New to STRs

[Christopher Zikakis]

I'm sure this has been covered but I'm having difficulty finding a few specific answers as I try to map out a strategy.  My wife and are are W-2 employees.

The goal is to eventually have a vacation home that my family and I can use and also selectively rent out to friends and extended family.  In order to achieve this my thought is to do the following:

1. Purchase a property that needs a bit of work.

2. Year 1 & 2: Utilize the STR exception, rent occasionally averaging 7 days or less, materially participate by handling bookings and renovating/improving the home. Perform a cost seg study. Occupy the home for less than 14 days annually.

3. Year 3:  Begin using the home personally, occasionally rent to friends/family mentioned previously.

Questions:

1. Are there any areas of concern with utilizing the STR exception for only 1-2 years then transitioning property to personal use with the occasional renter?

2. During the period where utilizing the STR exception are the expenses for renovation/improvement netted against the income the home produces (along with mortgage/property taxes/etc), with the net loss considered non-passive?

Said differently, in a very simplified version:

-30k   Cost of improvements (appliances, carpet, flooring, painting, etc)

-15k   Mortgage

-10k   Property Tax

-1k     Property Insurance

+24k Rental Income

-32k Net Loss: Would this be my deduction against W-2 Income?  Understand that there could also be bonus depreciation but putting that aside for now, just want to make sure I'm thinking about this the right way.

If it's not obvious, the goal is to give investing in real estate/rentals a try, and if we don't enjoy doing it, worst case we end up with a vacation home with a lot of improvements completed that we were able to deduct.

Thanks in advance.

[Joseph Palmiero]

Answer to questions 1: I think this could be a viable tax strategy by running it as a STR for 1-2 years. I like running it at least to the 2 year mark better. Echoing what @Michael Baum advised, there is potential risk with this strategy. The longer you operate it as a STR, in my opinion, the lower the risk becomes. The STR rules have been on the IRS books for a long time.  But, the audit risk could increase with the increased popularity of this strategy in recent years.

Answer to questions 2: You would not be able to deduct expenses until the property is placed into service. Placed into service is defined as when the property is ready and available for use. So expenses paid before that would added to the basis of the property and depreciated. Generally, expenses are fully deductible after that date.  You would be able to take bonus depreciation on your 5,7, and 15 year improvements after the property is placed into service. This would include items such as appliances, carpets, furniture, landscaping, fences, etc. I am assuming the 15k Mortgage is just the interest portion of the loan payments. Only interest is deductible.