Bonus depreciation for STR Material Participation

[John Carbone]

Has anyone filed taxes yet as a W-2 employee who owns only STR, rents for on average less than 7 days per rental (STR), and materially participates (usually requires 100 hours or more in a year and more than anyone else)

I’ve heard there are amazing tax benefits if you fall under all of the categories. My understanding is you do not need to pass the “real estate professional test” for this.

This seems like a big loophole for STR investors. Does anyone have experience going through this?

[Luke Carl]

Wouldn’t call it a loop hole. You’re on the right track. 

remember the tax man is going to get his. Just…. Is it now or is it later? 

[Lien Vuong]

Totally a viable option but keep in mind the documentation of the process and making sure that YOUR material participation does not exceed anyone else in the home - for example, your cleaners or maintenance people. 

[John Underwood]

Quote from @John Carbone:

Has anyone filed taxes yet as a W-2 employee who owns only STR, rents for on average less than 7 days per rental (STR), and materially participates (usually requires 100 hours or more in a year and more than anyone else)

I’ve heard there are amazing tax benefits if you fall under all of the categories. My understanding is you do not need to pass the “real estate professional test” for this.

This seems like a big loophole for STR investors. Does anyone have experience going through this?

I did a simple Google search.

Read this:

What Is Material Participation? | Millionacres
https://www.millionacres.com/taxes/what-is-material-participation/#:~:text=Get%20our%2043%2DPage%20Guide%20to%20Real%20Estate%20Investing%20Today!&text=Material%20participation%20refers%20to%20a,to%20measure%20gains%20or%20losses.

[John Carbone]

Quote from @John Underwood:

Quote from @John Carbone:

Has anyone filed taxes yet as a W-2 employee who owns only STR, rents for on average less than 7 days per rental (STR), and materially participates (usually requires 100 hours or more in a year and more than anyone else)

I’ve heard there are amazing tax benefits if you fall under all of the categories. My understanding is you do not need to pass the “real estate professional test” for this.

This seems like a big loophole for STR investors. Does anyone have experience going through this?

I did a simple Google search.

Read this:

What Is Material Participation? | Millionacres
https://www.millionacres.com/taxes/what-is-material-participation/#:~:text=Get%20our%2043%2DPage%20Guide%20to%20Real%20Estate%20Investing%20Today!&text=Material%20participation%20refers%20to%20a,to%20measure%20gains%20or%20losses.

I’m aware of what material participation is, i just wanted to see if anyone has personally done this and if there were any issues or pitfalls with doing it.

buy a million dollar cabin, cost segregation, 200- 250k tax deduction against w-2 income and rinse and repeat? Is it really that good? Surely there has to be some drawbacks? I’m sure audit rate on this has to be astronomical and just need good records? 

[Luke Carl]

I would say it probably happens more often than not especially if housewife or househusband is doing that managing. And around here they always are. 

[John Carbone]

Quote from @Luke Carl:

I would say it probably happens more often than not especially if housewife or househusband is doing that managing. And around here they always are. 

The person with the W-2 job though from my understanding can also be the one that materially participates. It’s not too difficult for someone with a full time job to do the 100 hour rule a year. Whereas it’s nearly impossible for a full time w-2 to qualify as a real estate professional. 

[Joe C.]

Can someone lay out more specifically what is being said here, in more detail?

Is this a Schedule C vs E discussion? I thought if you rent < 7 days avg it was a business instead of a rental.

[John Underwood]

My STR and LTR's are all schedule E.
Unless you are cooking them breakfast or offering daily cleaning with a turndown service you will be on a schedule E.

[John Carbone]

Quote from @Joe C.:
Can someone lay out more specifically what is being said here, in more detail?

Is this a Schedule C vs E discussion? I thought if you rent < 7 days avg it was a business instead of a rental.

My understanding is you can still do schedule E if you qualify the STR under these conditions. 

[Yonah Weiss]

@John Carbone, I have see a lot of discussion around this topic. @Brandon Hall has some great content, and literally just released a video today about the 100 hours - material participation requirement. Here is the youtube link. 

[Kevin Chubet]

Short-Term rentals are treated differently than traditional rental property. If you materially participate in a short-term rental you can take losses even if you aren't considered a real estate professional as long as you materially participate which there are many ways to satisfy this requirement. This is a great strategy for high income earners as they can purchase a short-term rental get a cost segregation and slam a huge loss through to offset current years income. 

The tax implications in the future will be this: less depreciation after year one (not by much as transient property is depreciated over 39 years not 27.5) and if you ever sell the property you will have significantly more depreciation to recapture. 

For what it is worth I had a client cost seg their AirBnB in Gaitlinburg and it reduced their taxes owed by 26K. It is a good tax savings strategy especially if you are a firm believer in money now is worth more than money later.

[John Carbone]

Quote from @Kevin Chubet:

Short-Term rentals are treated differently than traditional rental property. If you materially participate in a short-term rental you can take losses even if you aren't considered a real estate professional as long as you materially participate which there are many ways to satisfy this requirement. This is a great strategy for high income earners as they can purchase a short-term rental get a cost segregation and slam a huge loss through to offset current years income. 

The tax implications in the future will be this: less depreciation after year one (not by much as transient property is depreciated over 39 years not 27.5) and if you ever sell the property you will have significantly more depreciation to recapture. 

For what it is worth I had a client cost seg their AirBnB in Gaitlinburg and it reduced their taxes owed by 26K. It is a good tax savings strategy especially if you are a firm believer in money now is worth more than money later.

Are they schedule C or E? I’m being told by accountant you can’t do schedule E if going this route, but if you do schedule C then you have to provide substantial services. 

[Kevin Chubet]

Quote from @John Carbone:

Quote from @Kevin Chubet:

Short-Term rentals are treated differently than traditional rental property. If you materially participate in a short-term rental you can take losses even if you aren't considered a real estate professional as long as you materially participate which there are many ways to satisfy this requirement. This is a great strategy for high income earners as they can purchase a short-term rental get a cost segregation and slam a huge loss through to offset current years income. 

The tax implications in the future will be this: less depreciation after year one (not by much as transient property is depreciated over 39 years not 27.5) and if you ever sell the property you will have significantly more depreciation to recapture. 

For what it is worth I had a client cost seg their AirBnB in Gaitlinburg and it reduced their taxes owed by 26K. It is a good tax savings strategy especially if you are a firm believer in money now is worth more than money later.

Are they schedule C or E? I’m being told by accountant you can’t do schedule E if going this route, but if you do schedule C then you have to provide substantial services. 

 Schedule E the piece the IRS put out about moving rental from Schedule E to Schedule C was because someone provided services above and beyond what would occur at a typical rental so they treated it like a hotel. In the IRS Private Letter Ruling that caused people to worry about this they said they would consider it subject to self-employment taxes (schedule c) if you provide services above and beyond. In that example used the person provided maid services, swimming and fishing instruction, mail delivery, information about local churches and other things. If you just rent the property and provide the minimal essentials you should be fine in treating as Schedule E

[David Alzate]

@Kevin Chubet

Kevin does this STR tax strategy also applies if you acquired the property as a second home / vacation home using the 10% down loan? My wife and I are both W2 and we are evaluating to buy a vacation home to enjoy it, but planning also on renting it as a STR while not being there.

[Yonah Weiss]

Quote from @David Alzate:

@Kevin Chubet

Kevin does this STR tax strategy also applies if you acquired the property as a second home / vacation home using the 10% down loan? My wife and I are both W2 and we are evaluating to buy a vacation home to enjoy it, but planning also on renting it as a STR while not being there.

 Yes. It doesn't matter what kind of loan you used, if you are using it as a rental property, you can claim depreciation (and cost seg). The one thing to be careful about, is if you actually use it as a vacation home for more than 14 days during the year, or more that 10% of the total rented days. If you do, then your depreciation will be diminished.

[Kevin Chubet]

Quote from @Yonah Weiss:

Quote from @David Alzate:

@Kevin Chubet

Kevin does this STR tax strategy also applies if you acquired the property as a second home / vacation home using the 10% down loan? My wife and I are both W2 and we are evaluating to buy a vacation home to enjoy it, but planning also on renting it as a STR while not being there.

 Yes. It doesn't matter what kind of loan you used, if you are using it as a rental property, you can claim depreciation (and cost seg). The one thing to be careful about, is if you actually use it as a vacation home for more than 14 days during the year, or more that 10% of the total rented days. If you do, then your depreciation will be diminished.

 Vacation homes you do really need to pay attention to the days rented as Yonah said. If the rental is considered a vacation home then a loss isn't allowed for the current year. Not all is lost however as the loss can be used to offset future years income. Vacation homes take some planning, I personally think shooting for break even profit/loss with a vacation home is a good tax strategy but if it is a cash cow I would gladly just pay the tax as you still come out significantly ahead and if you have one I probably wouldn't bother with a cost seg study unless you are getting extremely high rents.

[Dong-wouk Park]

Quote from @Kevin Chubet:

Quote from @Yonah Weiss:

Quote from @David Alzate:

@Kevin Chubet

Kevin does this STR tax strategy also applies if you acquired the property as a second home / vacation home using the 10% down loan? My wife and I are both W2 and we are evaluating to buy a vacation home to enjoy it, but planning also on renting it as a STR while not being there.

 Yes. It doesn't matter what kind of loan you used, if you are using it as a rental property, you can claim depreciation (and cost seg). The one thing to be careful about, is if you actually use it as a vacation home for more than 14 days during the year, or more that 10% of the total rented days. If you do, then your depreciation will be diminished.

 Vacation homes you do really need to pay attention to the days rented as Yonah said. If the rental is considered a vacation home then a loss isn't allowed for the current year. Not all is lost however as the loss can be used to offset future years income. Vacation homes take some planning, I personally think shooting for break even profit/loss with a vacation home is a good tax strategy but if it is a cash cow I would gladly just pay the tax as you still come out significantly ahead and if you have one I probably wouldn't bother with a cost seg study unless you are getting extremely high rents.

Thank you for the awesome information. This sounds great! What kind of activities are including the material participation? For instance is buying furnitures to furnace the house consider part of normal management activities?

[John Wong]

Quote from @John Carbone:

Quote from @Luke Carl:

I would say it probably happens more often than not especially if housewife or househusband is doing that managing. And around here they always are. 

The person with the W-2 job though from my understanding can also be the one that materially participates. It’s not too difficult for someone with a full time job to do the 100 hour rule a year. Whereas it’s nearly impossible for a full time w-2 to qualify as a real estate professional. 

What if you w2 job is considered a real estate professional? Then you wouldnt need to materially participate right? I manage my STRs but my cleaners work a lot more hours than I do managing. But since my w2 job is considered as a RE professional then that should put me in the category to offset my w2 taxes?

[Yonah Weiss]

@John Wong what is your W2 job? It really depends. You will always need material participation in your own rentals.

[Kevin Chubet]

Quote from @John Wong:

Quote from @John Carbone:

Quote from @Luke Carl:

I would say it probably happens more often than not especially if housewife or househusband is doing that managing. And around here they always are. 

The person with the W-2 job though from my understanding can also be the one that materially participates. It’s not too difficult for someone with a full time job to do the 100 hour rule a year. Whereas it’s nearly impossible for a full time w-2 to qualify as a real estate professional. 

What if you w2 job is considered a real estate professional? Then you wouldnt need to materially participate right? I manage my STRs but my cleaners work a lot more hours than I do managing. But since my w2 job is considered as a RE professional then that should put me in the category to offset my w2 taxes?

 Unless you are a 5% owner W-2 hours actually don't count regardless. So you probably won't be able to be considered a real estate professional unfortunately

[Todd Goedeke]

@John Carbone material participation also applies to new construction of a STVR. Participation can include comanagement as project manager. It does not necessarily mean swinging a hammer, mowing lawn or installing plumbing. However, using ICFs in construction allows for easy manual labor participation.

[Heather Hall]

Quote from @Luke Carl:

I would say it probably happens more often than not especially if housewife or househusband is doing that managing. And around here they always are. 

 "house husband" just made my day!  I have never heard that term! @Luk