Airbnb rentals in your Solo 401k or IRA…can you do it? Does it make sense? Are there tax consequences lurking in the shadows?
I think we can all agree…tax laws are twisted. If you aren’t paying close attention, you might be caught unaware in a tax trap. UBIT is just such a potential trap. One particular investment that you want to be aware of regarding UBIT is Airbnb. In fact, Airbnb is becoming more popular with Solo 401k investors.
Tax deferred income very well may be the only reason you invest your retirement funds in a Solo 401k. However, the IRS doesn’t want your retirement account to have an unfair advantage over “normal” investors. Just like nonprofit companies, there are IRS rules to discourage tax deferred retirement accounts from directly competing with fully taxed businesses. These rules are commonly known as UBTI or UBIT (Unrelated Business Taxable Income), which are defined in IRS Code Sections 511-514.
UBIT rules don’t apply to most of the investment types that a Solo 401k account make. Common investments generate passive income from sources like loan interest, real estate rentals, real estate sales, annuities, and royalties. This income does not come from business activities such as selling products or services.
Airbnb Rentals in a Solo 401k May Have a Gray Area Subject to UBIT
It would seem that real estate property generating income from rental businesses such as Airbnb, HomeAway, and VRBO would be acceptable tax deferred rental income. And it well might be – under most circumstances. At the time this is written, the IRS doesn’t seem to have made any firm determination if income from these sources will be treated the same as most other rental property income or if there might be some subtle differences making this income subject to UBIT (although temporary rules are evolving).
One potential area is related to providing personal services along with the rental house. This generally applies if the rental is for less than 30 days. This means that if you want to maintain your full tax deferred status you probably should NOT be operating an Airbnb rental. That includes being a bed and breakfast, offering concierge services, having wine tasting parties, or even offering white water rafting adventures. However, the last item might be a separate “for hire” business.
Another is that these are temporary rentals (7 days or less). In this example, the IRS thinks you’re operating a hotel or hotel like business. That is, in contrast to running a long term rental. This one does appear to be fairly well defined as competitive with hotel businesses.
Does this leave you on the sidelines of a potentially very profitable Airbnb rental opportunity for your Solo 401k? Or do you possibly have alternatives…
No Safe Harbor But You Can Take Action
Since the IRS has not yet taken an absolute position, there is no true Safe Harbor answer if you want to invest your Solo 401k in Airbnb rentals. However, there are a couple of actions you can take to reduce your potential tax exposure.
First, don’t provide what are easily considered personal services. Don’t’ turn down the covers and leave a mint on the pillow. Don’t offer room service, and don’t offer to make theater reservations. You might offer that white water rafting adventure if it is run by a separate “for profit” business. However, that business should be offered to the public, and not only available as a package with the Airbnb. But you still want to get professional tax advice before offering any services of that type.
This doesn’t mean you can’t provide basic rental services. This could be delivering the key to arriving guests and providing maid service between guest stays. However, providing daily maid service is probably a hotel style service.
If you want to be as safe as possible about your tax-deferred status, you probably want to only accept rentals that will be beyond the 7 day temporary stay rule.
But, what else might you be able to do to minimize your tax burden?
A Possible Tax Reduction to Airbnb Rental Income
Something important to know is that UBIT is taxed at trust tax rates (up to 37% on income over $12,500 for 2018) in accordance with IRC Section 511. However, there is a tax strategy that you might want to consider if you will receive significant income that could be subject to UBIT. The strategy is known as a “C Corp Blocker.”
The strategy involves the Solo 401k account owner creating a C Corporation to first invest his/her retirement funds. The C Corporation then makes the investment into an operating business such as Airbnb rentals. This strategy does not mean that taxes will not be owed. However, it can take advantage of the Tax Cuts and Jobs Act of 2017, which changed the top corporate tax rate from 35% to one flat rate of 21%. At least 21% is a significantly lower tax rate than the top UBIT rate of 37%.
The C Corp Blocker strategy isn’t exclusive to Airbnb rentals. If you are interested in are other possible applications using retirement funds to invest in an active business, there are options for you. Obviously, you’ll want to consult with a tax expert knowledgeable in Solo 401k accounts and UBIT.
Have questions about a Solo 401k? The experts at Nabers group will help you get your retirement funds into your control, where they belong.