One of the best strategies?

[Melanie Baldridge]

Real estate is one of the most tax-advantaged investment strategies out there.

Real estate pros buy property using leverage and bonus depreciate to perpetually defer taxes.

Making millions a year and often paying $0 in taxes.

Short Term Rentals supercharge this:

RE pros use cost segregation and bonus depreciation combined with leverage to create massive losses with minimal cash.

Combined with 1031s and snowballing, you create a business that never pays tax.

Problem is only "RE pros" get to do it.

There are 3 income classifications in the US - Active, Portfolio, and Passive

Active income is income derived from your job, or normal trade or business.

Portfolio income is derived from bank instruments - stocks, bonds, etc.

Passive income is income earned from investments.

Active losses can wipe out both passive and portfolio income, but it doesn't work the other way around.

Portfolio (capital) losses are limited to $3,000 annually.

Passive losses can only be offset by passive gains.

Real estate rental income by its nature is deemed passive per IRC Sec 469

One way to get around it is to become a pro - spend more than 750 hours or 1/2 your time in real estate.

But most folks aren't real estate pros. Or they have jobs that won't allow them to commit the time.

Therefore, partners who write checks into real estate deals cannot use the wonderful passive losses created to offset their ordinary income from their job or business.

But what if I told you there might be a way to use leverage and depreciation even if you aren't a pro?

Enter the STR:

Short term rentals are defined by the IRS as properties with an average stay is less than 7 days.

They buck the passive rules for 469, and are considered active.

BUT - As with any other business, to deduct the losses the owner must materially participate.

Material participation is achieved by:

1. Spending more than 500 hours in the business

or

2. Spending more than 100 hours and more than anyone else, or substantially all the time in the business.

So if you own an STR and meet the test, you can set up a tax deduction machine.

Some issues -

- You have to count your time, and the time other people work in the biz (cleaning, maintenance, etc..)

- If use the property more than 15 days or 10% of the time it becomes a residence

I suspect this is part of why the STR trend has picked up so greatly amongst professionals working in tech.

The ability to use leverage and reduce taxes in your highest earning years without having to put money into qualified retirement accounts is a great way to build wealth.

So - If you own an STR:

1. Keep good accounting of your money and your time spent on the business.

2. Do not stay in the property for more than 15 days.

3. Complete a cost seg study - combined with leverage it is feasible to deduct your entire equity contribution in year 1.

Also follow me for more insights around cost segregation and real estate taxes!

[Aaron Zimmerman]

This is great! It hits the nail on the head. Only thing I’d add is between step 2 and step 3, talk with a CPA before doing a cost segregation study. An investor needs to be 100% sure they’ve jumped through all the hoops necessary.