A tax policy confusion: Where do short-term rental properties fit?

Property owners and businesses in Cook County that operate short-term rentals could see large increases in their property taxes in the coming years if a state directive becomes reality.  

A memo from the Minnesota Department of Revenue dated May 21 that was sent to every county assessor in the state says any property where the primary use of the home is a short-term rental should be classified as a 3a commercial property.

Currently, at least in Cook County, short-term rentals are classified as residential non-homestead and pay a significantly lower property tax than they would pay if taxed at the commercial rate. The exact ramifications of changing the tax classification for short-term rentals to commercial remains undefined because it involves a number of variables. But the impact could be significant. Cook County Auditor-Treasurer Braidy Powers says the property taxes for some short-term rentals on the North Shore and surrounding area could nearly triple based on the directive from the Minnesota Department of Revenue.

“Short-term rentals” include family cabins in the woods that are rented by the night, homes and other units in Grand Marais that sit in the allowed-use zone and condominiums in developments like Bluefin Bay, Lutsen Resort and Caribou Highlands.

In 2018, then Cook County Assessor Todd Smith (Smith has since been replaced by new Cook County Assessor Bob Thompson) and other county staff formed the shell of a plan to reclassify all short-term rentals in Cook County as “residential non-homestead.” The genesis of this notion was, in the view of the county assessor, to properly classify a property based on its use.

Under the directive of the May 21 memo, it appears the state Department of Revenue has disallowed the classification change and ruled that the short-term rentals should be classified as 3a commercial, according to Cook County Chamber of Commerce Director Jim Boyd.

“The difference is huge and, if allowed to stand, would destroy the short-term rental market,” Boyd said. “The impact on our economy could be devastating.”

The May 21 memo states clearly that any property in the state of Minnesota where the primary use is short-term rental needs to be classified as a 3a commercial property. However, what determines ‘the primary use’ of a property in this context leaves room for interpretation. The memo states that it “does not address how assessors should determine or verify a property’s primary use, the first step in classification.”

Jon Klockziem is the director of the property tax division for the Minnesota Department of Revenue. Klockziem is listed as the author of the May 21 memo. In an interview with WTIP that lasted for more than 30 minutes, Klockziem covered a variety of topics, including how much leeway an assessor has for determining the primary use of a short-term rental. And while the directive leaves room for interpretation to a county assessor, there are guidelines. It says county assessors should look to the following information and documentation for help in determining if a property’s primary use is short-term rental:

• Permits and licensure from the state or local government entity;
• Booking records or information from third party accommodation intermediaries;
• Income and expense records of the property;
• Occupancy records for the property.

During a meeting of the Cook County Board of Commissioners May 28, the board voted 5-0 to adopt a short-term rental ordinance. A section of the ordinance requires any property owner operating a short-term rental in Cook County to apply for a permit starting in January 2020. This appears to trigger one of the qualifiers listed in the memo from the Department of Revenue.

County Administrator Jeff Cadwell told WTIP the specifics of what the Department of Revenue directive means for Cook County remains somewhat unclear.  

“We don’t know yet what it means,” Cadwell said. “Really, we need some time to work through this. The county attorney, Braidy and I have not had a chance to meet with the assessor’s office and we have not had a chance to discuss with the board.”

And while classification for taxation, or defining the primary use of a property remains somewhat undefined, what’s even more challenging is sorting through what the tax increases will be should vacation rentals be classified as commercial property in Cook County.

The increase that short-term rental owners would face is difficult to calculate in part because of the 1996 Iron Range Fiscal Disparities Act. The Minnesota Legislature passed the act to aid communities in northern Minnesota that have a limited commercial-industrial tax base. The easiest way to think of the program is that certain cities get a share of property taxes from other communities that have more property wealth.

When WTIP showed Powers a chart of how the proposed classification change for short-term rentals could nearly triple the property taxes for most of these properties, Powers said the increases could actually be larger because of the Fiscal Disparities Act.

The chart was prepared by staff in the Cook County Assessor’s office. In a statement sent to WTIP, Powers explains:

“If we have relatively more relative commercial growth than the other six counties due to new classification of these VRBOs, then our fiscal disparities cost would go up more than shown, but if we have relatively less commercial growth than the other six counties due to new classification of these VRBOs, then our cost of fiscal disparities would go down from what is shown,” the statement reads. 

“My guess is that we would have a greater shift to commercial than the other counties due to this reclassification and thus a higher fiscal-disparities cost than shown,” Powers concluded.

WTIP obtained a copy of the chart reflecting the changes in property taxes for short-term rentals if they are classified as commercial. One example from this chart shows the following for a short-term rental currently in operation near Highway 61 in Tofte. The estimated market value for this property is $434,500.

These are the estimated property taxes under the varying classifications:

• Classified as 4c (12) (seasonal rec): $4,575
• 4b (1) (residential non-homestead, which is the current classification): $4,716
• 3a commercial (the proposed classification by the Department of Revenue): $12,252

State Senate Minority Leader Tom Bakk told WTIP that the increases in taxes on short-term rentals could have a ripple effect on other property owners in Cook County.

“If this happens it should lower taxes for homestead, seasonal rec and other commercial property significantly,” Bakk said.