Skift Take

We’ve been talking a lot about the intersection of real estate and short-term rentals and today we continue to do so with another related topic: 1031 exchanges.

We’ve been talking a lot about the intersection of real estate and short-term rentals and today we continue to do so with another related topic: 1031 exchanges.

For the uninitiated, in the U.S., 1031 exchanges involve swapping one income property for another for a tax advantage — transferring capital gains from a relinquished property to a newer one while allowing the investment to grow while deferring tax payments. For those eligible for a 1031 exchange, taxes from the sale are postponed until a future sale, potentially spanning several years.

Naturally, I was curious to know if these exchanges are popular among vacation rental and short-term rental property owners. 

The simple answer is yes. 

“I’ve had a lot of customers reach out to me regarding the 1031 exchanges. Right now it’s really hot amongst rental property owners,” said Cathyana Jean-Baptiste, founder and CEO of Skinny Tax, a Los Angeles-based accounting firm. “Generally back in the day, it was more companies that were doing these 1031 exchanges. Now I’m seeing a lot of regular homeowners getting into the business of 1031 exchanges. So there’s been an uptick in terms of the tax services for a general individual who wants to dive into a 1031 exchange and wants to switch one property for the other.”

Baptiste said that earlier 1031 exchanges were used by those in the business of flipping rental properties — think property managers, family offices, high net worth individuals, real estate developers. Today it is often an average taxpayer, who owns a primary residence but has a little income on the side, so decides to buy a small house to turn into a rental property or a unit to turn into a rental property.

“The Airbnb market has really brought 1031 exchanges to light,” Baptiste said. “A lot of people are saying, hey, I can rent properties out through this app. So let me get into the rental property market. And that’s why a lot of us tax professionals, we’ve seen a big uptick on these exchanges.”

That this is happening is not surprising — property owners are realizing that they are facing challenges, and as prices increase and properties are on the market longer, the management upkeep and expenses only continue to build up. 

What does this mean for the economy and the general residential housing market?

“So obviously, it’s bringing more passive income to the average individual taxpayer. But it is creating a situation where the rental property market is affecting the available housing for tenants trying to move in the longer term,” Baptiste said. “And I’ve noticed that with the Airbnb regulations in Los Angeles, for example, they’re having an issue with these individual taxpayers and small companies buying out a whole bunch of properties in certain neighborhoods just to flip them into rental properties. It’s shifting the available market for first-time homebuyers to a more expensive price point.”

The reason why Baptiste says it’s taking away real estate from long-term housing is because a 1031 exchange of a rental property has to be swapped with another rental property. It can’t be a flip from a rental property to a property that’s going to be used as a primary residence. 

And what are the macroeconomic implications of tilt from institutional real estate toward a new profile of home swappers?

“I think a lot of the risk comes with the actual maintenance of those rental properties,” Baptiste said. “A lot of the reason why this market was closed off to the average taxpayer is there’s a lot of maintenance. And so whether it’s,  fixing the units up, getting in the right tenants, and especially with a market where we had the COVID scare where people were basically allowed not to pay rent for several months — how do you maintain it in that situation?”

Baptiste also noted that individual homeowners may not have reserves for a liability situation. 

“If something, a shooting happens in that rental unit, someone dies or someone gets injured, they won’t have enough money to get out of that bad circumstance,” Baptiste said. “And insurance doesn’t cover all of the expenses and the risk of owning a rental building with tenants.”

Clark County Conundrums

Clark County, Nevada has witnessed numerous challenges with the process of legalizing, licensing, and regulating short-term rental units. These include legal battles over the constitutionality of proposed ordinances, extended deadlines for gathering required paperwork, and a pending lawsuit from short-term rental owners claiming that the convoluted process is harming their livelihoods. Clark County officials defend the process, aiming to subject vacation rentals to the same taxes as hotels.

The path to regulation began in 2021 and Clark County and other cities complied, but critics argue that the county’s rules are overly complex. The City of Henderson, for instance, requires significant spacing between rental units, Las Vegas only permits owner-occupied homes with limited rooms for rentals, and Clark County enforces curfews and specific usage rules.

Around 1,300 out of an estimated 7,000 to 10,000 short-term rental units have applied for licenses in the county. The licensing process involves extensive documentation and has faced criticism for being discouraging and poorly communicated. Similar to a ruling in Austin, the Greater Los Vegas Short-Term Rental Association filed a lawsuit against the county that resulted in some regulations being ruled unconstitutional. That led to adjustments but didn’t fully address other concerns.

Governor’s Plea

Arizona Governor Katie Hobbs has urged lawmakers to reconsider the 2016 law that removed cities’ authority to regulate vacation rentals, according to Tuscon.com. The lack of affordable housing in places like Sedona has become an urgent issue. When asked whether communities should be able to outlaw vacation rentals entirely, Hobbs responded, “I don’t have an answer for that.”

The 2016 law was initially presented to lawmakers as a way for individuals to earn extra income by renting out spare rooms. However, the actual outcome has been different, with investors buying up homes and apartments to turn them into short-term rentals, reducing housing availability for local residents. In response to complaints, lawmakers gave cities limited powers to require registration and manage noise and other violations. Yet, attempts to implement stricter measures, such as capping the number of short-term rentals in a neighborhood, have not succeeded.

Hobbs said that cities should have the ability to regulate vacation rentals according to their unique needs, which may involve rolling back state-imposed restrictions. As an example, she pointed to Sedona, where a significant portion of housing units are used for short-term rentals, affecting workforce housing availability and the ability of tourism industry workers to live in the area.

Bridgewater Regulates

The Township Council in Bridgewater, New Jersey has introduced an ordinance aimed at regulating Airbnb and similar short-term rentals. The ordinance, which received a 3-2 vote in favor, will advance to a public hearing and potential final adoption on August 17. This measure would require platforms like Airbnb to only list rentals for a minimum of 30 days. 

Into Guesty

In more AI integration news, INTO, a company specializing in AI integration and Montreal-based property management software provider Angel Host, have partnered to launch INTO GUESTY, an integration that combines AI with the Guesty platform to provide property managers with guest messaging tools.

Canadian Contrasts

The city of Montreal has established a four-person squad to clamp down on illegal Airbnb operations, especially in the Plateau-Mont-Royal, Ville-Marie, and Sud-Ouest boroughs where these listings are concentrated. Despite being prohibited in many areas, short-term rentals operate without permits. The initiative allows inspectors to assess properties without prior notice and issue fines, with penalties increasing for repeat offenses — $1,000 and $2,000, while corporations face fines ranging from $2,000 to $4,000.

This move follows a fatal fire in March 2023 that highlighted the lack of oversight for such rentals. The tragedy prompted Quebec to require permit numbers on listings, and effective from September 1, the city will impose penalties of up to $100,000 on online travel agencies for not complying with the regulations. 

Meanwhile on the other side of the country, Nova Scotia’s provincial government is taking urgent actions in response to the housing crisis. It is collaborating with Canadian online home-sharing platform Happipad hoping and urging Nova Scotians to rent out their extra rooms to individuals looking for short-term rentals. The partnership with an investment of $1.3 million will aim to encourage residents of Nova Scotia to offer their spare rooms for short-term rentals, thus providing a potential solution to the housing shortage.

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