First property and STR loophole with bonus depreciation

[John Lim]

Hi- I’m new to the forum and I’d greatly appreciate any advice.

I am under contract for a SFH property in metro Austin Area with a target closing date of end of May. Starting next year, I'd like to use the property as a primary residence, but I'm trying to take advantage of bonus depreciation running it as STR for remainder of the year and take the paper loss against my spouse's w2 income. The purchase price is around $2m and tax assessed value is around $1.3m. I'm thinking of spending about $200k for renovation adding a bathroom and a pool. Assuming I close by end of May and start Airbnb by end of June, I'd greatly appreciate if someone could shed some lights on below questions.

1. Is the cost segregation exercise worthwhile given the purchase price ($2M)? How much does it typically cost for a SFH?

2. Is the bonus depreciation calculated based on tax assessed value or PP?

3. Would I be able to get the full 60% bonus depreciation or is it prorated based on the length of ownership this year?

4. If I get a small construction loan to the property and pay interest expense, would this qualify as a business expense (adding pool and etc)?

5. If I start running it as STR starting in June of this year, do I have sufficient time to meet material participation? I'm unemployed at the moment and will be an active manager.

6. For renovation ($200k), it might take some time to get permits (ie, pool and additional bathrm) so plan to start it in late November. Can the renovation cost treated as a property expense? Should I run a cost segregation after completion of project and bake it as part of increase in basis?

7. The property is 2 stories with two separate access points. So from 2025, I'm thinking of living upstairs and running bottom floor (half of total RSF) as an STR. Can I still take advantage of STR loophole for 2025 tax?

[John Malone]

@John Lim yes because segregation most likely would be worth it if you’re taking advantage of the short term rental tax strategy. Your cost basis in the property is defined as the purchase price plus any improvements. Remember you must also back out the land value. Cost seg studies have many different price points, depending on the complexity of the property but I would budget a few thousand dollars for a property the size.

Regarding material participation, you should check with your CPA or tax advisor but generally speaking yes that would be enough time. If you adequately follow the MP rules in IRC 469.

[Account Closed]

Quote from @John Malone:

@John Lim yes because segregation most likely would be worth it if you’re taking advantage of the short term rental tax strategy. Your cost basis in the property is defined as the purchase price plus any improvements. Remember you must also back out the land value. Cost seg studies have many different price points, depending on the complexity of the property but I would budget a few thousand dollars for a property the size.

Regarding material participation, you should check with your CPA or tax advisor but generally speaking yes that would be enough time. If you adequately follow the MP rules in IRC 469.

In the realm of real estate investments, the short-term rental loophole offers a unique opportunity, subject, however, to certain rules and regulations. According to passive activity loss rules, every business is obligated to adhere to specific criteria, especially when it comes to short-term rentals. One crucial stipulation is that the property must be rented for 7 days or less on average. While this may exempt it from being classified as a rental activity, active participation remains a requirement, necessitating compliance with three tests: spending 500 hours on the property, dedicating at least 100 hours (and more than any other participant), and performing all the necessary work needed.

Additionally, long-term viability and consideration of depreciation recapture are important concerns. Excess business losses are capped for single individuals at $250,000 and for married individuals at $500,000, with any surplus being suspended and carried forward. Notably, short-term rentals are categorized as non-residential properties. If over 50% of guests stay on a transient basis, the property is subject to depreciation over 39 years. Bonus depreciation and Section 179 allowances for improvements can be utilized, with the latter, however, capped at zero to prevent negative losses. Determining whether the venture falls under a service or rental business hinges on the provision of substantial services; for instance, if a bed and breakfast service is offered, it must be reported on Schedule C, triggering a 15.3% self-employment tax.

Moreover, personal use plays a crucial role in the classification of the property. If used for 15 days or more or 10% of the rental days at fair market value, it becomes a residence, subject to specific regulations. The REPS-9 election prohibits grouping short-term and long-term rentals, emphasizing the need for careful strategic planning. Notably, personal visits for maintenance purposes do not contribute to personal use calculations. The involvement of onsite management, often seen as a potential red flag, can lead to the property failing crucial qualification tests. Understanding these rules is essential for investors seeking to capitalize on the short-term rental loophole while maintaining compliance with tax regulations.