Short-Term Rental Units in an Apartment Syndication: Tax, Loan and Local Rules
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Renting some apartment units by the night or week, or as furnished stays, can raise revenue per unit, but in a syndication it changes four things. Tax: under the passive activity rules, an activity whose average customer stay is seven days or less is not a "rental activity" (26 CFR 1.469-1T(e)(3)(ii)), and a building counts as residential rental property (27.5-year depreciation) only if at least 80% of its gross rental income comes from dwelling units, which exclude units in an establishment where more than half the units are used on a transient basis (26 U.S.C. 168(e)(2)(A)). Loans: multifamily loan documents commonly restrict leases shorter than a set term or transient use. Insurance: standard apartment policies may not cover transient occupancy. And local law: many cities require permits, collect hotel occupancy taxes, cap or ban short-term rentals in apartment buildings. Check all four before short stays go into a business plan.
This guide walks through each. For the business plan as a whole, see the value-add business plan.
How do short stays affect passive activity rules?
Under the temporary regulations, an activity involving the use of tangible property is not a rental activity if the average period of customer use is seven days or less, or 30 days or less when the owner provides significant personal services. Such an activity is treated as a business, and whether it is passive depends on material participation. For limited partners in a syndication that usually still means passive treatment, but the deal's CPA needs to track the short-stay units as a possibly separate activity and report it correctly. See passive loss carryovers.
How do short stays affect depreciation?
A building is residential rental property, depreciated over 27.5 years, only if 80% or more of its gross rental income for the year is rental income from dwelling units. Units in a hotel, motel or other establishment where more than half of the units are used on a transient basis are not dwelling units. So:
- A few furnished or nightly units in a 100-unit building, producing a small share of rent, generally leave the building residential.
- If short-stay income grows past 20% of gross rental income, or more than half the units go transient, the building can become nonresidential real property, depreciated over 39 years, which lowers annual depreciation for every investor.
Model the percentage before you convert units, and ask your CPA how cost segregation results change.
What do lenders and insurers say?
- Loan documents. Many multifamily loan agreements require residential leases of a minimum term, prohibit transient or hotel use, or require lender consent to change the property's use. A violation can be a default. Read the loan agreement and get written consent before adding short stays.
- Insurance. Standard apartment policies are written for residential tenants. Transient guests can change the risk and may need a different policy or endorsement. Tell your broker first. See syndication insurance.
What about local rules?
Cities regulate short-term rentals in very different ways: registration or permits, a cap on nights, owner-occupancy requirements that apartment owners cannot meet, building-wide bans, and hotel occupancy taxes collected by the owner or the platform. Some ban short-term rentals in multifamily buildings entirely. Check the city's current rules and any lease or HOA restrictions, and plan for them to change during your hold.
Is it worth it?
Short stays can earn more per night, but they bring higher turnover cost, furnishing, cleaning, platform fees, staffing and vacancy between stays, plus the tax, lender and legal risks above. Many sponsors who try it limit it to a small share of units in markets that clearly allow it. If you include it, show investors the assumptions, the share of income and the downside if the city or lender stops it.
How DoorRaise fits in
DoorRaise helps sponsors raise equity for apartment buildings with 5+ units from their friends and followers under Rule 506(b) or 506(c). It prepares the standard offering documents, forms the LLC, files Form D and state notices, and verifies accredited investors for 506(c) deals. Escrow is at Enterprise Bank & Trust, an FDIC-insured bank, and investors fund by wire only. See pricing. DoorRaise is not a law firm, broker-dealer, investment adviser, funding portal or bank.
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DoorRaise is built for apartment buildings with 5 or more units: one link for the deal, escrow until closing and a standard fee card.
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FAQ
Does a short-term rental unit make investors' losses non-passive?
Not for typical limited partners. The short-stay activity may not be a rental activity, but limited partners rarely materially participate, so their share generally stays passive.
Do furnished 30-day-plus corporate rentals count as short-term?
Stays longer than 30 days are generally rental activity, and a furnished apartment leased monthly is usually still a dwelling unit. Local rules may still define "short-term" differently.
Can the deal pass occupancy taxes to guests?
Usually yes, but the deal (or the platform) must register, collect and remit them as local law requires.
Will a lender let us add short stays later?
Only with consent if the loan restricts it. Ask before you close if short stays are part of the plan.
Next step: see other income ideas that keep the building residential in other income in underwriting.
Sources
- 26 CFR 1.469-1T, passive activity rules (definition of rental activity and the 7-day exception)
- 26 U.S.C. 168(e)(2), residential rental property and dwelling units
- IRS Publication 527, Residential Rental Property
This article is general information, not tax, legal or investment advice. Local rules change often. Talk to a CPA, your lender and a local attorney before renting units short term. DoorRaise is not a law firm, broker-dealer, investment adviser or funding portal.