Short Term Rental Tax Advantages

[Frank Apap]

Hi, I am quite new to real estate investment.  I stumbled on some information about short term rental tax benefits as it pertains to lowering W-2 Income.  I am trying to figure out if this is really as good as it sounds.  I have been interested in getting into short term rentals and after reading about the tax benefits my interest is peaked.

Are there any basic rules of thumb on how to go about further researching if this is a good fit for me?  I'm a bit unclear on the math of what cost property, relative to my w-2 makes sense in terms of offsetting my income.  If my short term rental is not a positive cash-flow could it still be a good investment given the tax advantages?  

If anyone has first hand experience and an example of how to use this deduction, that would be really helpful.

[Benjamin Weinhart]

Hi Frank,

I, like many on this forum would say that if you're looking at getting into a new venture just for the tax advantages it might bring, it's normally not a good idea to factor that into consideration. I think it's important to focus on if the investment would be good for you in the long run and then see the tax advantages as a nice benefit (obviously this changes with growth/larger investors). There isn't a one-size-fits-all solution as you mention, but I would be sure that this is something that you see as sustainable due to the substantial up-front investment that it requires from the outlay. In general though, you're able to directly offset your income from the active rental activity with the *losses* you take from the business, but once the business becomes profitable, this would also add to your taxable income. 

Do keep in mind as well you may need to recapture any depreciation taken if you go to sell the property and don't use a 721/1031 exchange to assist with deferring that taxable gain.

[Zachary Jensen]

Quote from @Frank Apap:

Hi, I am quite new to real estate investment.  I stumbled on some information about short term rental tax benefits as it pertains to lowering W-2 Income.  I am trying to figure out if this is really as good as it sounds.  I have been interested in getting into short term rentals and after reading about the tax benefits my interest is peaked.

Are there any basic rules of thumb on how to go about further researching if this is a good fit for me?  I'm a bit unclear on the math of what cost property, relative to my w-2 makes sense in terms of offsetting my income.  If my short term rental is not a positive cash-flow could it still be a good investment given the tax advantages?  

If anyone has first hand experience and an example of how to use this deduction, that would be really helpful.

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.

[Mohammed Rahman]

Hey @Frank Apap - owning any rental property comes with its own set of tax advantages but I would recommend doing more research if I'm in your shoes. 

Owning a STR isn't just about the tax advantages but also comes with the responsibility of running (unless you decide to pay $ monthly to have a property manager, which comes its own challenges).

If I'm in your shoes, I recommend chatting with some local investors (attend a few meetups) to get a good sense of whats possible and not based on others that have a similar W2 scenario as yours. 

[Frank Apap]

Thank you all.  I think I've gotten the general messages that:

a) Don't invest JUST for the tax advantages.
b) I need to do more research.

Excited to do some more research and learn more by hanging around these forums.

[Zachary Jensen]

Quote from @Frank Apap:

Thank you all.  I think I've gotten the general messages that:

a) Don't invest JUST for the tax advantages.
b) I need to do more research.

Excited to do some more research and learn more by hanging around these forums.

 I would suggest you talk with a few accountants you can trust. You will get different answers, and likely have to pay (consulting isn't free!) but it could short cut your way to having a deeper understanding and avoid any misinformation of which forums are bountiful. 
Note * I do not sell consulting or advice giving.