If you are into Airbnb or VRBO, what are the top tax benefits and loopholes for short-term rentals? Toby Mathis and Jeff Webb of Anderson Advisors answer your tax questions. Submit your tax question to taxtuesday@andersonadvisors.
- We have to clean the short-term rental the first year to get the hours necessary for active/material participation. It is a 90-to-120 (minute or mile) drive one way. Since we will be working, can we stay in the unit that night without counting it as personal use? You can include the travel time. However, staying the night will not count toward working on it. It definitely counts as personal use.
- I have a beach house that I’m starting to rent out, so I got a DBA business name. I’ve been renovating and fixing it up to make it more attractive. I have a regular job and was told that if I made more than $150,000, I would not be able to write off my expenses and costs associated with my rental. Is this true? It depends on if it’s a rental or residential investment. Also, in some states and counties, the DBA is a fictitious name, and it offers no kind of protection or benefit at all.
- Can you explain the short-term rental tax benefit and how to get 100 hours of material participation? If short-term rentals are seven days or less, it’s a business. Determine if it’s 1245 or 1250 property and passive or active/material participation income.
- I have a four-unit that I want to live in and rent out the other three units. What are all the tax deductions and write-offs I can use to zero out earnings? Bifurcate it into two properties. One unit would be your personal residence and the other 75% would be rental properties. Any expenses related to your rental unit would go against your real estate taxes and mortgage interest.
For all questions/answers discussed, sign up to be a Platinum member to view the replay!
Go to iTunes to leave a review of the Tax Tuesday podcast.
Full Episode Transcript:
Toby: All right, welcome to Tax Tuesday. Hopefully you guys can hear us and all is good out there in tax land. My name is Toby Mathis.... Read Full Transcript
Jeff: And I’m Jeff Webb.
Toby: We are bringing tax knowledge to the masses today. Today’s an interesting one. I looked at the questions just a little bit ago. It seems like people have short-term rentals on the brain. I think I counted four or five questions that pertain to short-term rentals. If you’re somebody who’s into Airbnb, Vrbo, what are the other ones? Are there any others?
Jeff: Those are the only two I’m aware of.
Toby: Then this is going to be a fun day for you. If you’re not, there are other questions. I just noticed there was definitely a little bit of a bend towards that.
All right, this says VP of professional services. You are now the CFO.
Jeff: That is correct.
Toby: Yeah, to update our slides appropriately. A big CFO, which is great.
Jeff: Maybe I’ll put a CFO picture up.
Toby: I don’t even know what a CFO is. UFO, I’ve heard of. CFO, it just is rare.
All right. Where are you guys all coming from? If you’re sitting some place, just say what city and state. It’s always fun to see how many people are all over the place.
Twin Falls, Idaho. Look at that. Allison is fast. Boulder, Colorado. Now they’re just flying through. Oh, my God. This is horrible. I cannot read these fast enough. Portland, Los Angeles, West Orange. Nashville, Tennessee, New Jersey, Simi Valley, Mesa, Santa Cruz, Philadelphia, PA, my hometown.
There’s Seattle, Houston, McKinney, Texas. See now, totally I’m cheating. Tampa, Aliso Viejo, Portland Oregon. We got people from New York. Hey from New York. Los Angeles, Boone, Iowa. I don’t think I’ve ever seen Boone, Iowa. Robin, welcome.
Louisiana. Where in Louisiana, Ross? It’s a big state. We got some Kansas City, some West Orange, some Chicago in the house, Austin, Texas, Murfreesboro. That’s cool. Mark, welcome. We got people from all over the place. There’s Kansas City, Missouri.
We got BC, Canada in the house. I got a good friend, a lawyer up there in British Columbia and Vancouver. I had some friends. I actually had a consul, somebody that was sitting in Vancouver today. He said it was absolutely beautiful.
Green Valley, Arizona, some Las Vegas, that’s where we’re sitting. Seattle, Washington, St. George, Huntington Beach, California, surf capital of the world, and all over the place. There’s Honolulu. We have folks, really. There’s Lancaster, California. That was PA for a second. I was all getting excited and giddy.
We got people from across the country and even across some of the globe. Welcome. These are fun little tidbits. We should be here for about an hour. We already have a ton of people on. We have people on Facebook Live. Welcome and hey. I’ll give you the […].
Welcome to another fun-filled Tuesday, where we just try to answer questions. We’re going to go through the questions that we’re going to answer here in a second. Wait a second, Hawaii is the surfing capital of the world. Now we’re going to have a fight. I thought Huntington Beach was. I’ve seen Dukes there. I don’t know. Although I’d probably side with Hawaii, but that’s just me. The water is warmer.
All right. Email your questions during the week, firstname.lastname@example.org. We pick questions. Now we have a fight going on. I don’t think you guys can see each other, but Huntington Beach, apparently, it’s going to be all caps here in a second. We got Dukes.
If you guys have questions during the week, send them in. We pick them, then I read them, and Jeff and I answer them. That’s how it works. Hawaii has a patent on surfing. Oh, I don’t know. Opened up a can of worms on that one. We’ll say they’re both joined, because remember, you got Dukes in both places. Come on.
US opens hers. Yup, there we go. Huntington Beach is probably rocking right now. All right, we have a lot to go over that does not involve surfing unless we’re talking about the kind that you do on the Internet.
All right, opening questions. I picked some long ones and I apologize. They’re not always the most fun to read, but I get it. I just get a whole bunch and I just grabbed 10, 15, 20, whatever I feel like on that particular day, today. We’re in the teens. We’ll go through these, but they’re good and educational, that’s why I like them.
“We are converting our vacation home into a short-term rental in 2023. Too many personal days used in 2022.” I’ll explain what that means. Jeff and I will explain. “We want to make some updates, so we are wondering on the time. Should we convert to a short-term rental in early 2023, make it available for X days, then block out the calendar, then remodel an update? Or should we just do the remodel now in 2022 before converting, and then the basis when converted to the LLC will already be increased?”
Somebody has been doing their homework. You’re very very intelligent. You get a big star for even knowing these questions to ask. “I want to have a cost seg done and would like those updates included in the cost seg if I could.” Really good questions. This is why I love this one.
When I looked at it, it was just really long, and it had a bunch of XXX in it, and I was like, oh, my God, what are they asking? And then I realized it’s just the number of days. But I grabbed that one and I said, that’s going to be a good one.
All right, “We have to clean the short-term rental this first year to get the hours necessary for active participation. It is a 90–120 minute drive one way. Since we will be working, can we stay in the unit that night without counting it as personal use?” That’ll be an interesting one.
“If you’re retired and receive social security and annuity income, can you get your closing cost deducted from your income tax when you file?” We’ll answer that one.
“I’m setting up a corporation to wholesale and flip and later on hold real estate.” Please don’t hold it in the corporation, please. “I have high startup costs—$20,000—and this is my first business entity that I’ve ever started. I am a full-time ICU nurse and pay lots of taxes.” Thank you for your service. I know that’s a tough one. “Is there any way I can rollover losses from the corporation to my W-2 taxes from my nursing job?” Really good question. Jeff will probably be answering that one.
“I have a beach house that I’m starting to rent out. I got a DBA business name. I’ve been renovating and fixing it up to make it more attractive. I have a regular job and was told that if I made more than $150,000, I would not be able to write off my expenses and costs associated with my rental. Is this true?”
You see what I’m saying? These are good questions. It’d be very educational for everybody. It’s good for Jeff and I to discuss, too, because believe it or not, there are gray areas here.
“I have a C-Corp in Nevada through which I send some quarterly consulting and management revenue from my other manufacturing business. I don’t take a salary or dividends, but I use the earnings for equipment financing. On my taxes, I categorize most of the accumulated earnings as appropriated earnings to avoid the accumulated earnings tax, but the retained earnings numbers grow every year with the income taxes paid. How do I categorize earnings used for taxes to lower the chance of accumulated earnings tax?” Really good question.
I bet you guys have never heard of this thing before. We will have some fun with this one. This is where Jeff gets excited. I can’t really tell, but he’s definitely excited right now. Accumulated earnings tax. See? Some people used to say football. It’s football season, and there, like, yes, I get excited, if I say accumulated earnings tax. Jeff’s like, yes, it’s been so long.
“As an investor/owner, is it possible to claim part of my internet, phone, and home office as expenses?” We’ll talk about that.
“Can you explain the short-term rental tax benefit and how to get 100 hours of material participation?” We’ll go through that too.
“If I offset all of the passive income with depreciation or accelerated depreciation, would that eliminate the AMT adjustment? Note, W-2 income is less than $57,000 a year and very little interest from bank accounts of dividends less than $1000 per year for both.” Good question. AMT, another one. The mister here, the CPA guy next to me, is probably stoked today. That’s our new word for the day, stoked because of Huntington Beach.
“I have a four-unit. I want to live in and rent out the other three units.” House hacking. “What are all the tax deductions and write-offs I can use to zero out earnings?” We’ll be here till midnight going through all the different tax deductions. No, we’ll go through these, too.
All right, last couple of questions. “Any details on the short-term rental loophole in terms of how long to keep the rental in service for if you can do it for one year, and then benefit from classification, and then decide to use the property only for your personal use after that one year? If so, how much time does it need to stay in service or how many rental days do you need to have a year?” We’ll go through that. We’ll break that one down. That’s a little bit of a word salad. We will break that down into bite sized pieces.
“I bought a $400,000 home in 2021 and is now ready to use for short-term rental, to use the short-term rental loophole to offset some of my W-2 active income. I want to use cost segregation study and claim bonus depreciation. Any thoughts on using a DIY (do it yourself) for the cost seg on a property of this value?” Yes, and we will share them with you. You ready, Jeff?
Jeff: I’ve seen the short-term rental loophole a couple of times now.
Toby: I wonder whether they’ve been watching our channel. If you have W-2 income, this is one of the few ways where you can get some relief because it’s not a rental property. It’s a…
Jeff: Trade or business.
Toby: It’s a trade or business. People don’t realize that, necessarily. Hey, if you like this type of information, if you want to learn as much as you can, if you want to fill your brain full of tax strategies because, by the way, the Internal Revenue Code tells us what we should be investing in. They’ll usually say, hey, we’re going to beat you up if you do this, and we’re going to reward you if you do this over here. That way, you can go, let’s go over here.
By all means, go to our YouTube. Sign up, subscribe. It doesn’t cost you anything and you don’t get spammed. It’s literally just YouTube. If you like a video, please like it. Click the little Like button, whatever it is. It might say like, it might smile, or something.
It lets Google know that you’re actually watching it or YouTube knows, which is Google, and helps with our algorithms so we have better reach, so we can share our word. We’re getting the word out. Taxes are not just for boring people, but for exciting people like Jeff and me. We are really exciting.
All right, “We are converting our vacation home into a short-term rental in 2023. Too many personal days used in 2021 or 2022” By the way, what’s a short-term rental?
Jeff: A short-term rental is generally a home that you rent out to for an average of seven or less days and provide substantial services to your short-term tenants.
Toby: You don’t have to provide substantial services. It’s seven days or less, right? Basically, if you have 10 rentals and those 10 rentals use your house 300 days, your average term is 30 days per rental. If you flip that around, and you have 100 tenants during the year and rented for 300 days, your average stay is 3 days, which is 7 days or less, which means it’s not rental activity. It’s a trade or business.
Jeff: You’re running a hotel.
Toby: You’re running a hotel, and it’s non-residential, too. They say it’s transient nature, so it is not even residential property. We’re not writing off our home under 27½ years. We are writing off our home 39 years. Here’s the deal. They want to take a vacation home, which is called a second home. They used it too many personal days in 2022. Why is that important, Jeff?
Jeff: There’s a rule that says if you use it more than 10% of the days you rented it out, if you used it personally for more than 10% of the days or the second rule is more than 15 days, 15 days or more that it doesn’t count as a rental counts as a vacation home.
Toby: You go above, it’s the greater of 14 days or 10% of the total days rented. It’s treated as a residence, which means you can’t take losses on it. That’s the bad part. You would bifurcate out the portion that was used for business and the portion that was used for investing.
By the way, I had neglected to say something earlier. We have Matthew, Patty, Christos Dana, Dutch, Eliot, Ian, Piao, and Troy, all answering questions in the Q&A. If you have questions, do not put them into chat, put them into Q&A and you’ll have a tax attorney, CPA, or accountant answering your question, absolutely free. All right, sorry.
Jeff: What happens with a vacation home is your deductible expenses are limited to your income from that activity. If I have rental income of $10,000, but expenses of $100,000, my deductible, no loss.
Toby: No loss against your W-2. We don’t get to play the game of, hey, I have other passive income from other rental activities, I can’t use it. I’m toast. It sounds to me that they used it for too many days more than they rented it. It’s a residence, it’s not an investment property. They’re going to change that.
Now this is what’s really, really important. “We want to make some updates, so we’re wondering about the timing.” When I hear updates, they want to fix the place up. “Should we convert to a short-term rental in early 2023, make it available for XXX days, then block out the calendar, and then remodel or update? Or should we just do the remodel now?” What do you think, Jeff?
Jeff: I think I’m going to go ahead and start it out as that short-term rental, get a couple of rentals under my belt, then take it out of service for however long it takes to do those updates and remodels, and then get that done.
Toby: Jeff’s absolutely 100% right and I agree. I had put it into service, I would make my improvements, then I would take it out of service to do the improvements, and then put it back in. The reason that this is important is because when you look at a property—let’s say that this is specifically for short-term, this might not be the case on a long-term rental—I have structural components that are called 1250 property and I have personal property—things that can be removed—that are 1245.
Things that are 1245 have a much shorter, useful life, like your carpet can be removed. It has a useful life of five years, so we write it off much faster. Under our current setup, bonus depreciation is available on anything that’s below 20 years.
You could write off your carpeting in one year, whether it’s Airbnb or otherwise. But your structural, like your roof is still written off over, in this case, 39 years because it’s considered non-residential property, believe it or not, even though it’s treated like a hotel. The reason this is important is because when you have non-residential property and you make improvements to it, you can write off that improvement under a shorter lifespan. What is it, a 15-year property?
Toby: Any of it, I can write off in year one, right?
Jeff: But that expires at the end of this year.
Toby: You could do that in 2022.
Jeff: But not in 2023.
Toby: It won’t work in 2023.
Jeff: Unless they extend it again.
Toby: What are the chances? Right? Did they extend it because it was for 2018, 2019, 2020?
Jeff: And then extended to 2021 and 2022.
Toby: We’d have to also look at the Inflation Reduction Act to see if there’s anything in there, because they have been extending a lot of these. Let’s just go back to this. If it’s qualified improvement property, it is deductible immediately. If you have a non-residential property and you make improvements, you get to write it off even if it is something that would be considered 1250 property.
Otherwise, the only property you can accelerate depreciation on is 1245 property, which are cabinets, your fans, driveway, your carpeting, your linoleum, your cat, things that you put into the property.
If you put it into service, short-term rental, seven days or less, then do the updates, that should be considered, because like Jeff’s pointing out, it might not be the case next year, qualified improvement property, although they keep extending it.
If you just did the improvement now and then put it in the service, you’re not completely out of luck. It just means that the only property that gives you the massive deduction is that 1245 property, which is the five-year property, the seven-year property, and the 15-year property. That’s our little wackadoodle thing.
Jeff: The qualified improvement property that you’re talking about has to be in service at the time that you make those improvements.
Toby: What Jeff is saying is we have to have the property in service as a non-residential, trade or business, before the improvements are put in there in order for those to be deducted.
Jeff: Sometimes you make me sound really smart.
Toby: You’re smart. All right. That just says, hey, I have two choices here, which is going to yield me the greatest amount of deduction, put it into service, do the improvements. It’s almost always going to be better. It’s almost always going to be easier, too, from a cost seg standpoint as opposed to coming in after the fact and doing it.
The reason being is because you have all the receipts. You just did the big improvement and you could show the cost seg engineer, here’s what I spent it on. Instead of looking at it and I’m basing it on a percentage base, you can literally take, this is what they spent on it because here’s a receipt. It makes it a lot easier.
That’s your answer. You can absolutely do a cost seg. You can absolutely do the improvements in and under either one of those if you do the qualified improvement and we have the extension into 2023. If you did it this year, I could tell you definitively, the answer is you would just right off the qualified improvement.
If it’s next year, you should be able to see if they extend it. I just don’t know sitting here. But no matter what, you’ll be able to write off the 1245 property if you go through the process of getting a cost seg. A cost seg is nothing more than saying here’s the value of the carpet, here’s the value of the driveway, here’s the value of the shrubs, the fence, the cabinets that you put in, and here’s the value of some specialty plumbing and electric stuff.
All that, they compartmentalize. It’s usually about 30% of the improvement value of a property. If you do that, you can write that off 100% next year. You could absolutely do that, because of the bonus depreciation. When does it stop being 100? In two years?
Jeff: This year. In 2023, it drops 80%.
Toby: That makes me want to think about this a little bit.
Jeff: The other thing I was wondering was, would this be a candidate for a master lease?
Toby: It depends on whether they’re a real estate professional. I know what you’re saying.
Jeff: I’m thinking that it might be a way to turn it into a short-term rental in 2022.
Toby: But if they have too many personal days in 2022, then…
Jeff: I see what you’re saying.
Toby: It’s still a residence. It just means that we won’t be able to use the loss in 2022. What if we put it into service, did our improvement and then did a cost seg make it effective in 2023? You would still have your cost seg. All that means is that if I had $100,000 of improvements that were 1245 property, I get $80,000 deduction next year, as opposed to this year would be 100?
Jeff: No, that’s a good point. If you place it in service in 2022 and do the cost seg before the end of the year, actually, you can do it after the end of the year for 2022.
Toby: Yeah, you could actually do it next year.
Jeff: You’re going to get a little more bang for your buck.
Toby: Which by the way, you could actually be making this election to use a cost seg for 2021, even right now. Even though you’re sitting here in the second half of 2022, you could be making that election ticked in accelerated depreciation if you wanted to for your properties that you held last year in lowering your 2021 taxes.
There’s always a way to take advantage of the incentives that are put out there in the code. Sometimes you don’t realize, you can go back. You can even be making contributions to employer retirement plans, so long as you haven’t filed the return yet.
If you have an S-Corp and you have a Solo 401(k), you could still be making employer contributions for last year that are deductible in 2021. Somebody says, “Do you have to pay for all your upgrades or just sign a contract?” I believe you have to put them into service.
Jeff: It’s not even a matter of paying for it. It’s whether or not they’re being used in the business.
Toby: It actually has to be put into service. Otherwise, it wouldn’t work. I know what you guys are saying. In some cases, what is the one where they’re saying that a firm contract to purchase is in solar?
You’re seeing some people saying, hey, if you want the 30% credit, as long as you have a contract to purchase the solar and install it, it’s a hard contract that could be enforced against you, that you could take the tax credit this year. That’s the only time I see something where you could contract for it and actually get it from the government.
“We have to clean the short-term rental this first year to get the hours necessary for active participation.” There are no actual hours for active participation, but I think you mean material participation. Whatever, I get your point. “It is a 90–120 drive one way.” I don’t know if that’s a minute or mile. “Since we will be working, can we stay in the unit that night without counting it as personal use?”
Jeff: Some mixed questions. I think you can include the travel time. However, staying the night will not count towards working on it.
Toby: I think they’re saying, does it count as personal use?
Jeff: It definitely counts as personal use.
Toby: If you are staying in a house, I think they’re looking at the 14-day or the 10% of renting days, then they’re worried that they’re going to push themselves above the threshold and make it into a property that has to bifurcate the investment use versus the personal use.
Jeff: And this is going to be the IRS possessions. There’s a Motel 6 right down the street from your house. I know where that is.
Toby: So you would tell them not to stay in the property?
Jeff: I would say if it’s only one night, it’s probably not really going to affect anything unless you’ve already used it a bunch.
Toby: Here’s another way to look at it. How many days are you actually renting it this year? If it’s like 30 days or worse, let’s say it’s 20 days, make sure that you’re not doing more than 10% of those, because it could bite you. I understand that you want to stay with the unit the night.
I believe that the rules are that you can do it when you’re doing rehabs and remodels, and construction that you can stay in it. It doesn’t count. But when you’re not doing that, I think it counts as a personal day. Otherwise, people would just say, hey, I stayed there, but I was cleaning the unit for three days. I understand why they’re doing this because they want the material participation.
You don’t have to worry about hours. Again, if nobody else is cleaning your unit, nobody else is providing substantial services. You don’t have to worry about the 100-hour test. It’s only if somebody else is providing. If somebody else was cleaning it, then we’d be worried about you hitting your 100 hours. You would have to do more hours than anybody else.
If you have somebody cleaning your unit, that’s not the death knell. Make sure that you’re rotating that person, so nobody is doing more than 100 hours. Nobody’s doing more time than you. And then make sure that you’re documenting the time that you actually do things for the short-term rental, including handling your bookings, drive it there, doing any fix up, putting things around, whatever you’re working on on the property.
Just know that you got to keep good records, because the IRS looks at it. The tax courts have looked at these with a raised eyebrow when somebody drives along ways and they go, you didn’t do eight hours. You were there and you probably did too. If you ask for some ridiculous amount, they might look at you and say, no.
Jeff: Probably the biggest killer for material participation is a third party property manager for short-term rentals, especially if it’s out of state, if your property is out of state.
Toby: Make sure you’re doing the rentals. That’s the big one. Let me just go back and answer this. Active participation, by the way, is if you’re doing rental, not short-terms. The short-term rentals, seven days or less, is a trade or business.
If you’re doing rental activity, active participation, it just means you’re managing the manager. You get up to a $25,000 deduction. That is not the issue here. The issue here is material participation, just to put a little correction there.
All right, “If you are retired and receive social security and annuity income, can you get your closing cost deductible from your income tax when you file?”
Jeff: Reading this, I’m guessing they’re talking about closing costs on the purchase or sale of a house. If it’s on the sale of a house, it actually reduces your capital gains now. If you buy a house and have closing costs, it’s going to go into the basis of your property. If I buy a house for $100,000 and I have $10,000 for closing costs, I’m going to have a basis of $110,000.
Toby: I would say that there’s one exception to that rule, which is if you’re paying down points, if you’re paying down the cost of your loan, then you would write it off as what?
Jeff: It actually writes off as mortgage interest.
Toby: Yeah, that’s a mortgage. Prepaid mortgage is basically, some people call that a closing cost.
Jeff: Origination fees or…
Toby: Your traditional closing cost, you’re adding into your basis, or you’re writing it off as basis. It’s increasing your basis in both cases. One of them, you’re not using to deduct against anything. When you’re selling, you’re using it to deduct against the sales price, so you’re getting a deduction that way.
But it doesn’t matter whether you’re retired or receiving social security. They do not care. That rule is just hard and fast. You don’t get to write off closing costs with the one exception of closing costs that are actually interest deductions.
All right, “I’m setting up a corporation to wholesale and flip and later on hold real estate.” They’re going to wholesale and flip property and then they’re going to hold real estate. Don’t hold real estate in a corporation, period. The only exception is if you’re selling a property that was your personal residence to a wholly-owned S-Corporation for purposes of stepping up basis and accelerated depreciation and taking advantage of the 121 exclusion, which is the $250,000 or $500,000 exclusion.
If you’re moving out of a house, and you want to make it into a rental, and you’ve owned it for a while, and you want to step up the basis, because its property value has gone through the roof, you don’t have to pay tax on the gain. You could do that even on an installment sale. We would elect out of the installment sale treatment and just take the exclusion, which means no tax on the sale of your house. That’s the only time I want to see a house in a corporation. Can you think of anything else?
Jeff: No, not really.
Toby: If you’re going to hold real estate, do not do it in a corporation. If you’re going to flip real estate, then I don’t care. Do it in a corporation. “I have a high startup costs, $20,000 and this is my first business entity I’ve ever started. I’m a full-time ICU nurse and pay lots of taxes. Is there any way I can rollover losses from the corporation to my W-2 taxes from my nursing job?”
Jeff: There are no way to rollover losses from your corporation to your personal return, because it’s the corporation’s losses? The W-2, they’re your separate entities.
Toby: What if it’s an S-Corporation?
Jeff: S-Corporation, definitely.
Toby: Then you could write off the loss if you put the money in.
Jeff: Actually, any losses would roll over to you personally.
Toby: You could write off your ICU nurse, W-2, if the S-Corporation essentially paid you back. It has to incur the expense, right?
Toby: If you paid for stuff and you put it in there, and you said, hey, it’s going to reimburse you at some point, it’s a cash basis taxpayer, meaning that it gets to take the loss when it pays you back. You’re going to have to loan it some money to pay you back. It sounds goofy, but then the S-Corp would have a $20,000 loss and you could write it off on your personal taxes under those circumstances, if you materially participated in the business.
Jeff: Something I was thinking about, because you said, please don’t put your long-term rentals in your corporation. If you’re going to do long-term rentals, I would either rent them at my name or a partnership name and then have this very same corporation managing these rental properties.
Toby: Yeah. Somebody says, what should I hold real estate in if not a corporation? You’re always going to do an LLC if you’re in California. It might be in Wyoming statutory trust. If it’s in Florida, it might be a land trust. They have statutes just like LLCs.
It’s going to be in a pass-through entity that we can ignore for tax purposes or that can be held in a partnership, an LLC taxed as a partnership. The reason that we do that is to qualify for loans, because there’s a difference on where it gets reported for purposes of Freddie and Fannie loans. It’s 75% of value on page one of Schedule E. It’s 100% of values on page two of Schedule E on your 1040.
A K-1 that comes from a partnership goes on page two. A K-1 that comes from an S-Corp goes on page two. A disregarded entity that has real estate goes on page one of your Schedule E, which is really, really problematic if you’re trying to qualify for loans, because you want all the income to be to be carried.
Would you hold it in? What Jeff just said is absolutely 100% correct. If you’re going to have to buy and hold real estate, it’s going to be either an LLC or trust holding that real estate. More than likely, that LLC or trust is going to be directed and owned by a singular LLC, most likely in Wyoming, because nobody can take it away from you. That is taxed as a partnership.
If it’s your only one, it might be an LLC in your home state unless that home state is California or Florida, in which case we might do it slightly different. What Jeff said is even easier, because you could have the corporation manage that entity, and pull additional revenue out of it that goes from being something that would ordinarily flow on your return as rental income. And now is going to the corporation and coming in that’s using probably to reimburse your expenses that you’re carrying on its behalf or to pay expenses directly.
If this is confusing to you, guys, I would really encourage you to go to the YouTube channel and start watching the real estate videos, both myself and Clint. We go over this over, and over, and over again. We also teach a class called the Tax and Asset Protection Workshop every other Saturday. I’m going to probably show you a link. Actually, I don’t think I put it in there today, but maybe Patty will share a link out there in chat land.
You can go to the Tax and Asset Protection Event and we will teach you where you hold your real estate. It doesn’t cost you anything. You just come on except for a little bit of time. You got to go spend a day with us. You’re going to want to do that. Maybe Patty can share that link. You’re having people ask you, so I’ll just go, Patty, Patty. Patty. Just teasing. Somebody maybe we’ll share that link. They’ll get it out there. We’ll figure out where it is and we’ll send it out to you guys.
All right, “I have a beach house that I’m starting to rent out. I got a DBA business name. I’ve been renovating and fixing it up to make it more attractive. I have a regular job and was told that if I made more than $150,000, I would not be able to write off my expenses and costs associated with my rental. Is this true?”
Jeff: This is a first of a couple of questions that the answer is it depends. I want to address the DBA first. The DBA , in California, it’s called a fictitious name. It offers you no protection at all.
Toby: How do you know it’s in California?
Jeff: There’s a beach involved.
Toby: What if it’s Florida? What if it’s North Carolina? What if it’s South Carolina? What if it’s Virginia?
Jeff: The DBA doesn’t offer you with any liability protection nor does it give you any anonymity. At least in the case of California, they’re usually ran by the local counties and all. At least, who was actually the owner of that DBA?
Toby: A DBA does not give you any benefit, whatsoever, other than you get to possibly have another name on your check. I would actually put it in a trust or an LLC. If it is California or Wyoming, statutory trust to avoid the $800. There are beaches in Michigan. There are beaches in Ohio. There are beaches all over the place. There are a lot of beaches.
Jeff: Life’s a beach.
Toby: Like we were talking about earlier, there’s Huntington Beach and there’s Hawaii that has beaches. There are a lot of beaches. You’re not at a loss of beaches, but you immediately went to California?
Jeff: Yeah, I know.
Toby: All right, so the $150,000 rule, though, they’re obviously thinking of the active. Somebody said, you could only write off the expenses if it’s under $150,000. They’re talking about losses being deductible as an active participant in rental real estate.
You have this beach house. The first thing we got to figure out is, is it a residence that’s being used as an investment or is it just an investment? If it is just an investment, is it short-term or is it long-term?
Once we know those things, then we can give you a really good clear idea, because if it’s short-term rental, it’s not rental. We don’t worry about active participation. We don’t worry about real estate professional or any of those things. The only question is, is it ordinary loss, is it non-passive? And you get to write off all your expenses and depreciate the house.
If it’s a rental and it’s longer than an average stay of 7 days, longer than 8–30 days with substantial services provided, and then greater than 30 days with extraordinary services provided, those are the rules as to when it’s not a rental. If it’s a rental and you really are just doing this month-to-month or an annual lease, which is probably the more likely event, then the question is, can I write off my expenses? Yes. But if it creates a loss with your expenses and depreciation, now there’s an exception.
The exception to the general rule, the general rule being, I can’t use my passive losses against my active income. I can write off up to $25,000 of passive losses if I actively participated in real estate. That just means I picked the manager. I don’t have to manage the property, but it phases out between $100,000 and $150,000.
For every $2, it goes up above $100,000, your income, you lose $1 of deduction. At $150,000, you lose that $25,000 completely. If you’re making $100,000 a year, you can write off up to $25,000 of passive losses from rental real estate and use them against your income.
All of a sudden, let’s say you’re making $100,000 and you have $25,000 of loss, you’re now making $75,000. On top of that, your standard deduction, you’re barely paying taxes at all. You’re going to be really, really happy. That’s going to have a pretty major impact on your overall tax bill.
You get up to $150,000, that goes away, but you still have real estate professional, you still have the short-term rental, you still have some other things in your back pocket, plus you can always write off the expenses and costs against that income. If you have rental income, you can always use it. The only question is, can I write off the loss?
If it creates a loss, you do not lose your loss. You can use it against other passive income. If you have other rentals, if you have another business interests that you don’t materially participate in, you get to use it against it.
This is twisted, but you can actually use it against short-term rental that you do not materially participate in because you have somebody else do it and you’re passive, then you can even use it to offset that.
If I was in a pizza shop with Jeff—that’s my favorite example—Jeff and I opened a pizza shop. He works and I don’t do anything. I’m a silent partner. I could use any losses from my beach house to offset any income that the pizza parlor gives me because they’re both considered passive. Very exciting stuff, Jeff. I don’t know if anybody understood anything I just said.
All right, “I have a C-Corporation in Nevada through which I send some quarterly consulting and management revenue from my other manufacturing businesses.” It sounds like you have a management company that is contracted with other businesses, and it’s getting paid. “On my taxes, I categorize most of the accumulated earnings as appropriated earnings to avoid the accumulated earnings tax, but the retained earnings number grows every year with the income taxes paid. How do I categorize earnings used for taxes to lower the chance of an accumulated earnings tax?”
Jeff: I almost never see appropriated earnings used on the balance sheet for tax returns.
Toby: What is an appropriated earning?
Jeff: Appropriated earnings are earnings that you have set aside for a specific purpose. Maybe you’re going to open up another franchise, build a building, or something like that. Those would be appropriated earnings. Basically, you’re saying the money’s already spent.
Toby: What’s the accumulated earnings? What’s this tax? And why do we have to be aware of it?
Jeff: Accumulated earnings tax is a tax on corporations for basically not paying your money out to your investors, either in the form of dividends, salaries, or something.
Toby: In other words, you have a bunch of cash. The only reason you’re leaving it in there is because you didn’t want to pay tax on it. As long as you have another reason for that cash to be going in there—hey, I need it for other projects, I’m going to require more assets, I’m loaning it, I have revenue opportunities, but I need to have enough cash stockpile to do so—as long as you have some plausible reason, you don’t pay tax on it. I don’t think I’ve ever seen an accumulated earnings tax imposed on one of our clients.
Jeff: I have not seen it on any small clients I’ve ever worked with.
Toby: It’s when big companies have no reason to stockpile cash. They’re not expanding. They have no other reason then. They’re just sitting on it. They’re not giving it out to their shareholders, where the IRS would be able to charge a dividend tax, which is long-term capital gains or paid out in revenue, in which case the IRS would get revenue. They just want something to happen with the cash. If you’re just accumulating it, just make sure you have a reason to accumulate it that’s not tax-motivated.
Jeff: A couple of things about this tax is if you have less than $250,000 accumulated, it’s not looked at. It’s an automatic exemption. But if you do have more than that, sit down, write up a plan, put it in your file cabinet. I would also put it in the company minutes, what my plan is, why I’m holding this cash back.
Toby: As long as you’re documenting and you say, here’s what I’m doing, you’re going to be fine. You got to have a lot of cash before they even look at you. Again, I’ve not seen a small company ever get hit with this. It’s what, 20%, the accumulated earnings tax?
Jeff: Yup, 20%.
Toby: Yeah, so they just say, hey, you’re not using your money, let’s hit it. Just make sure you’re doing something with it and you have a reason. Invest it in something. Loan it, put it out on the street, do hard money, loans, loan it to yourself, I don’t care. Just do something. Jeff’s probably going to have an aneurysm if I say loan it to yourself, but you just make sure you’re documenting that you have a reason to be stockpiling cash.
Jeff: Loaning to yourself is actually a really good idea.
Toby: Or pay it out to yourself. It’s long-term capital gains. It’s going to be 0%, 15% or 20%. It’s not that bad of a hit.
Jeff: I wanted to go back to something they said earlier that it keeps getting bigger and bigger. What would you say about actually managing the money that’s coming in? Maybe they’re putting too much into the corporation?
Toby: Obviously, you’re going to have a better tax bracket. Maybe you’re in the highest bracket and you’re like, hey, it’s 21%. Loan it back out and use it in your other entities that are doing investments. Take out your mortgage. Take out any loans you have on any real estate. Buy more real estate. Use the money as a loan. Pay the corporation a small interest. That way, you never have to worry about it.
Jeff: Also take a hard look at reimbursable expenses that you could be deducting in the corporation to help lower some of these earnings.
Toby: A question that somebody asked that was in the chat. I know Patty makes everybody go to question and answer, but they asked a question about UBIT for short-term rentals in a 401(k). Have you seen the UBIT issue if somebody is doing short-term rentals in a 401(k)?
Jeff: Yes. Short-term rentals are a trade or business and they will generate UBIT.
Toby: Unless it’s passive?
Jeff: I think it’s still going to generate. It’s still trade or business.
Toby: It’s still trade or business income. UBIT is when you have unrelated business income and you’re doing an activity inside of a retirement plan, or any exempt entities. It’s UBIT. They basically say, hey, you’re in an active trade or business, it’s not fair not to tax you, because you’re competing with other businesses. I could see there being a couple of ways that you might be able to do that and get around, but it’s definitely something you want to talk to somebody and dig into.
You can generally get away with small amounts of things instead of a 401(k). If you’re flipping, we have like, hey, don’t do more than five flips. Stagger them, do them very seldom, or better yet, just borrow the money out of the 401(k) and do it in a corporation. It’s even better.
Let’s just say that you are doing some of this activity, just make sure that it’s the exception to the rule. Make sure that you cannot be managing that. That has to be a third party or you’re going to be dealing with some prohibitive transaction. Make sure that you’re not doing it.
Jeff: I think you really need to look at your strategy, because UBIT is taxed on unrelated business income, not losses. If you have a short-term rental that you’re running at a loss or close to breakeven, you could be holding that property for growth.
Toby: Most real estate, I know that there are people out there that do the 401(k) now because that’s where their money is and that’s what they’re investing in real estate, I get it. But short-term, you get such a huge tax benefit right now to have that in your personal realm. I would much prefer you guys have it in your personal realm.
Jeff: Can I add one more thing? Don’t do a cost segregation inside of an IRA or 401(k).
Toby: Not unless you’re borrowing a ton of money in an IRA. Probably, never. You shouldn’t be doing that anyway.
Hey, my partner Clint came out with this really cool book. I looked at this cover and I immediately said, oh, great, you did a men’s health book. Let’s see if you guys figure that one out. It’s Next Level Real Estate Asset Protection by Clint. He just put it out. I don’t think it’s even available. I think it gets shipped. Maybe now, I think. It’s number one Amazon new release in buying and selling homes. Fantastic. Clint does a really great job of breaking down the entities. Based on some of the questions I saw, you might want to be looking at it. It is available in Kindle and hard cover.
I’m just trying to remember. I think it just went live, so I think you can actually order it. Let’s see what it says, buy now. Wednesday, September 7th or pre-delivery by September 9th. I think it’s just coming out. It might be something. I get mine. It is available right now. Okay, you can go get it right now.
It’s really one of those things. We write. All of us are goobers, we write books. Someone says, I got a copy. Clint’s really, really good on the asset protection side. We do events all the time. I tend to do the tax and Clint does the asset protection. He’s really good at breaking down anonymity and with the difference between land trusts, corporations, statutory trusts, all that good stuff.
I don’t see any reason why this would not be a great thing for anybody who’s doing real estate to ask or to read, so it’s always fun. I got my copy. Jeff, do you have a copy?
Jeff: I don’t have my copy.
Toby: I might have an extra one for you in my room or in my office. I just like this because I can use it as a prop now so I can point at Jeff. That’s what I’m going to do and be like, he said it.
Jeff: What do you think, Jeff?
Toby: Yes. Anyway, I just like that. It has a funny arrow. When I first saw it again, I was like, oh, you’re writing a book on your experience with men’s health. I’m glad you’re coming clean, Clint. My understanding is that he took the blue pill and all he did is got taller.
All right, more questions. “Will you be giving Clint’s book out for free at upcoming events?” No, I don’t think so. I am clueless on it. That’s up to Clint. Somebody says, “Do you do cost segregation services?” No, but we have a great resource that we could send you, Erik Oliver over at Cost Seg Authority. aba.link/csa, I know that’s the link. Sorry, sometimes I’m offensive. Bad Toby, bad Toby.
All right, “As an investor/owner, is it possible to claim part of my internet, phone, and home office as expenses?”
Jeff: This is the second ‘it depends’ question. The Internet and phone, it’s going to depend on what entity you are. If you’re an S- or a C-Corp, you can deduct them 100% if your employer requires you to have internet and phone.
Toby: But if they’re just an investor in real estate, they would still be able to write off a few things, would they not?
Jeff: Yes. You could write off the Internet and phone, but it’s going to be limited to how much of it is used for the business.
Toby: What Jeff is talking about is if you have one of these beautiful little iPhones or whatever they are and your employer wants you to use it in your employment, I can reimburse 100%. If I work for Jeff, CPA, and I use this, hey, I have to answer tax questions, Jeff can reimburse me 100%. I don’t have to say what portion is personal or business. That’s the benefit of an accountable plan, when you’re an employee of an organization.
To be an employee, by the way, that organization must be taxed, not has to be, but it must be taxed as S-Corp, C-Corp, or a charity—501(c)(3). Most likely, if it’s for profit—it’s S- or a C-Corp, it could be an LLC taxed as an S-Corp, LLC taxed as a C-Corp—I am going to reimburse 100% of that.
If you are an investor, now I’m having to say, hey, I made 100 phone calls for 300 minutes, how many of those are related to your investment properties? Oh, you made three of those 100 calls and it was a portion of the time, I’m not going to get to write off much. That stinks. I need to be able to write off the whole thing. You need to have the corporation in the mix.
By the way, this explains that. Not to pimp Clint’s book too much, but when you come to our event, the Tax and Asset Protection event, we get into that. When you go and you spend time looking at the strategies that we’ve taught over the years and all the hundreds of hours of video on our YouTube, we explain that. We’re breaking that down quite often.
Jeff: I like what you just said and I think it’s even more applicable for the home office if you’re running it through a corporation who’s managing your […].
Toby: It’s much better. Literally 10 times the amount in several circumstances because instead of just doing the $5 an hour or $5 a square foot or the gross square footage, you can do net usable footage or you can do room methodology. Direct cost is 100%. Indirect costs, you can do portions. You could really get some benefit if you have an administrative office in the home that you’re being reimbursed for, as opposed to a traditional home office.
Somebody says, “What if you have a separate phone number for owner/investor activities?” Then you can break it down easier. If you have a separate phone or phone number that’s only used 100% for business, then you write that up. But then you have another phone for personal, and I’d rather not track it. That’s just me. I’d rather not deal with it. I’d rather just write it all off, which you can do if you’re an employee of your S-Corp or C-Corp.
Somebody says, “I bought the book, but I need to wait for the 6th of September. It’s worth it. Is it the 30th today?
Jeff: 30th, and the 5th is Labor Day.
Toby: “1031s are so stressful.” James, start doing reverse 1031s, where you acquire the property and then you sell. It might be a little bit less. Or find a good company that has properties that you can just talk to and maybe park it in investment properties until you find something that you really, really want. Just make sure you’re doing it that way. You might be doing the DST (Delaware Statutory Trust). It’s buying stuff.
“My CPA did my S-Corp the last two years as a short-term rental passive, but now I realize I’m actually qualified as a trade or business with that. Oh, my gosh, is it something that can be corrected?” Yeah, Mike, absolutely. You got three years. We could fix it. Sorry, I’m reading chats. I’m not going to read chats anymore. I’m going to go like this.
“Can you explain the short-term rental tax benefit and how to get 100 hours of material participation?”
Jeff: I don’t even know where to start with this one.
Toby. We already talked about short-term rentals.
Jeff: We talked a lot.
Toby: If there are seven days or less, it’s a business. Just think of a pizza parlor. Jeff and I entered into an agreement. We’re going to have an LLC that has a pizza shop. We’re going to buy a pizza oven. That’s equipment.
In a short-term rental, we’re in a business. We’re in the pizza business, but our equipment is the portion of the property that’s called 1245 property. We have to determine what that is versus the structure. We can’t write off the structure any faster than 39 years, but I can write off all of that, the linoleum on the floor, if you have hardwoods, the carpet, the countertops, all the specialty equipment.
If, hey, I had to plumb it, I had to put in electricity for this thing, I’m writing off a big chunk of that, about 30% of the value of the improvement of the home itself. Not the land, the improvement itself, I get to write off. If it’s a trade or business, whether I get to write that off against my W-2 income or my other income, depends on the type of income and it is, and did I materially participate?
Jeff and I have a pizza parlor. Jeff works in the pizza parlor, I do not. I’m just a silent owner. If there are losses, my loss is passive. I cannot use that passive loss against my W-2 income. Jeff is working in the business. He’s what’s called a material participant. He gets to use the loss against his other income.
When we look at a short-term rental, we now know it’s trade or business. If we create a loss by doing the cost seg and depreciating the pizza oven, the short-term components, now the only question is, am I working in the business or am I a silent partner? Working in the business means material participation.
There are seven tests of material participation. The easiest is nobody else works in the business, it’s just me. I don’t even have to have an hour requirement. The test that you’re looking at here is the second one, which is I did 100 hours and nobody else did more than me.
Jeff could qualify for this in our pizza oven. He could actually have done more than 100 hours in the pizza business. As long as nobody else did 100 hours, it’s material participation. Really tough to do if it’s a pizza shop or if it’s a short-term rental. Somebody’s going to probably be spending more time on it during the year.
You get to the next one, which is 500 hours. If I work 500 hours in my short-term rental, it doesn’t matter what anybody else does. I’m actively participating. I’m a material participant in that activity. I get to write off the losses against my W-2 and other income. That’s the-10,000 foot view of short-term rentals. Anything you want to add?
Jeff: I’m just think about, how do I get the hours? It could be anything from directly working on the property. It could be indirect collecting payments, calling repair people. It could be keeping the books and records for the property.
Toby: It has to be something involved with that property and managing that property. Again, if you do an Airbnb, you’re running the rent website, you’re talking to people, you’re doing this and the other. If you don’t want to worry about material participation, do everything yourself. You don’t have to worry about it.
That’s why you saw that earlier question about the cleaning. Cleaning could be considered a substantial activity. If somebody cleans the unit and you’re saying, hey, nobody else substantially participated in it, I did everything, the IRS would say, no, somebody else cleaned the unit. How many hours should they do? Now you’re down that path, like, oh, God, I have to figure this out.
It might be five hours, but now it just pushed you into a situation where you have to do 100 hours and nobody did more than you. By the way, it’s not just you. You and a spouse, if you’re married, have to add up to 100 hours. It’s not that difficult, really, if you’re consistently doing Airbnb activities. You still treat them as one big activity if you have multiple.
The question is always, can I get through that threshold for our clients? I’ll tell you, we usually have W-2 clients, there are a lot of doctors, a lot of professionals. They don’t want to have to meet that 100 hours. They’re just buying. Usually, they buy at the end of the year. Usually, October, November, December, they self-manage, get the big write off, and then turn it into a long-term rental.
They’re like, hey, I want the big deduction now. It saves me so much money against my income because I’m in the highest bracket. Every dollar I get to write off and put into this year is worth 50¢ to make it into a rental later, or I’ll let somebody else run it and I don’t care about the losses being passive or active anymore. That’s basically it.
“If I offset all of the passive income with depreciation or accelerated depreciation, would that eliminate the AMT adjustment?” This person is making less than $57,000 a year. Aren’t they underneath the threshold?
Jeff: Oh, yeah. The threshold for a single person is $73,000. For married, I think it’s $114,000. What used to be the biggest AMT adjustment was state and local taxes. Since they’ve been limited to $10,000, even that’s virtually gone. There are still a couple left.
Toby: You don’t use passive deduction against because it doesn’t offset active income.
Jeff: They can have different depreciation methods. We’re talking about short-term rentals so much. The life we said was 39 year. For AMT, it’s 40 years, so minute difference. ISOs tend to have a big effect on some stock options and tangible drilling costs. It’s not the normal thing that most people have.
Toby: Here’s the answer to this question. You don’t have to worry about it. You’re beneath the AMT threshold. You don’t have to worry about it at all. For anybody above that, talk to your account, because it’s really complicated. Your passive income would not really have an effect if it’s truly passive income.
Rental real estate’s not going to have any effect on your AMT equation. You’re going to either hit it or you’re not. What has an effect, like Jeff just said, are things that adjust your ordinary active income downward, which means oil and gas, losses from business in which you materially participate. Trades or businesses, that’s where the short-term rental could come in. What other things could actually adjust the AGI? It wouldn’t even be 401(k) or contributions to a retirement plan.
Jeff: Incentive stock options have a big effect.
Toby: There you go. All right. Sorry, Toby has been pontificating too much today. I’m going to be put in timeout.
“I have a four-unit I want to live in and rent out the other three units. What are the tax deductions and write offs I can use to zero out earnings?”
Jeff: Here’s how I would handle this. I would bifurcate, because it’s still bifurcated for cutting into four pieces. Anyway, this is into two properties. I’d have my personal residence on one of the units and the other 75% would be my rental properties. Any expenses related to my rental unit would go against my real estate taxes and mortgage interest. My share of that would go against my 1040 Schedule A. Any other expenses would be just like any other rental.
Toby: You’re just looking at the total expenses on it. I cannot depreciate my personal property. If I live in one unit and assuming that they’re all equal size, then you would get three quarters of the depreciation. You would get three quarters of the expenses that were incurred, like property taxes. You would get three quarters of things that were for the entire property, which you can’t really think of any others that would really go other than the property taxes.
Maybe the loan. Three quarters of the interest would be considered investment interest and not personal mortgage. You would just treat it three quarters as an investment property, one quarter as a personal home. Then when you went to sell it, you would do the same thing. You’d say, all right, if I sold it and there was gain, I could literally 1031 exchange three of the four units, the profit on it. I could use a 121 exclusion, the $500,000 or $250,000 of capital gain exclusion on the sale of a home, whether you’re married, filing, or single. I could use that against that one unit of the four.
Jeff: Exactly what I was thinking.
Toby: All right. I told you guys, people had short-term on the brain this last week. “Any details on the short-term rental loophole in terms of how long you keep the rental and service for if you can do it for one year, and then benefit from classification, and then decide to use the property only for your personal use after that one year? If so, how much time does it need to stay in service, or how many rental days do you need to have a year?”
Jeff: I would say first off that if you start renting it in (say) 2023, it needs to stay a short-term rental for the entire year, and do the cost segregation during that year to take advantage of the bonus depreciation, and then you can turn it into that personal property in 2024.
Toby: Technically, there’s no rule. Let’s say we looked at 2022. They’d say, is this short-term, is this long-term, is this a residence? Let’s go in reverse. Did you use it 14 days or 10% of the rented days?
Let’s say you rented it for 200 days. Did you use it for 20 days? If so, it’s a residence. There’s a portion of it that you’re not going to be able to take any deduction or loss against. There’s a portion of it, percentage wise, let’s say that you did 200 days and you had 20 days of business here for personal use.
You’d have 90% of the period of time was investment. You’d be able to write off 90% of the improvement, the depreciation amount, so you have to break it into that piece. You got to figure that out. Is it a residence or is it not? Then you look and say, is it long-term rental or is it short-term?
If it’s short-term with no residential use, like, hey, I didn’t live in it, I didn’t stay in it, then it’s really clean. Can I now write that off? Even if I only put it in service in December, the IRS would look at that one period of time and say, how many days was it rented? How many unique rentals were there? In other words, it was rented for 20 days and there were 4 different leases, Airbnb guests or bookings. You’d take the 20 divided by the 4, that’s 5 days, it’s short-term rental. For that year, it qualifies as a short-term rental.
Now we look at the following year and you ask the same questions again. Was it a residence? Was it an investment? If it was investment, was it short-term, was it long-term? It’s a whole other period.
To answer your question, you could put it into service in December. You could accelerate the depreciation, because it’s a trade or business. We don’t really care as long as you don’t get rid of the property. It’s not going to have a tax impact to accelerate depreciation into that first year as long as you’re not disposing of the asset. If you turn it into a residence the following year, it doesn’t do anything. It doesn’t hurt you.
Jeff: Yeah. Our concern is not how long you’re holding it, but things you may be doing during that same year that you’re short-term rental that’s going to ruin that short-term rental status.
Toby: Well, you rent it for a long period of time or you stay in it too much.
Jeff: Yeah, then you’re not going to be able to take that cost segregation and you’re not going to be able to get the big deduction.
Toby: That’s always the issue. People always say, we get this one. I think we had this one last time. Hey, I have a house, it’s worth a lot, I’m going to make it into a short-term rental at the end of the year.
This is why you can’t do that, because they say, how much of the time of the year? Was it residential? Were you staying in it or a member of your family or below market rents? Those are the things that they look at.
If I had been living in it all year, 300 days I was living in it, all right, that’s residence. There might be a small portion of the depreciation that you could take, but it’s not going to be much. You can’t use any of that loss against your other income for that period of time if it’s a residence. That’s where you get toast.
“Is there a video in the strategy where you buy properties into the year?” Yeah, look at my channel. You’ll see it. I think I just did one. I think cost seg is the number one tax strategy, but they’re definitely floating around there, or you look at Clint’s YouTube. There’s probably some on there too. I know he talks about it, but we both go into these concepts.
It’s a small world that you end up in when you’re in rental real estate. You see how we break it down. You’re thinking in little lists. Okay, is it residential? Do you have personal use? Is it a vacation home? Is it your residence?
There’s one that we never talked about, which is the 14 days or less, where if you don’t take depreciation, they don’t have to recognize any rents either. If you take your personal home and you rent it out for 14 days, you can take all that income, you don’t have to pay tax on it. You don’t have to report it, but you don’t depreciate the property either. It’s still a residence.
You look at it and say, okay, is it more than 14 days more than 10% of the use, whichever one is greater? Yes. Then we only get a proportion of the deduction? No. Then we get the full deduction. Then the only question is, is it residential real estate or is it non-residential real estate? Is it short-term? Is it considered rental activity or not?
If it’s not, then it’s a trade or business. If it is, then we lump it in with rental activities and other passive activities. Do you have any other passive activities that you’re involved in that generate profit? If we have a loss from this one, they offset or vice versa.
If you have extra losses that are passive, then we go down the next checklist. Are you an active participant, or are you a real estate professional and we just start going through a little list in our head saying whether there’s something that you could do to offset it? That’s really about it.
I just gave you a broad view, but that’s literally the whole world there on real estate. You’re just going through and seeing which bucket you’re going to fall in, which category, and then what are the rules for those? You get pretty deep and you get nuanced on little issues, but you’re looking at it for that 10,000 foot view. That’s about what it is.
Here’s a great example. “I bought a $400,000 home in 2021 and it’s now ready to use as a short-term rental, to use the short-term rental loophole,” I know everybody’s really interested in that one, “to offset some of my W-2 active income. I want to use a cost segregation study and claim bonus depreciation.”
They just hit everything we just talked about. It’s an active trade or business because it’s a short-term rental. It’s not a typical rental. They want to accelerate the depreciation on those items that can be removed from the home or removed from the property, which includes everything from your cabinets, to (again) your carpet, to your linoleum, to your driveway, to your sidewalks, to trees you put out there, to the flowers you plant, to the fence that you put out there.
All of that can be deducted. The last thing they said, bonus depreciation, I can write that whole thing off right now in one year. Then they go, “Should I use a do-it-yourself cost seg?” I don’t know your thoughts on it. Actually, I’ll ask you your thoughts.
Jeff: My thoughts are no, but I think you may have a different answer.
Toby: I would say, absolutely, 100% not, because the do-it-yourself sounds like a good deal. It might be a lower price, but it’s not the value. The value of having somebody do it, it’s what you’re supposed to do. It’s what the audit guide requires as an engineer. If you did it under a do-it-yourself, you’re still going to pay, but you’re gonna get so much less of a deduction, because they have to be so much more conservative.
In other words, if I had Erik Oliver and his team and his engineers go out to a property, a million dollar property, subtract the land off it. Let’s say it’s $200,000 of land, there’s $800,000. A good company’s going to give me between $200,000 and $240,000 of deduction.
A do-it-yourself might get me $150,000. What’s the cost to you of losing out on that extra $50,000-$70,000 of deduction? Depends on your tax bill, but it’s significantly higher than any savings you’re getting on a do-it-yourself.
Jeff: Sometimes we fall into that, I’m just going to get the store brand because it’s cheaper and it tastes the same. This ain’t it. This can make a huge difference on your deduction. Yeah, it may sound expensive for what you’re paying for it, but you’re more than getting that back in your cost segregation.
Jeff: Yup. If you’re going to do something, focus on value. The way I used to say it, because I used to make fun of H&R Block and some of the others—no offense if you work for them—-I just pointed out that when it came to business returns and investment returns, the government said they got 0% correct when they actually did the study on them. I thought that was really extraordinary.
How do you do it? None. You think a broken clock is we just write with twice a day, they would have gotten one right, but they didn’t. You might be able to go there and save 20% on tax prep. Because I went to H&R Block. Yes, I saved money. No, you didn’t because they did it wrong and you missed out on $10,000 worth of tax benefit, so you saved $200.
Let’s say that it was $800 to get your returns done at H&R Block when you could have gone to a CPA firm or a good firm and paid $1000. Somebody says, I saved $200, but it costs me $10,000. That’s value versus price. Wealthy people focus on value. They want to know that it’s done right.
I’ll just tell you, we could be doing the cost seg studies. If I was going to do a do-it-yourself, they have solutions for CPA firms and lawyers to use to do the studies, but it’s not in your best interest. Yes, I could actually make money on it, but it’s not in our clients’ best interest, so we don’t do it.
“I am an engineer that can do cost seg for others. Do you still recommend a third party?” Jeffrey, I would talk to Cost Seg Authority, absolutely. Even you, you could probably do your own, but it’s like the doctor working on themselves or the lawyer representing themselves. They say the lawyer that represents himself has a fool for a client. It’s because you’re gonna have blinders on.
Again, it’s up to you, but I would actually talk to Cost Seg Authority. Maybe you could do analysis for them. Or maybe they could work with you because you’re a professional and say, hey, here, it’s going to take us a lot less time if you do all this work, but if you do this, we’ll assist you. Just have that discussion. But as a matter of course, don’t do things yourself.
Everybody that always knows that, there’s a learning curve and there’s always a price to be paid. I’d rather you not pay that price. I’d rather you get the benefit. The Cost Seg Authority will tell you whether the benefits are worth it, because they will do an analysis before they charge you to tell you what they think it will get.
“How about cost seg, can we use it for the long-term?” Yeah. I don’t know what that means.
Jeff: Long-term rentals, but yes.
Toby: Yeah, you absolutely can. You’re breaking it down. Again, you have that study. I look at the IRS audit guide, and it wants a professional study of somebody who went into the property. There’s an exception if you have the same property, same build, like it’s the same home or the same units in an apartment complex or something along those lines. But for single families, you do them for each one. You don’t mess around.
It’s not worth it. The money saved versus actually being physically in there, and getting the nuances, and getting every dollar as a deduction, the amount that you leave behind is much more than the extra cost that would have cost to do it right.
There’s my YouTube channel. If you haven’t heard about it enough, there it is. Again, I’m staring at you. You can go in there and subscribe. We like subscribers to it. There are lots and lots of playlists. Some of you guys said, where do I find out more information about the short-term strategy and things like that. Go in there and coast around my channel, you will find it.
Last thing, ask your questions. We answered, I’m looking at 275 questions we had. We had a really good group on, so we had 275 questions. You could ask email@example.com during the next two weeks between our Tax Tuesdays, and we still answer your questions. Why do we do this, Jeff? Are we just nuts because we like answering tax questions for nothing?
Jeff: We like educating people. A smart client is a better client.
Toby: Smart clients are the best clients.
Somebody says, “Are new builds still need a cost seg engineer?” Not necessarily. You still want to have somebody that understands it. But if you ever broke down the components and what you cost, then you can do it, absolutely.
All right. I don’t sell cost seg, guys. I’ll just send you someplace else. Yeah, Jeffrey, if you reach out, we’ll send you the team that does it. We work with a firm, a CPA firm. All they do is energy credits and cost segregation.
Energy credits are going to be huge next year, the 45L. If you’re doing rehabs, if you’re building properties, you want to be aware of this. It’s up to a $5000 tax credit per unit. If you do apartments, you want to be aware of these things to see if you can get the tax credit. Not a deduction, it’s a credit. They just extended not only the 2000, but they enhanced it and made it easier.
Somebody says, “Doing my cost seg walkthroughs this week.” Yes. You can do cost segs even for 2021 still. You can do them even if you sold the property. You’d be shocked at how much you might actually get put back in your pocket when you do it.
Anyway, reach out to us at firstname.lastname@example.org. Visit us on our website. Sign up for our courses. We teach them every other week. We love going out and educating you. Anything else, sir?
Jeff: No, sir.
Toby: Very active group today. You guys get a star. I know we were heavy on the short-term rentals. I get that.
Jeff: Do we have some questions on those?
Toby: Yeah, we had a couple of questions on short-term rentals. We have days where we have none and then we just got […]. At least you guys are thinking, which is awesome. That was awesome. I appreciate you guys. We will see you in two weeks. Until then, this is Toby and…
Toby: At Tax Tuesday. Thanks, guys.
As always, take advantage of our free educational content. And every other Tuesday we have Toby’s Tax Tuesday, a great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets.
- Claim your FREE Strategy Session, and learn how Anderson Advisors can protect your assets.
- Join our next Tax & Asset Protection event to learn more advanced tax minimization & entity structuring strategies
- For all things investing, check out the Infinity Investing YouTube channel
- Subscribe to our YouTube channel to make sure you never miss the latest strategies & updates