your income since you’ll have steady, predictable income.
Financing
- Variable incomes and higher-risk tenants make it harder to get financing and lead to higher interest rates for short-term properties.
- Consistent income and lower-risk tenants from long-term rentals mean you’ll probably have an easier time securing financing with better terms and lower interest rates.
Inspections and Maintenance
- In between each booking for short-term units, you’ll have access to the property to perform inspections and maintenance. By performing inspections regularly, you can catch and repair minor issues before they turn into expensive problems.
- For long-term rentals, you must give your tenants notice when it’s time for an inspection. Then you have to schedule time to make any repairs based on the inspection results. The entire process takes longer, so you have fewer chances to catch small issues before they become bigger, more expensive problems.
Laws or Restrictions
- Many areas have strict rules regarding short-term rentals. Check the city and local laws and the HOA regulations before you purchase a property to use as a rental. The rules may limit the maximum lease period, require property owners to have a permit or collect occupancy taxes, or forbid short-term units in certain areas because of zoning laws.
- Some HOAs prohibit rentals of any kind in their neighborhoods. Check the bylaws before you buy a property for long-term rental use.
Management Fees
- Property management fees can be much higher for short-term rentals—up to 30% of the collected rent.
- For long-term units, management fees are lower—between 8% and 10%—because the properties have less turnover.
Operating Costs
- Short-term rentals are usually fully furnished, so that’s another outlay you’ll need to budget for, along with amenities such as sheets, towels, toilet paper, and cooking supplies.
- Landlords also cover the cost of utilities for short-term properties. You can build the cost of electricity, gas, water, trash, internet, and cable or streaming services into your rent rates. Just be sure to budget carefully for the variable bills, like water and electricity.
- Long-term leases make it easier to budget and forecast your income since you’ll have predictable rents.
Property Damage
- Short-term tenants tend to cause more property damage during their stays, so repair and maintenance costs are usually higher.
- Since the property is their home, long-term tenants tend to take better care of the rental, decreasing your risk of property damage.
Rent Rates
- Local market demand and conditions affect rental rates, but short-term rental properties may generate two to three times the amount of monthly rent compared to long-term rentals.
- The daily rent rate is lower with long-term rental properties. And since you’ll have a lease spanning several months, you won’t be able to adjust the rent rate as often to reflect changes in the market. This limits your cash flow.
Selling
- You aren’t committed to a long lease with short-term units, so it’s easier to sell the property if you need to adjust your holdings.
- Many potential buyers do not want the hassle of taking over lease obligations for a property that has a renter in it already. Unless your property is sitting empty, don’t count on a quick sale.
Tax Deductions
- Direct rental expenditures, like marketing costs or rental insurance premiums, associated with a rental property are completely deductible. However, you may only deduct a percentage of the property’s general costs, like the mortgage interest or utilities. The deductible percentage equals the percentage of the year that the property is in service, so your deductions may be lower for short-term units if you only intend to rent them out for part of the year.
- With a long-term property that’s rented most of the year, you can usually deduct the full amount for general expenditures, like mortgage interest, utilities, or repairs.
Tax-free Option
- If you only want to experiment with short-term rentals, take advantage of the 14-day rule. With this provision, the IRS allows you to rent out your dwelling for 14 days or fewer each year tax-free. The catch is that you, the property owner, must also occupy the property for at least 14 days. In this scenario, you don’t pay tax on the rental income, and your deductions are limited to property taxes and mortgage interest.
- Long-term rentals don’t qualify for the 14-day rule.
Tenants
- Short-term tenants are generally riskier because you don’t run background checks or collect references. With some rental platforms, like Airbnb or Vrbo, hosts can rate their guests, but not every company offers that. If you’re more comfortable with risk, then this may not be an issue for you.
- Tenant screening is a standard part of long-term rental businesses. It’s another outlay, but it lowers your risk. Evicting a bad tenant is expensive and time consuming. Legal fees add up quickly, and if a bad tenant refuses to pay the rent, you could face serious cash flow issues.
Turnover
- Shorter rental periods mean higher turnover. You’ll also have to deal with increased admin tasks, like preparing contracts and confirming bookings. Be prepared to spend either more time prepping your property for the next tenants or more money outsourcing those tasks.
- With long-term tenants, you won’t have to deal with prepping the property for new tenants as often. Plus, you’re only drawing up one or two leases per year, cutting down on your admin work.
Takeaways
One of the great things about investing in real estate is that you get to decide how to build your portfolio. If the higher daily rents and frequent turnover of short-term rentals appeal to you, you can focus exclusively on vacation rentals. If steady income and lower operating costs are more in line with your vision, then long-term rentals may be a great choice for you. You can even purchase a mixture of short- and long-term properties to diversify your holdings. But before you buy any property or choose an investment strategy, talk with your tax preparer and lawyer. The tax implications and laws regarding rental properties will have a big impact on how you structure your real estate investment business. Your advisory team can help you choose the investment strategy that’s best for your situation. No matter which approach you decide on, REI Hub offers specialized accounting software for real estate investors so you can track the financial health of your investments by property. Register for a free trial today!
