When short-term (vacation) rental income is hit with self-employment tax under section 1402(a)(1)

Plain-English summary

This Chief Counsel Advice addresses short-term rentals, the kind listed on online marketplaces like Airbnb or VRBO, and whether the owner's net rental income is subject to self-employment (SECA) tax. Normally, "rentals from real estate" are excluded from net earnings from self-employment under § 1402(a)(1), so no self-employment tax applies. The advice makes two points. First, it does not matter that a short-term rental is not a "passive activity" under the § 469 rules (for example because the average stay is seven days or less and the owner materially participates): the § 469 characterization does not determine whether the § 1402(a)(1) rental exclusion applies. Second, the exclusion turns on services. If the owner provides no services, or only services needed to keep the space fit for occupancy, the income stays excluded from self-employment tax. But if the owner provides substantial services primarily for the guests' convenience (hotel-like services beyond basic upkeep) that are a material part of what guests pay, the income is included in net earnings from self-employment and is subject to SECA tax. Applying this to two examples, a fully furnished vacation property with daily maid service, toiletries, Wi-Fi, beach equipment, and prepaid ride-share vouchers is subject to self-employment tax, while renting out a single furnished room and bathroom that is only cleaned between guests is not. The advice relies on Rev. Rul. 57-108, Rev. Rul. 83-139, and the Tax Court decisions in Bobo, Hopper, and Johnson (all applying the Ninth Circuit's Delno standard). This matters to the many people earning short-term rental income: whether they owe an extra 15.3% self-employment tax depends on how many guest services they provide, not on the passive-activity rules.

Ruling snapshot

• Question: Does § 469(c)'s "rental activity" characterization control whether short-term rental income is excluded from self-employment tax under § 1402(a)(1), and when are rentals of living quarters excluded?
• Outcome: Advice given. (1) No, the § 469(c) characterization is not determinative. (2) Rental income is excluded from NESE when no services, or only occupancy-maintaining services, are provided; it is included when substantial services for the occupants' convenience constitute a material part of the rent.
• Key authorities: IRC §§ 1401, 1402(a)(1); Treas. Reg. §§ 1.1402(a)-4(c), 1.469-1T(d), (e)(3), 1.469-5T; Rev. Rul. 57-108; Rev. Rul. 83-139; Bobo v. Commissioner, 70 T.C. 706 (1978); Hopper v. Commissioner, 94 T.C. 542 (1990); Delno v. Celebrezze, 347 F.2d 159 (9th Cir. 1965)

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 202151005
       Release Date: 12/23/2021
       CC:EEE:EOET:ET2:MZhidkov
       POSTN-123645-21

UILC: 469.03-00, 1402.01-00, 1402.01-01

date: November 19, 2021

 to:   John R. Reis
       Senior Program Analyst
       (Small Business/Self-Employed)

from: Michael Swim
Senior Technician Reviewer
Employment Tax Branch 1
Office of Associate Chief Counsel
(Employee Benefits, Exempt Organizations, and Employment Taxes)
CC:EEE:EOET:ET1

subject: Application of I.R.C. §§ 469(c) and 1402(a)(1) to Short-Term Rentals from Real
Estate

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.


                                                ISSUES

       1) Whether the characterization of an activity as a “rental activity” under § 469(c)(2)
          determines whether the activity is “rentals from real estate” excluded from net
          earnings from self-employment (“NESE”) under § 1402(a)(1) for Self-Employment
          Contributions Act (“SECA”) tax purposes.

       2) In situations not involving a real estate dealer, when are rentals of living quarters
          considered “rentals from real estate” excluded from NESE under § 1402(a)(1).

                                            CONCLUSIONS

POSTN-123645-21 2

1) No, whether an activity is a “rental activity” under § 469(c)(2) is not determinative of
whether the exclusion in § 1402(a)(1) applies.

2) In situations not involving a real estate dealer, net rental income from the rental of
living quarters is considered “rentals from real estate” excluded from NESE when no
services are rendered for the occupants. However, if services are rendered for the
occupants and the services rendered (1) are not clearly required to maintain the
space in a condition for occupancy, and (2) are of such a substantial nature that the
compensation for these services can be said to constitute a material portion of the
rent, then the net rental income received is not excluded under § 1402(a)(1) and is
included in NESE.

                                     FACT SITUATIONS

You have asked for advice on the following general fact patterns:

1) The taxpayer is an individual who directly and solely owns and rents, in the course of
a trade or business,1 a fully furnished vacation property via an online rental
marketplace.2 The taxpayer is not a real estate dealer within the meaning of Treas.
Reg. § 1.1402(a)-4(a).3 The taxpayer provides linens, kitchen utensils, and all other
items to make the vacation property fully habitable for each occupant. In addition,
the taxpayer provides daily maid services, including delivery of individual use
toiletries and other sundries, access to dedicated Wi-Fi service for the rental
property, access to beach and other recreational equipment for use during the stay,
and prepaid vouchers for ride-share services between the rental property and the
nearest business district. For the year at issue, the average period of customer use
of the vacation property is seven days, and therefore the activity is not considered a
rental activity for purposes of § 469 pursuant to Treas. Reg. § 1.469-1T(e)(3)(ii)(A)
In addition, the taxpayer materially participates in the activity within the meaning of §
469(h)(1) and Treas. Reg. § 1.469-5T and, therefore, the activity is not a passive
activity within the meaning of § 469(c).

1 Assume, in both examples #1 and #2, sufficient other facts exist so that each example rises to the level

of a § 162 trade or business. See Treas. Reg. § 1.1402(c)-1. The facts provided are not intended to be
used for purposes of analysis of whether the taxpayer is engaged in a trade or business under § 162 or
any other provision of the Code.
2 Assume, in both examples #1 and #2, that the taxpayer does not use the property for “personal”

purposes, as defined in § 280A(d)(2).
3 Treas. Reg. § 1.1402-4(a) states that an individual who is engaged in the business of selling real estate

to customers with a view to the gains and profits that may be derived from such sales is generally a real-
estate dealer.
POSTN-123645-21 3

2) The taxpayer is an individual who directly and solely owns and rents, in the course of
a trade or business, a fully furnished room and bathroom in a dwelling via an online
rental marketplace. The taxpayer is not a real estate dealer. Occupants only have
access to the common areas of the home to enter and exit the room and bathroom
and have no access to other common areas such as the kitchen and laundry room.
The taxpayer cleans the room and bathroom in between each occupant’s stay. For
the year at issue, the average period of customer use of the vacation property is
seven days, and therefore the activity is not considered a rental activity for purposes
of § 469 pursuant to Treas. Reg. § 1.469-1T(e)(3)(ii)(A). In addition, the taxpayer
materially participates in the activity within the meaning of § 469(h)(1) and Treas.
Reg. § 1.469-5T, and, therefore, the activity is not a passive activity within the
meaning of § 469(c).

                              LAW AND ANALYSIS

    Under § 469(c), a passive activity is generally any trade or business activity in

which the taxpayer does not materially participate or any rental activity. Treas. Reg.
§ 1.469-1T(e)(3)(ii)(A) provides that an activity involving the use of tangible property is
not a rental activity for a taxable year if for the taxable year the average period of
customer use for the property is seven days or less. Under § 469(h), a taxpayer
materially participates in a trade or business activity only if the taxpayer is involved in
the operations of the activity on a regular, continuous, and substantial basis. In the
case of individuals, Treas. Reg. § 1.469-5T provides seven tests for material
participation. In particular, Treas. Reg. § 1.469-5T(a)(1) provides that an individual will
generally be treated as materially participating in an activity for a taxable year if the
individual participates in the activity for more than 500 hours during such year.

   Treas. Reg. § 1.469-1T(d)(1) provides that the characterization of items of

income or deduction as passive activity gross income or passive activity deductions
does not affect the treatment of items of income or deduction under provisions of the
Code other than § 469. Therefore, whether amounts are passive activity gross income
under Treas. Reg. § 1.469-2T(c) or passive activity losses under Treas. Reg. § 1.469-
2T(b) is not determinative of whether those amounts are rentals from real estate under
§ 1402(a)(1) and Treas. Reg. § 1.1402(a)-4. However, under Treas. Reg. § 1.469-
1T(d)(3) a deduction that is disallowed for a taxable year under § 469 and the
regulations thereunder is not taken into account as a deduction that is allowed for the
taxable year in computing the amount subject to any tax imposed by subtitle A of the
Internal Revenue Code.

   Section 1401 imposes tax on the self-employment income of individuals. Section

1402(b) defines self-employment income by reference to net earnings from self-
employment, with certain modifications. Section 1402(a) provides that the term “net
earnings from self-employment” (“NESE”) means the gross income derived by
individuals from any trade or business they carry on, less the deductions that are
POSTN-123645-21 4

attributable to such trade or business. However, under § 1402(a)(1), rentals from real
estate, together with deductions properly deductible and attributable to the rentals from
real estate (collectively, “net rental income”), are excluded from NESE, unless these
amounts are received in the course of a trade or business as a real estate dealer.4

   Treas. Reg. § 1.1402(a)-4(c)(1) provides that rentals from living quarters, where

no services are rendered for the occupants, are generally considered rentals from real
estate under § 1402(a)(1), except in the case of real estate dealers. However, Treas.
Reg. § 1.1402(a)-4(c)(2) provides,

    Payments for the use or occupancy of rooms or other space where services are
    also rendered to the occupant . . . are included in determining net earnings from
    self-employment. Generally, services are considered rendered to the occupant if
    they are primarily for his convenience and are other than those usually or
    customarily rendered in connection with the rental of rooms or other space for
    occupancy only.

Treas. Reg. § 1.1402(a)-4(c)(2) lists examples of situations where services are
rendered for the convenience of occupants, such as hotels, boarding homes,
warehouses, and storage garages.

   In Rev. Rul. 57-108, 1957-1 C.B. 273, the IRS ruled that a landlord who rented

furnished vacation beach dwellings and rendered services “for the comfort and
convenience of his guests in connection with their recreational activities”—including
maid services, swimming and fishing instruction, mail delivery, furnishing of bus
schedules, and information about local churches—rendered services primarily for the
occupants’ convenience. Consequently, the net rental income from the vacation beach
dwellings was included in the landlord’s NESE because the § 1402(a)(1) exclusion did
not apply.

   In Bobo v. Commissioner, 70 T.C. 706 (1978), acq. 1983-2 C.B. 4, the Tax Court

considered a mobile home park that provided leased trailer park units with utility
hookups, sewage facilities, and laundry facilities. The Tax Court held that the net rental
income from the rental of the trailer park units was excluded from the owners’ NESE
under § 1402(a)(1). The court relied on Delno, infra, in setting the standard for when
services are considered not rendered for the occupant,

    [Section 1402(a)(1)] should be applied to exclude only payments for use of
    space, and, by implication, such services as are required to maintain the space in
    condition for occupancy. If the owner performs additional services of such

4 This memorandum does not address nor is intended to address arrangements between an owner or

tenant and another individual which provides that the individual shall produce agricultural or horticultural
commodities on the land covered, or the agricultural and horticultural exception contained in section
1402(a)(1).
POSTN-123645-21 5

   substantial nature that compensation for them can be said to constitute a
   material part of the payment made by the tenant, the “rent” received then
   consists in part of income attributable to the performance of labor which is not
   incidental to the realization of return from passive investment.

Bobo at 709 (citing Delno v. Celebrezze, 347 F.2d 159, 166 (9th Cir. 1965) (relating to
parallel Social Security eligibility provisions). Again relying on Delno, the Tax Court first
determined that the phrase, “‘usually or customarily rendered’ . . . must be read with
emphasis upon the closing phrase ‘for occupancy only.’” Bobo at 710. The court
reasoned that an analysis of whether services are rendered solely for the convenience
of the occupants pursuant to Treas. Reg. § 1.1402(a)-4(c))(2) is a question of fact
based on “whether [the services rendered] are required to maintain the space in
condition for occupancy and, if not, whether [the services rendered] are substantial.” Id.
at 710-11; see also Johnson v. Commissioner, 60 T.C. 829, 832-33 (1973) (stating, “any
service not clearly required to maintain the property in condition for occupancy be
considered work performed for the tenant, and not for the conservation of invested
capital,” in support of a narrow construction of the exclusion from NESE for rental real
estate).

   Ultimately, the court determined that, even though the trailer park furnished

laundry services that were “clearly rendered for the convenience of the tenant and not to
maintain the property in condition for occupancy,” the tenants’ payments for the laundry
services were not “substantial enough to classify all the tenants’ [rental] payments as
received for ‘services to the occupants.’” Id. at 711 (citing Treas. Reg. § 1.1402(a)-
4(c)(2)). Accordingly, the court held the payments at issue were rental from real estate
excluded from NESE.

    In Rev. Rul. 83-139, 1983-2 C.B. 150, the Service relied on the Tax Court’s

analysis in Bobo (as it applied the holding in Delno) in distinguishing between two
factual situations. Situation (1) involved a trailer park owner and operator who operated
a trailer park that provided similar services to those provided in Bobo. Situation (2)
involved a trailer park owner and operator who provided a trailer park that provided all
the services as the trailer park in Bobo, but also operated “a recreation hall, consisting
of a card area, pool room, kitchen, auditorium, stage, and library.” The Service
determined, citing to Delno and Johnson, supra, that only situation (2) gave rise to
substantial services for the convenience of the occupant, stating:

   The Service agrees with the court in Bobo that each case turns upon the facts
   presented and whether the services provided by the trailer park owner are
   services rendered for the convenience of the tenants as opposed to services
   required to maintain the space rented to tenants in condition for occupancy.
   When determining whether service is for the maintenance of property, the courts
   have emphasized that the rental exclusion must be read narrowly and that any
   service not clearly required to maintain the property in condition for occupancy is
   considered work performed for the tenant.

POSTN-123645-21 6

Rev. Rul. 83-139, 1983-2 C.B. 150. Finding that the services were of such substantial
nature that the compensation for them could clearly be said to constitute a material part
of the payments made by the tenants, the Service ruled that the § 1402(a)(1) exclusion
for rental real estate did not apply in situation (2), and the income received was
includible in computing NESE.5

    In Hopper v Commissioner, 94 T.C. 542, 548 (1990), the Tax Court held that net

rental income from storage units where the landlord also provided a soft drink machine
and sold locks, packaging materials, pallets, and insurance, was excluded from the
owners’ NESE under § 1402(a)(1) because the services provided for the convenience of
the occupants of the storage units were not substantial. Even though Treas. Reg.
§ 1.1402(a)-4(c)(2) uses warehouses and storage garages as examples of activities that
are not rentals from real estate, the “nomenclature of the examples used” in Treas. Reg.
§ 1.1402(a)-4(c)(2) does not impact the analysis. Id. at 547. Rather, the § 1402(a)(1)
analysis depends on the facts and circumstances of each specific case. See id.
Specifically,

    Whether services are considered as rendered to the occupant within the meaning
    of section 1.1402(a)-4(c)(2), Income Tax Regs., raises a question of fact. This
    question can be resolved by determining whether such services are required to
    maintain the space in condition for occupancy. If the answer is yes, then the
    services are not considered as rendered to the occupant. In this regard, the
    services listed in section 1.1402(a)-4(c)(2), Income Tax Regs., as those which
    are required to maintain the space in condition for occupancy are only illustrative.

Id. at 547 (relying on Delno, 347 F.2d at 163, and Bobo, 70 T.C. at 710).

                                             Fact Situation 1

   The net rental income in Fact Situation 1 is not excluded from NESE under

§ 1402(a)(1) because the taxpayer provides substantial services beyond those required
to maintain the space in a condition suitable for occupancy. See Bobo, 70 T.C. at 710;
Rev. Rul. 83-139. Whether services are considered rendered for the occupant is based
on the particular facts and circumstances in each case. See Hopper, 94 T.C. at 548
(1990). Here, the payments made to the taxpayer for these services are for the
convenience of the property’s occupants. The services go beyond those clearly required
to maintain the space in a condition for occupancy and are of such a substantial nature
that the compensation for these services can be said to constitute a material portion of
the rent. Thus, the payments are not excluded under § 1402(a)(1) but rather are

5 The Social Security Administration (“SSA”) interprets its eligibility provisions using the reasoning from

Bobo and Rev. Rul. 83-139. See Net Earnings from Self-Employment-Rentals from Real Estate-Servs. to
Occupants of Mobile Home Parks, SSR 86-12 (S.S.A. 1986).
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included in NESE.6 The characterization of this activity as not a passive activity within
the meaning of § 469(c) does not affect whether the activity is excluded from NESE
under § 1402(a)(1).7
Fact Situation 2

   The net rental income from Fact Situation 2 is excluded from NESE under

§ 1402(a)(1) because the taxpayer does not provide substantial services beyond those
required to maintain the space in a condition suitable for occupancy. See Bobo, 70 T.C.
706 at 710; Rev. Rul. 83-139. Services the taxpayer provides to clean and maintain the
property to bring it to a suitable condition for occupancy are not relevant in applying
Treas. Reg. § 1.1402(a)-4(c)(2) because such services are not furnished primarily for
the convenience of the property’s occupants. See Hopper, 94 T.C. at 547. Further,
services provided for the convenience of occupants must be substantial, and whether
provided services are substantial depends on the facts and circumstances of each case.
See id. at 548. Specifically, the services provided for the convenience of the occupants
must be of such a substantial nature that compensation for them can be said to
constitute a material part of the payments made by the occupants. See id. at 546 (citing
Delno, 347 F.2d at 166). No such services are provided in Fact Situation 2. The
characterization of this activity as not a passive activity within the meaning of § 469(c)
does not affect whether the activity is excluded from NESE under § 1402(a)(1).

  Please call Mikhail Zhidkov of the Office of Associate Chief Counsel (Employee

Benefits, Exempt Organizations, and Employment Taxes) at (202) 317-4774 (not a toll-
free call) if you have further questions relating to section 1402. If your question relates
to section 469, please call Marla M. Borkson of the Office of Associate Chief Counsel
(Passthroughs & Special Industries) at (202) 317-6850 (not a toll-free call).

6 Rev. Rul. 57-108 suggests that, in the case of vacation property, the services for the convenience of the

occupants must be substantial, such as maid services, swimming and fishing instructions, and furnishing
local transportation schedules. Here, similar services are provided for the convenience of the occupants.
Thus, the exclusion under § 1402(a)(1) does not apply, and the net rental income is included in NESE.
7 If the activity were a rental activity under Treas. Reg. § 1.469-1T(e)(3) and, therefore, a passive activity

under § 469(c), a loss generated by this activity would still be limited for purposes of computing NESE
under § 1.469-1T(d)(3).