Legal Considerations in Starting a Short-Term Rental Business
Short-term rentals are nothing new. For decades, homeowners have been renting out their properties in touristy areas to earn income. But with the advent of platforms such as Airbnb and VRBO, there has been an explosion in short-term rentals, including many in areas that were not previously considered travel destinations.
The growing demand for short-term rentals has created revenue streams for property owners who want to rent out an entire house or apartment, a single room or suite, or even a tiny house or camper that sits on their property. Some owners use the income to help pay their mortgage and living expenses, while others have turned multiple rental properties into a full-fledged business.
Short-term rentals come with some controversy as well as many practical business considerations, such as compliance with local zoning regulations and tax rules. While the short-term rental market continues to evolve at the state and local level, which means you will need to stay on top of changing laws, you can potentially earn significant profits in this space.
Short-Term Rental Industry Outlook
There is arguably no better example of market disruption in recent history than the introduction of Airbnb in 2008. When the site rolled out, it effectively introduced a new market for short-term rentals.
Airbnb and similar online platforms made it much easier for owners and renters to connect. Space that previously sat idle or was more difficult to book suddenly had income potential, and areas adjacent to tourist hotspots garnered newfound traveler attention.
The “Airbnbification” of the rental market has been a boon for property owners and renters alike, giving both greater flexibility and more options. The upward trajectory of the short-term rental segment, consisting mainly of private accommodation bookings, stalled during the COVID-19 pandemic, but as of mid-2022, demand is back up and is forecasted to remain high for the foreseeable future.
There are approximately 1.3 million available short-term rental units on various booking platforms. Most of them are houses, apartments, condos, lofts, and private rooms. Still, tiny houses, nature lodges, buses, huts, tents, farm stays, and other rental types reflect an interest in unique travel experiences. The US vacation rental industry is the most lucrative in the world, valued at over $15 billion. Seven out of ten vacation rental companies are small businesses that manage between one and nineteen units.
Short-Term Rental Blowback and Zoning Ordinances
Market disruptions inevitably bring naysayers and countermeasures. Short-term rentals are divisive, and many areas seek a middle-ground between property owner rights and community concerns. The former say restrictions on short-term rentals infringe on their right to gain income from their property; the latter argue that short-term rentals can become party homes and price locals out of the market.
In response, many cities and states have passed laws regulating short-term rentals, and certain areas have banned them altogether. Regulations cover issues such as the type of structure that may be considered a short-term rental, how long and how often you can rent the property, and whether the host must be present on the premises. Comparable provisions may apply to properties that are managed by a homeowners’ association (HOA).
If you own a property in a location that allows short-term rentals but imposes restrictions, it is important to do things by the book. For example, in addition to obtaining a general business license to operate as a short-term rental owner, you will most likely have to obtain a short-term rental license from your city or county, which ensures that the property meets local zoning laws and health and safety requirements.
Failure to comply with short-term rental laws can result in fines of hundreds or thousands of dollars per violation or per day of noncompliance. Owners who violated Miami’s short-term rental laws faced penalties of up to $20,000. Although this ordinance, which banned short-term rentals, was later struck down as illegal, ongoing fines could seriously eat into your income—or force you to abandon your rental.
Other Legal Considerations for Short-Term Rentals
Obeying local laws for short-term rental zoning and licensing is a must, but before you are ready to rent, here are a few more business and legal points to keep in mind:
● Rental tax rules. Not only will you need to track the income you earn from rentals and pay the typical income and self-employment taxes on it, you may also be subject to a special tax that applies to short-term rentals. Your local government may call this an occupancy tax, lodging tax, or hotel tax. Whatever name the tax goes by locally, you are responsible for collecting it from guests and remitting it to the property authority unless you work through a service such as Airbnb, which may do it for you.
● Business entity. Forming a business entity, such as an LLC, can help separate your personal assets from your rental assets. This could provide important asset protection, for example, if a guest is injured on your property and sues you. If the business is held liable, your personal assets will not be available to satisfy the claim. Having a separate business entity for your rentals can also provide tax benefits.
● Insurance. Your homeowners insurance may not cover short-term rentals if you rent your property regularly. Operating a regular short-term rental counts as a business activity, which is not covered by a standard homeowners policy. Companies like Airbnb offer supplementary short-term rental insurance, but you may want to consider business insurance as well.
● Security. There is a fine line between protecting your guests and being mindful of their privacy. However, if somebody is injured by an attacker on your property,you could face legal action for negligent security. Deterrents such as doorbell cameras, motion-activated lights, outdoor security cameras, and window and door locks can give your guests peace of mind and protect you legally.
● Management agreements. If you contract with Airbnb or another online platform, there will be a standard, nonnegotiable terms of service agreement. This agreement addresses only the bookings, though. There is a lot of work to be done between stays, including cleaning, maintenance and repairs, marketing, and guest communications. And even if you use sites like Airbnb, you may have a parallel website that lists your rental units and eliminates third-party service fees (but creates more work for you). Regardless of how you decide to manage your rentals, you may outsource the day-to-day running of the business to a management company. When doing so, it is crucial to have a carefully written third-party management agreement that covers, among other things, what they are responsible for and the circumstances in which you can hold them liable for any damages that occur to the guests or the property.
● Business finances. Even if you are just renting out a spare bedroom for supplemental income, the rental will create additional financial and tax issues. For renters with multiple properties, these issues may quickly become tough to manage. Meticulous financial records are a must. You should keep track of all business expenses, rental day logs, revenues, management fees, etc. You also need to be mindful of when taxes are due and deductions for which you may be eligible, such as mortgage interest and property taxes. It is a good idea to open a separate bank account and credit card for your rental business to keep everything organized.
Our Professionals Can Help with Your Rental Business
There has never been a better time to start a short-term rental business. Demand for short-term rentals is at an all-time high, and owners are finding creative ways to turn their property into revenue. At the same time, as the market matures, the regulatory landscape will continue to take new twists and turns.
Online software tools made specifically for rental business owners are available, but they are no substitute for legal and tax professionals who live in your community, know the local laws, and understand the local business climate. We want to facilitate your rental success. Before you list a short-term rental, set up a meeting with our attorneys to ensure that you have checked every legal box.
Schedule a consultation today.