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Want a steady source of side income in the long term? Investing in the right vacation home rentals can help build wealth over time and potentially reduce your tax liabilities. According to Evolve Vacation Rental, vacation home rentals are a wise investment because you build value through property appreciation, earn tax deductions (depending on how many days you rent your property), and take on less risk if your vacation homes are in top tourist destinations.

Tax Rules on Rental Properties

While you are earning extra side income with these properties, there can be tax implications for having rental properties.Your property is considered a personal residence if you use it for more than 14 days or more than 10 percent of the days it’s rented. If this is the case, you don’t have to report income but that also means you can’t deduct expenses associated with the rental except for the usual homeowner deductions for mortgage interest, real-estate taxes and casualty losses, according to H&R Block.

The IRS considers your property an investment property or small business if you use your vacation home for 14 days or fewer in a year, or less than 10 percent of the days it’s rented. In this case, you will be able to deduct all eligible rental expenses and deduct losses up to $25,000 in the current or future tax years.

How Much Money Can You Earn?

Vacation rental income is highly variable. If you’re thinking about investing in a property or you already have a short-term rental, you need to take property size, quality, and location into consideration to estimate bookings and rental income. For example, a two-bedroom, three-bathroom condo in Kissimmee, Florida, which is a 10-15 minute drive to Walt Disney World, is expected to book 238 nights per year for an occupancy rate of about 65% at $103 per night.  It would generate $25,505 in rental income per year. Because the condo is valued at $195,000, you don’t need to spend as much upfront or earn as much rental income to cover costs.

John Banczak, executive chairman of TurnKey Vacation Rentals, says that for every $100,000 you spend to buy a vacation home, you should target annual rental income of $12,000 to $14,000 if you’re purchasing it as a cash-flow investment. If you bought a home for $500,000 as a rental property, the house should earn about $60,000 to $70,000 in annual rental revenue.

LLCs Under the New Tax Law

A limited liability corporation, which stands for LLC, is a business structure that combines pass-through taxation (like in a partnership or sole proprietorship) with the limited liability of a corporation. An LLC is not a corporation—it is a legal form of a company that provides protection and limited liability of the owners, but allows the business to be taxed like a partnership. Under the Tax Cuts and Jobs Act, LLCs may qualify for the new Section 199A 20% deduction. The tax law increases the value of high-contribution retirement programs such as Defined Benefit and Cash Balance plans because they provide a triple compound benefit. Large, above-the-line deductible contributions can enable taxpayers to qualify for the Section 199A 20% deduction by reducing taxable income below the $157,500 (single taxpayer) or $315,000 (married taxpayer) thresholds, which can further reduce taxable income so that it’s taxed at lower rates.

Merits of Defined Benefit Plan for Vacation Rental Side Business

We have a client who is a successful executive with a Wall Street investment company who has a side business from buying, renovating and renting vacation properties on the East Coast. This business generates more than $200,000 per year of additional income. He will open a Defined Benefit plan and Solo 401(k) to reduce his current tax liability. His side business will contribute well over $125,000 in 2019. If he contributes at the same level for 18 years, his projected accumulation at retirement will be $1.2 million.

Interested in saving big on taxes and building wealth for your retirement? Get a free online estimate using our Defined Benefit plan calculator to see how much you can save.