Short term rental in a foreign country

[Mohamed Youssef]

One of my clients recently asked about using the Short-Term Rental loophole for a property in a foreign country (Mexico). While short-term rentals (Airbnb, Vrbo, etc.) in the U.S. can offer tax advantages, the rules change when the property is outside the country. Here are the key tax implications we discussed:- 

- Depreciation takes longer: Foreign rental properties must use the Alternative Depreciation System (ADS), which means a 30-year depreciation schedule instead of 27.5 years for U.S. properties. If the IRS classifies the property as nonresidential, it could be 40 years. This results in smaller annual deductions.

- No bonus depreciation: Unlike U.S. rentals, foreign properties do not qualify for bonus depreciation. Any furniture, appliances, or renovations must be depreciated over longer ADS schedules rather than being deducted upfront.

- Cost segregation has limited benefits: While cost segregation can still be used to separate personal property items like furniture and fixtures, ADS rules apply. This means depreciation schedules are longer than they would be for a U.S. property, so the tax benefits aren’t as immediate.

- Material participation rules still apply: If you meet the IRS material participation tests, losses from a short-term rental can be treated as nonpassive, allowing them to offset W-2 or business income. The challenge with a foreign rental is proving active involvement remotely, especially if a property manager is handling day-to-day operations. Keeping detailed records is key but convincing the IRS will be a challenge.

- Foreign tax credit can help: If rental income is taxed in the country where the property is located, the U.S. offers a foreign tax credit to avoid double taxation. However, the credit is limited to the amount of U.S. tax owed on that same income, so it doesn’t always provide full relief.

While short-term rental in a foreign country could be a great investment and cash flow strategy, investors need to be aware of the limitations when it comes to tax planning.