Purchasing Short Term Rental to offset W2 income advice (TX)

[Nathan Robinson]

Hi folks, 

I'm looking for ways to offset the taxes that I will owe on W2 income. I came across the short term rental designation that allows for asset depreciation to offset W2 income. This combined with the 100% bonus depreciation for 2022. I want to reach out to a CPA to see if this is something I could realistically pursue before EOY this year. Anyone here have a CPA in Texas who has helped others work through this? I'm okay with running a STR and the work involved I just don't want to screw up. The questions I have are how much this would reduce my AGI, if this is the right strategy for my situation and if I have enough time to pursue this before the end of the year or not?

Thanks!

[Don Konipol]

Quote from @Nathan Robinson:

Hi folks, 

I'm looking for ways to offset the taxes that I will owe on W2 income. I came across the short term rental designation that allows for asset depreciation to offset W2 income. This combined with the 100% bonus depreciation for 2022. I want to reach out to a CPA to see if this is something I could realistically pursue before EOY this year. Anyone here have a CPA in Texas who has helped others work through this? I'm okay with running a STR and the work involved I just don't want to screw up. The questions I have are how much this would reduce my AGI, if this is the right strategy for my situation and if I have enough time to pursue this before the end of the year or not?

Thanks!

I don’t know your individual tax bracket, so this is general advice.  I see A LOT of taxpayers trying to avoid paying tax on low marginal tax earnings.  The cost of doing this is usually more than the tax savings.  In other words it is not profitable to shelter income on which you will be paying 10-15 - or usually even 25% marginal tax rate on.  Further, many, if not most of the tax sheltering available to property investors is actually tax deferral, not tax avoidance.  While there is a time value of money component, making a pay later deferral beneficial so that you can earn income on your “tax” money until it’s paid, the resultant “savings” are far different than never having to pay tax on those earnings.  An argument made by some advisors is that you never have to pay tax, you just keep “1031”ing the profits into the next deal.  While this may be technically correct, there are two problems with this that are seldom mentioned.  First, is that the basis of your investment is carried over, so that little depreciation, and hence little tax sheltering is available on this amount.  Perhaps more importantly, 1031 exchanges have a cost to them, which is many times hidden in the purchase or exchange price of the property being exchanged into.  And the properties available for 1031 exchange are a smaller subset of properties otherwise available to invest in, so we can expect to pay a slightly higher price.  

AGGRESSIVE tax avoidance tends to take on a life of its own; each act leads to another act in an attempt to continue not paying taxes.  At some point a large chunk of your time is spent putting various plans into effect, and investment decisions are driven by an unhealthy amount of tax consideration rather than market valuation.  Worst case scenario is when the Federal government changes the tax law, or worse their interpretation of the law after the fact.  Google what happened to “tax shelter” investors in 1987.  

None of this is to say you shouldn’t arrange your affairs so as to pay the lowest amount of taxes possible.  Just be aware that it isn’t free; there is a lot of costs associated with tax savings.  Everything from hiring tax advisors, paying more to have your more complicated tax returns produced (for years), increasing your risk of IRS audit, transaction costs for things like 1031 exchanges, and opportunity cost of spending extra hours on this pursuit.  I believe one needs to estimate the savings and the money and time commitment of obtaining those savings; any additional risks associated with making “tax advantaged” investments, and the possibility of being in a higher tax bracket when it’s no longer possible to defer taxes any longer.  For myself I make no additional effort to avoid taxes in the low brackets.