Surge in cabin rentals in northern Minnesota sparks tax debate

At the tip of Minnesota's Arrowhead, the market for vacation rentals is so hot that even the residential real estate listings try to lure buyers by hyping the possibility of making money:

"Excellent VRBO potential," read one, referencing the Vacation Rental By Owner business.

"This tiny house is currently used as a rental … May through October," advertised another.

Thanks to the internet, renting out cabins has become so popular that some officials are now wondering: At what point does the simple family cabin morph into something more? And should it be taxed more heavily?

In Cook County, where the tourism rental frenzy is particularly acute, property tax Assessor Todd Smith is embarking on an angst-filled effort to consider changing how such dwellings are classified to ensure that the tax burden is fairly distributed.

"We're … trying to be as equitable to the taxpayers as we possibly can," Smith said. "That's really what our job is."

While properties in Minnesota fall into one of dozens of classifications for tax purposes, some assessors say there is no clear category for rented-out vacation homes. As Smith seeks guidance from state officials, his colleagues in other counties are taking note.

"They're leading the pack because they are affected the most," said Lake County Assessor Gregg Swartwoudt. "We're all waiting to see what happens."

Officials in the Cook County seat of Grand Marais scoured websites recently and found that a full 10 percent of the county's taxable parcels were listed on vacation rental websites.

While most of the county is forest owned by the state and federal government, outsiders have for decades owned vacation properties around the Gunflint Trail and the rocky North Shore of Lake Superior.

Many are family cabins, some of which have been rented out periodically. Others are individually owned, condo-style properties managed by resorts. But, more recently, some property owners seem to be placing multiple stand-alone properties into the short-term rental market full time.

Along one shoreline-hugging road, a small company from Kansas bought four houses or cabins over the past few years. Three have been renovated and are now offered on websites for upward of $345 a night. A vacation rental website shows them as mostly booked for the summer.

The cabins sold for handsome prices, Smith said. As set out by state rules, assessors used those sale prices to determine taxable value on comparable properties nearby.

The sales were "driving the market, so values were going up," Smith explained.

Rick and Arlene Campion were shocked this spring when the proposed taxable value on their longtime cabin was set to increase more than $50,000. The property where the retired couple go to relax and gaze at Lake Superior had been in Arlene Campion's family for decades. In all that time, they said, they had never seen such a steep jump in price.

So they appealed. Once appraisers realized their property wasn't the same as the nearby vacation rentals, their taxable value went down.

The problem, the Assessor's Office said, was the increase in value of nearby cabins used as vacation rentals.

"These people are doing it for a year-round rental business," Rick Campion said.

After several appeals by other cabin owners, Smith's office began to reconsider whether it was fair to assign the "noncommercial seasonal residential recreational" classification to everyone — those owning properties used solely as family cabins as well as those that seemed designed to rent out almost constantly.

Smith, who doesn't set tax rates but only determines classifications based on use, at one point considered designating popular rentals as commercial — something that could have raised some property taxes by 150 to 300 percent.

The proposal sparked some panic, including among some longtime residents who have recently invested time, energy and savings into building or restoring properties to rent out. A switch to a commercial classification could have destroyed their ability to do business.

But most short-term rentals simply aren't that profitable, argues Steve Surbaugh, co-owner of Cascade Vacation Rentals, which manages short-term rentals for property owners.

"Vacation rentals don't actually net very much money at the end of the day," Surbaugh said. He advises most clients that renting out their second homes can help pay for property taxes, insurance and utilities. Homes that do really well on the vacation rental market might also produce income to help with upgrades, maintenance and modest mortgage contributions, he said.

Real estate developer Tim Thone said a house he built along Lake Superior in 1995 has been offered as a vacation rental for decades, and he believes it is among the most booked on the North Shore. But he still doesn't make money from it, he said. There simply aren't enough interested renters most of the year.

He keeps the property because his family has made wonderful memories there, he said. But he argues that it shouldn't be compared to businesses that operate year round.

"My income is based on 150 nights a year," he said. "You really can't just paint it with a brush as if somebody's there every day."

Hoping to resolve the issue, Smith contacted the state Department of Revenue for advice. But he hasn't yet gotten a clear answer, he said.

"Changes in property use over time, including increase of vacation rentals by owner properties, create new circumstances," a department spokesman said in an e-mail to the Star Tribune. " … Our objective is to assist counties to apply the statute in a way that classifies property based on primary use."

Minnesota already has one of the most complicated property tax systems in the country, with dozens of classifications compared with just a handful in some states. Adding a new class isn't a popular idea.

But finding the right designation is a question of fairness, assessors say.

In some areas, hotel owners complain that they're losing revenue to less-regulated cabin rentals.

"If you're going to operate sometimes like a hotel, then you should be on equal footing," said Swartwoudt, the Lake County assessor. "These places that are truly Airbnb and vacation rentals, they're paying taxes as though they're residential properties, but they're being used to compete against hotels."

Jeff Forester, executive director of Minnesota Lakes and Rivers Advocates, formerly called the Minnesota Seasonal Recreational Property Owners Coalition, said the question being raised in Cook County is a twist on a vacation rental issue that he hadn't yet encountered.

The question, he said, is "at what point does it become a business?"

"Obviously we support the right of people to do what they want with their properties," Forester said. "There has to be some definition of what it means to be a business."

Vacation rentals have a significant economic impact, Surbaugh pointed out. A firm hired to study vacation rentals in Cook County in 2014 found that their guests spent more than $15 million a year, and lodging revenue increased 22 percent from 2012 to 2013. Since then, officials believe the number of rentals has continued to climb.

In the Brainerd Lakes area, another cabin hot spot, Crow Wing County Assessor Gary Griffin said he, too, would like more guidance on the classification issue.

"If you're in that arena, it kind of polarizes people one way or the other," he said. "I will be watching. Absolutely."

Pam Louwagie • 612-673-7102