Short Term Rental Tax Loophole for Physicians

Michael BaumPro Member

Olympia, WA · Member since 2016 · 8k+ posts · 7k+ votes

3y

For the 100th time, it isn't a loophole. It is simply the IRS tax law.

7 Reply

John UnderwoodPro Member

Investor · Greer, SC · Member since 2014 · 13k+ posts · 17k+ votes

3y

It's not a loophole it's part of the tax code. It's not just for doctors either.

5 Reply

Arda Bircan

OP

Investor · Miami · Member since 2021 · 23 posts · 13 votes

3y

I did not say it was only for physicians. Anyone can leverage the tax strategy. However, it is ideal for the high-income earners (and thus high tax liability). There are plenty of doctors that are able to have a high earning job and invest in STR and use those losses to offset their income. And you're able to do this without being a real estate professional.

1 Reply

Lisa Marie

Member since 2021 · 56 posts · 120 votes

3y

Bonus depreciation may sound good -- "oh, I can offset it against my W2 income and not have to pay tax", but in reality, it is just another way for the tax professionals to get more business by charging you for doing the cost seg as well as preparing an ever-increasingly complicated tax return. If you are a corporation or a real estate developer, it may be different, but for the vast majority of the mom and pop investors, it has no value.

First of all, I always find it laughable that any high income professional, doctor or lawyer or corporate executive, would want to trade their most valuable resource (time) for something they already have plenty (money). Second of all, any depreciation, regular or bonus, is a delayed tax. You still have to pay it eventually, possibly at a higher rate. If you are close to retirement age, and think your W2 income will decrease significantly in a couple of years, then cost seg and bonus depreciation can be useful. But I don't think that's the case for most people.

I am just a housewife, but my husband is an engineer and has an MBA. We have a STR beach house and he looked into the bonus depreciation scheme. He even went so far as creating an Excel file (as an engineer would do), and concluded that (1) if you are not already a real estate investor, you are actually better off by taking the money and investing in the stock market; (2) if you already own a STR, cost seg has a small benefit, but the benefit decreases the longer you own the property, also there is the cost of the cost seg itself. To be clear, he is not saying that you should not invest in real estate or STR. He is saying that if you want to invest in STR, do it because you think it's a good way to make money or because you want to diversify your assets, but don't do it just for the cost seg tax savings.

The key point to remember is that yes you can get the bonus depreciation right away, and depending on your W2 income amount, you can skip paying tax for the first 3 or 4 years. But then what? Once the bonus depreciation is over, your tax goes back up. Another key point: how much is your time worth? If you make $200k a year, that's $100/hr your employer is paying you. To use this "tax loophole", you need to spend at least 100 hrs AND more than anybody else. 100 hrs is 8 hrs a month -- if you have 3 or 4 rentals per month, your cleaner will spend more than that. I think realistically, 150 hrs or even 200 hrs is more likely, especially for a new STR owner.

Here is the Excel table my husband did, with some very simplistic assumptions. Assuming you have $1.2M cash, which can be invested in the stock market and reasonably get a 7% return. Or you can buy a $1.2M STR with the building valued at $1M, which is your max bonus depreciation amount. Assuming your W2 income is $250k, and you get a gross income of $100k from your STR. Roughly it translates to about $50k Net after deducting all expenses.

Conclusion: you save some money in the first 3 years, but at a cost of spending a lot of time to manage the STR, not to mention any start-up time to buy and furnish and launch the STR. But over a span of 10 years, you actually make less money.

Again, I want to emphasize, I am not saying it's a bad idea to invest in an STR. I am saying it's a bad idea to invest in an STR purely for the benefit of cost seg to lower your tax bill.

	Option 1: invest money	Option 2: STR with Cost Seg
	Investment income on $1.2 M	W2 income	25% tax on Income	Money in the bank	Value of my time	Net Income on $1.2M STR	$1M Bonus Depreciation	W2 income	25% tax on income	Money in the bank	Value of my time ($100*200 hrs)	REAL NET PROFIT
Year 1	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$300,000	$250,000	$0	$300,000	($20,000)	$280,000
Year 2	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$300,000	$250,000	$0	$300,000	($20,000)	$280,000
Year 3	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$300,000	$250,000	$0	$300,000	($20,000)	$280,000
Year 4	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$100,000	$250,000	$50,000	$250,000	($20,000)	$230,000
Year 5	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 6	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 7	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 8	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 9	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 10	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
TOTAL				$2,550,000								$2,420,000

4 Reply

Lisa Marie

Member since 2021 · 56 posts · 120 votes

3y

After I submitted the previous post, I realized how badly the Excel table was distorted by the BP forum webpage. Sorry.

It doesn't matter. These are made-up numbers. You can argue about some of the specific numbers in the assumptions, but the bottom line is, there is no "free lunch" when it comes to paying tax. You may be able to delay a little, but in order to achieve it, it will still cost you dearly in other departments, and the tax bill catches up eventually and may end up being more expensive in the long run.

0 Reply

Michael BaumPro Member

Olympia, WA · Member since 2016 · 8k+ posts · 7k+ votes

3y

Why are you even here @Lisa Marie if real estate is a poor way to make money and you should invest in the stock market?

Most of what you said makes no sense. Are you a tax attorney or CPA?

2 Reply

John Malone

Attorney · Boston, MA · Member since 2023 · 139 posts · 75 votes

3y

@Lisa Marie without getting into the nuances, accelerated depreciation is extremely beneficial for many, but not all. Its never a one sized fits all of course.

Generally, a deduction today is more powerful than a deduction tomorrow with time value money and rising rates over time.

It is rare to run into a HNW entrepreneur who opts out (other than some delayed income situations where is makes sense).

However, you accountant should be building you the model with/without accelerated. It doesn’t take long with tax software but if you can save current tax dollars today, many think its worth it (not considering the strategies to avoid recapture as well).

2 Reply

Jon Martin

Member since 2022 · 1k+ posts · 1k+ votes

3y

Quote from @Lisa Marie:

Bonus depreciation may sound good -- "oh, I can offset it against my W2 income and not have to pay tax", but in reality, it is just another way for the tax professionals to get more business by charging you for doing the cost seg as well as preparing an ever-increasingly complicated tax return. If you are a corporation or a real estate developer, it may be different, but for the vast majority of the mom and pop investors, it has no value.

First of all, I always find it laughable that any high income professional, doctor or lawyer or corporate executive, would want to trade their most valuable resource (time) for something they already have plenty (money). Second of all, any depreciation, regular or bonus, is a delayed tax. You still have to pay it eventually, possibly at a higher rate. If you are close to retirement age, and think your W2 income will decrease significantly in a couple of years, then cost seg and bonus depreciation can be useful. But I don't think that's the case for most people.

I am just a housewife, but my husband is an engineer and has an MBA. We have a STR beach house and he looked into the bonus depreciation scheme. He even went so far as creating an Excel file (as an engineer would do), and concluded that (1) if you are not already a real estate investor, you are actually better off by taking the money and investing in the stock market; (2) if you already own a STR, cost seg has a small benefit, but the benefit decreases the longer you own the property, also there is the cost of the cost seg itself. To be clear, he is not saying that you should not invest in real estate or STR. He is saying that if you want to invest in STR, do it because you think it's a good way to make money or because you want to diversify your assets, but don't do it just for the cost seg tax savings.

The key point to remember is that yes you can get the bonus depreciation right away, and depending on your W2 income amount, you can skip paying tax for the first 3 or 4 years. But then what? Once the bonus depreciation is over, your tax goes back up. Another key point: how much is your time worth? If you make $200k a year, that's $100/hr your employer is paying you. To use this "tax loophole", you need to spend at least 100 hrs AND more than anybody else. 100 hrs is 8 hrs a month -- if you have 3 or 4 rentals per month, your cleaner will spend more than that. I think realistically, 150 hrs or even 200 hrs is more likely, especially for a new STR owner.

Here is the Excel table my husband did, with some very simplistic assumptions. Assuming you have $1.2M cash, which can be invested in the stock market and reasonably get a 7% return. Or you can buy a $1.2M STR with the building valued at $1M, which is your max bonus depreciation amount. Assuming your W2 income is $250k, and you get a gross income of $100k from your STR. Roughly it translates to about $50k Net after deducting all expenses.

Conclusion: you save some money in the first 3 years, but at a cost of spending a lot of time to manage the STR, not to mention any start-up time to buy and furnish and launch the STR. But over a span of 10 years, you actually make less money.

Again, I want to emphasize, I am not saying it's a bad idea to invest in an STR. I am saying it's a bad idea to invest in an STR purely for the benefit of cost seg to lower your tax bill.

	Option 1: invest money	Option 2: STR with Cost Seg
	Investment income on $1.2 M	W2 income	25% tax on Income	Money in the bank	Value of my time	Net Income on $1.2M STR	$1M Bonus Depreciation	W2 income	25% tax on income	Money in the bank	Value of my time ($100*200 hrs)	REAL NET PROFIT
Year 1	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$300,000	$250,000	$0	$300,000	($20,000)	$280,000
Year 2	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$300,000	$250,000	$0	$300,000	($20,000)	$280,000
Year 3	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$300,000	$250,000	$0	$300,000	($20,000)	$280,000
Year 4	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$100,000	$250,000	$50,000	$250,000	($20,000)	$230,000
Year 5	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 6	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 7	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 8	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 9	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 10	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
TOTAL				$2,550,000								$2,420,000

While I can appreciate the cost/time/benefit analysis, and think that this should be done by everyone for all things in life, as a whole I don't agree with any of this. You can get a cost seg for a SFR for ~$600, so you dont need to spend thousands. I'm not worried about recapture because I buy in appreciating markets that also cash flow as an STR. Plus, I already self manage because I am basically paying myself thousands of dollars per year for doing so. Therefore the W2 offset is quite significant for something I would be doing anyway.

3 Reply

Nancy Bachety

Rental Property Investor · North Fork, NY · Member since 2016 · 1k+ posts · 631 votes

3y

First, I do not understand the reason for the original post. Was it an “a ha” moment you felt was worth sharing to a bunch of medical students?

Second, @Lisa Marie your thorough understanding of your husband's math is commendable. You don’t include the principal payoff that your guests are providing nor the property appreciation. You made an excellent point about diversifying investments. You didn’t include using a vacation house that is paid for by someone else. Even if it’s for a girls weekend or guys time out.

A cost seg only delays tax day. In fact, what happens in years 5+ when you already accelerated depreciation?

As a high income earner, I materially participated for non-passive losses. I retired early as a teacher because my time is now controlled by me and my STR's pay much better. But, I do miss my students, sometimes I think of them when I roll over or book trips.

4 Reply

Ryan MoyerBusiness Member

Property Manager · Orlando Kissimmee Davenport Salt Lake City, Park City · Member since 2019 · 991 posts · 1k+ votes

3y

Quote from @Lisa Marie:

Bonus depreciation may sound good -- "oh, I can offset it against my W2 income and not have to pay tax", but in reality, it is just another way for the tax professionals to get more business by charging you for doing the cost seg as well as preparing an ever-increasingly complicated tax return. If you are a corporation or a real estate developer, it may be different, but for the vast majority of the mom and pop investors, it has no value.

First of all, I always find it laughable that any high income professional, doctor or lawyer or corporate executive, would want to trade their most valuable resource (time) for something they already have plenty (money). Second of all, any depreciation, regular or bonus, is a delayed tax. You still have to pay it eventually, possibly at a higher rate. If you are close to retirement age, and think your W2 income will decrease significantly in a couple of years, then cost seg and bonus depreciation can be useful. But I don't think that's the case for most people.

I am just a housewife, but my husband is an engineer and has an MBA. We have a STR beach house and he looked into the bonus depreciation scheme. He even went so far as creating an Excel file (as an engineer would do), and concluded that (1) if you are not already a real estate investor, you are actually better off by taking the money and investing in the stock market; (2) if you already own a STR, cost seg has a small benefit, but the benefit decreases the longer you own the property, also there is the cost of the cost seg itself. To be clear, he is not saying that you should not invest in real estate or STR. He is saying that if you want to invest in STR, do it because you think it's a good way to make money or because you want to diversify your assets, but don't do it just for the cost seg tax savings.

The key point to remember is that yes you can get the bonus depreciation right away, and depending on your W2 income amount, you can skip paying tax for the first 3 or 4 years. But then what? Once the bonus depreciation is over, your tax goes back up. Another key point: how much is your time worth? If you make $200k a year, that's $100/hr your employer is paying you. To use this "tax loophole", you need to spend at least 100 hrs AND more than anybody else. 100 hrs is 8 hrs a month -- if you have 3 or 4 rentals per month, your cleaner will spend more than that. I think realistically, 150 hrs or even 200 hrs is more likely, especially for a new STR owner.

Here is the Excel table my husband did, with some very simplistic assumptions. Assuming you have $1.2M cash, which can be invested in the stock market and reasonably get a 7% return. Or you can buy a $1.2M STR with the building valued at $1M, which is your max bonus depreciation amount. Assuming your W2 income is $250k, and you get a gross income of $100k from your STR. Roughly it translates to about $50k Net after deducting all expenses.

Conclusion: you save some money in the first 3 years, but at a cost of spending a lot of time to manage the STR, not to mention any start-up time to buy and furnish and launch the STR. But over a span of 10 years, you actually make less money.

Again, I want to emphasize, I am not saying it's a bad idea to invest in an STR. I am saying it's a bad idea to invest in an STR purely for the benefit of cost seg to lower your tax bill.

	Option 1: invest money	Option 2: STR with Cost Seg
	Investment income on $1.2 M	W2 income	25% tax on Income	Money in the bank	Value of my time	Net Income on $1.2M STR	$1M Bonus Depreciation	W2 income	25% tax on income	Money in the bank	Value of my time ($100*200 hrs)	REAL NET PROFIT
Year 1	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$300,000	$250,000	$0	$300,000	($20,000)	$280,000
Year 2	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$300,000	$250,000	$0	$300,000	($20,000)	$280,000
Year 3	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$300,000	$250,000	$0	$300,000	($20,000)	$280,000
Year 4	$90,000	$250,000	$85,000	$255,000	0	$50,000	-$100,000	$250,000	$50,000	$250,000	($20,000)	$230,000
Year 5	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 6	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 7	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 8	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 9	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
Year 10	$90,000	$250,000	$85,000	$255,000	0	$50,000	$0	$250,000	$75,000	$225,000		$225,000
TOTAL				$2,550,000								$2,420,000

In the immortal words of Tom Hardy in Inception, "you mustn't be afraid to dream a little bigger, darling".

You have a good understanding of things, but you're missing the ways it can be leveraged.

Bonus depreciation works best when you have one high earning spouse and one non-working spouse. That way the non-working spouse can commit the time, all while creating cash/assets that reduce the amount the working spouse needs to work in the future (this is extremely common for physicians in general right now, as many of them are burnt out and looking to reduce hours in the coming years).

You're right that the tax advantage is only a 1-year thing. But if you have a working W2 spouse and a non-working spouse materially participating, your tax savings are going to come in the form of a giant tax refund. If the working spouse has a salary of 500k with the employer taking taxes out of their paycheck, and they purchase a $1M house that their spouse materially participates on, after cost seg/bonus depreciation that would net them around $100k in cash via a tax refund after their $350k tax deduction from the bonus depreciation.

And what better to spend that refund on than the down payment on another house to use for bonus depreciation next year, which generates a big refund next year, which you can use for another down payment the year after, which generates another big refund the year after, and now we're scaling baby.

And now a decade or two later you've got 10+ properties. Money has inflated, rents have gone up, but your mortgage is fixed. All those people that have houses from 15 years ago that we're all saying "well of course you're making tons of money in STR, you have a mortgage from 2010!". That's you, and the guests have been paying that mortgage the whole time.

You're right that the tax "savings" are actually just deferment. In addition to the time value of money (you now have 10 cash flowing properties with tons of equity that you couldn't have afforded otherwise), you also have to consider that those taxes only have to be paid back when you sell. Most people that use bonus depreciation don't ever plan on selling. If they need a cash infusion, they'll just borrow against the home. And if they do sell, they 1031 and roll the deferment over to the new property. Then eventually one day they die, the deferred tax is not inherited, and it disappears into the air.

So 20 years from now you retire (or sooner, if you'd like) and you've got 10+ cash flowing properties that were purchased way back at 2023 prices (those lucky people that got real estate when it was that cheap!) with tons of equity via appreciation and 20 years of mortgage paydown, that pay you more in your retirement than you ever dreamed of. You've spent no money out of pocket for this since your tax refunds covered it all (meaning you could continue dumping your savings into the stock market, so it's not like you're missing those returns). You travel in luxury for 20 years, then you die, and your heir inherits those 10+ cash flowing properties that are now completely paid off, with insane amounts of equity, and all those tax deferments fly away into the sky.

Oh yea, and that $2000 per cost segregation? Barely a rounding error in all of this.

Obviously, not everyone is comfortable with that kind of leverage, and you're right that someone making 70k a year just doing it once for an extra 12k on their tax return it may not make as much sense for. But for some circumstances, it can be unimaginably lucrative.

EDIT: Usual disclaimers here. I'm not a CPA, just a guy on the internet!

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5 Reply

Dan H.Pro Member

Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes

3y

You do not need to do cost segregation to benefit from being an RE professional. Many investors have standard depreciation and expenses in excess of rental income. If the rental income significantly exceeds the normal write-offs (standard expenses plus standard depreciation) then there are options including extracting value via a refinance (reduces the cash flow), do a brrrr or other costly value add, or do cost segregation.

The IRS provides RE investors many options to minimize taxes. Leveraging them is part of the game. 1031. Rebase line at death. Depreciation. Cost segregation. RE professional. Extraction of value with delayed tax consequences. Etc.

Good luck

0 Reply

Arda Bircan

OP

Investor · Miami · Member since 2021 · 23 posts · 13 votes

3y

@Lisa

@Lisa Marie Unfortunately, it doesn't seem like you have a basic understanding of cost segregation and accelerated depreciation benefits or how to use this tax strategy effectively to acquire more real estate/ STRs and build wealth over time. I am afraid the assumptions you're making are outright wrong and very misleading. Let's focus on the facts and data so folks who are reading this can learn more about the the Short Term Rental Tax Strategy and apply it to build generational wealth.

First off, I did NOT say buy STRs for cost segregation benefits in my original post. Here is the golden rules: invest for cash flow first, appreciation second and cost seg benefit third. By the way, any sound RE investor would tell you the same rules. these are not well kept secrets.

Yes, you can think of a cost segregation study like accelerating a loan from the IRS. Doing a cost segregation study will allow a significant amount of depreciation to be taken in the earlier years of the study. This means that you will speed up your tax benefits, and your taxable income will go down, meaning more money in your pockets. Choosing this method has its very clear advantages, however, there are important points to consider. Heavy depreciation will lower the cost basis for the property which will be recaptured when it’s time to sell. This is why cost segregation can be considered a loan. Because at one point you do have to pay it back.

This being said, utilizing a tax strategy requires planning. It is not a one size fits all strategy. You should definitely speak with a qualified CPA who can do a cost seg. (not every CPA can do cost segregation studies) before doing anything. However, here are a couple of signals that a cost segregation study might be right for you.

1. High tax bracket

A simple google search will show what tax bracket you are currently in. If your bracket is over 24%, this is a good sign that a cost segregation study could be beneficial to you. Higher tax brackets mean higher savings with depreciating properties.

2. Purchase prices over $350,000

Large properties see more benefit from cost segregation studies because of their significant value. A good breaking point for this is $350,000. This is where the benefits begin to outweigh the costs.

3. Material Participation

If you are able to materially participate in your property, then a study could likely be beneficial.

I also completely disagree with your statements about how much time it takes to manage a STR and how difficult it is ,etc. I manage 7 STRs and do not spend more than 4 hours a week managing them. Let me repeat I spend 4 hours a week managing them. Because I automated 90% of my STR business to boost profits & efficiency. Using a property management system (PMS) enables you to bring automation to all major areas of Airbnb rental operation (cleaning coordination, guest communication, digital self-check-in, review requests, pricing, upsells, and finances)

The bottom line a busy physician with a fairly high W2 can pass material participation tests (100 hrs AND more than anybody else), claim tax losses from his or her STR business and save 6 figures in taxes without working full-time in real estate. And @Ryan Moyer hit the nail on the head. Spend that refund on than the down payment on another house to use for bonus depreciation next year, which generates a big refund next year, which you can use for another down payment the year after, which generates another big refund the year after. Yes, you're scaling now but more importantly, you can truly stop trading time for money and and start living your life on your on terms while building generational wealth for your family.

0 Reply

Lisa Marie

Member since 2021 · 56 posts · 120 votes

3y

@Michael Baum, @Ryan Moyer, @Nancy Bachety, @Arda Bircan and many others, I thank you all for your input. However, based on some of the feedbacks, I have a feeling that some people didn’t read my whole entry or missed some points I tried to make, so I will make some clarification here.

(1) I said this previously and I will repeat it again: "I am not saying it's a bad idea to invest in an STR. I am saying it's a bad idea to invest in an STR purely for the benefit of cost seg to lower your tax bill.”

(2) My husband has a high W2 income and I am a stay-at-home wife. We have a STR property that's worth 7 figures. We are supposedly the perfect demographics. But our research led us to say no to Cost Seg. That's why I wanted to share our analysis and explain why I disagreed with some arguments made by the OP.

(3) My husband did an analysis for a friend who had high W2 income but didn't own an STR yet. The conclusion was that he would be better off investing elsewhere. That's the Excel file I tried to post but was unreadable due to the formatting by BP's website.

(4) If you already have an STR, cost seg or not depends on many other factors. My husband did the number crunching and decided that it would not benefit us as buy-and-hold real estate investors. It may work for somebody who intends to grow their real estate empire, but it's not for us – it feels like a runaway train that you can never jump off.

(5 Having said all that, everybody is entitled to their opinion, but since Bigger Pockets is more of an educational site, I think it's important that we do not confuse opinions from facts. I only comment on things that I have personal first-hand experiences, and I hope others would do the same. In that regards, I admire people like Andrew Steffens or Colin H who are frequent posters on this forum. They are quick to provide input, but always stay within their lanes and temper any opinions with “that’s how I do it” or “that’s what I think”, instead of making sweeping statements like “if you are X, you should do Y”. So, along that line, I would like to know how many people on this thread have actually done cost segs on their properties and how much W2 income tax you saved from that.

1 Reply

Michael BaumPro Member

Olympia, WA · Member since 2016 · 8k+ posts · 7k+ votes

3y

The problem @Lisa Marie, is that your post kinda says that it is a waste of time to invest in STRs based on a single person's analysis.

If I stayed in my lane, I would never have left the driveway...

1 Reply

Jon Martin

Member since 2022 · 1k+ posts · 1k+ votes

3y

Quote from @Lisa Marie:

So, along that line, I would like to know how many people on this thread have actually done cost segs on their properties and how much W2 income tax you saved from that.

I paid $600 for a cost seg that will take $60K (80%*75K) off of my taxable income for 2023. I won't say what my W2 income is but I will say I expect to save over a quarter of that of that amount between fed and state taxes. So yeah, absolutely worth it. I can also say that the money I save by self managing, even when broken down per hour, is not far off from my "hourly wage" based on my salary. I look at it as a side hustle where I pay myself.

Like @Ryan Moyer said I can utilize that cash now to invest in more properties and kick the can down the road, potentially past my time on earth. That cash is worth much more to me now in the scaling stage.

As for your "better off in the stock market" comment, your analysis is flawed because it is based on an equal cash vs cash assumption. Most people do not have that kind of cash to put into the market, but maybe we can scrounge up 15-20% of that for a down payment. That's the power of leverage in real estate, where I can pull the returns of a $1M investment with 20% of the cash. I can't do that at Charles Schwab.

Regarding what you said about not investing solely for the purpose of utilizing cost seg and bonus depreciation, sure, I would agree that your decision to invest in an STR should go beyond that and should work in its absence. In a related example, I was looking to get in to a property before year end to lower my tax bill further. Then I realized that if I don't have enough cash to invest in a property for 2024 tax year, then I am better off waiting until then because another cost seg will lower my tax burden within a reduced tax bracket for 2023. Whereas in 2024, that bonus depreciation, even at 60%, will be worth more if that's the only property I buy between now and the end of 2024. So yes, there is nuance and people should take a close look at their situation to see if it makes sense, but at the very least the first seg I mentioned is an absolute no brainer for me.

1 Reply

Austin WhitePro Member

Investor · Houston, TX · Member since 2015 · 17 posts · 7 votes

2y

Does anyone run into the challenge of Alternative Minimum Tax? If so, how do you handle? For the example of a physician who gets a $250k deduction through bonus depreciation, it sounds like the AMT would still require them to pay a higher amount of taxes correct?

1 Reply

Eric Williams

Accountant · Houston, TX · Member since 2023 · 147 posts · 41 votes

2y

You do not need to do any of those tests for short-term rentals.

They are one of six exceptions to the per se passive rules.

It's in the temp regs

1.469-1T

Exceptions. For purposes of this paragraph (e)(3), an activity involving the use of tangible property is not a rental activity for a taxable year if for such taxable year—

(A) The average period of customer use for such property is seven days or less;

(B) The average period of customer use for such property is 30 days or less, and significant personal services (within the meaning of paragraph (e)(3)(iv) of this section) are provided by or on behalf of the owner of the property in connection with making the property available for use by customers;

(C) Extraordinary personal services (within the meaning of paragraph (e)(3)(v) of this section) are provided by or on behalf of the owner of the property in connection with making such property available for use by customers (without regard to the average period of customer use);

(D) The rental of such property is treated as incidental to a nonrental activity of the taxpayer under paragraph (e)(3)(vi) of this section;

(E) The taxpayer customarily makes the property available during defined business hours for nonexclusive use by various customers; or

(F) The provision of the property for use in an activity conducted by a partnership, S corporation, or joint venture in which the taxpayer owns an interest is not a rental activity under paragraph (e)(3)(vii) of this section.

2 Reply

Michael BaumPro Member

Olympia, WA · Member since 2016 · 8k+ posts · 7k+ votes

2y

Hey @Eric Williams, great list. Are you a CPA and/or tax attorney?

If not you might want to post that in your answers so people understand it isn't professional advice.

0 Reply

Ron Singh

CA · Member since 2014 · 244 posts · 47 votes

2y

Quote from @Arda Bircan:

Investing in short-term rental (STR) properties and using the STR Tax Loophole is one of the few tax strategies that can save physicians with a fairly high W2 income 6 figures in taxes without working full-time in real estate.

It is difficult for a physician, or other professional to become a real estate professional as they can't spend half of their working hours in a real estate business. This is where the short-term rental tax loophole can help. To ensure you can apply the tax deductions against ordinary/active income, you have to materially participate in the STR business.

Material participation tests are the rules the IRS uses to determine if you worked on your short term rental business on a regular basis during the year. There are seven ways to accomplish this, but the 3 most common and easiest material participation tests used to shelter income for physicians are:

1. Your participation in the activity for the tax year constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year.

2. You participate in the activity for more than 100 hours during the tax year, and your participation in the activity is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year.

3. You participated for more than 100 hours in a regular, continuous, and substantial basis during the year.

The goal is to use your short-term rental for non-passive losses. Because non-passive losses can offset non-passive income/ active income. If you can meet the criteria, your short-term rental will save you significant amount of money on taxes. That’s the first big component of a short-term rental tax strategy. The second is depreciation.

Depreciation for Your Short-Term Rental Tax Strategy

you need a savvy real estate CPA who's going to lead you through leveraging depreciation for your short term rental. You will have your CPA do a cost segregation study on your property. That cost segregation will reclassify certain components of your property from 39 year life (depreciation life for an STR property) into 5 and 15 year life. 5 and 15 year property can generally represent anywhere from 20-30% of a property's purchase price.

So, if you had a $1 million dollar property and did a cost segregation structure, anywhere from 20-30% could be resegregated and fully depreciated. This would give you a $250,000 deduction. This is powerful because your losses are non-passive, and that tax loss can be used to offset taxes on your W-2 income.

Steps to take in order to shelter your W-2 Income

#1. Buy a short-term rental.

#2. Materially participate in the rental.

#3. Obtain a cost segregation study.

#4. Use accelerated depreciation the first year.

#5. Claim paper losses from your business.

#6. Hire a real estate CPA who understands how to use the tax deductions from your short-term rental and apply it to your ordinary income.

What’s Changing About Depreciation for Short Term Rentals & Why it's the time to act NOW.

Certain aspects of this strategy will phase-out over the next few years. 2022 was the last year of 100% bonus depreciation. It is currently slated for a phased approach to decrease the percentage every year for the next five years. In 2023, it dropped down to 80% bonus depreciation. So, if you were going to get a $250k deduction, you’d get $200k in 2023. In 2024, it will drop down to 60%. The $250k deduction would become $150k. Still sizable, but the power of the strategy will decrease.

@Michael Baum, @Ryan Moyer, @Nancy Bachety, @Arda Bircan

Hi all, great post and response.

here is a scenario :

buy home in tax year 2023,

for str rental/airbnb, self manage

planning to hold property long term 10+ years

purchase price 1M (land 400k, building cost 600k)

Depriciation will be on 600k

how much depreciation possible, couple scenarios :

1. can you split tax depreciation in first 5 years ? 600k/5 =120k depreciation each year for first 5 year

or
2. can you depreciate max 80% of building value in year 2023, (similar like 179 bonus depreciation for qualifie( business veh) ?
so 80% of 600k = 480k dedication in year 1

please correct me in above both cases won't be correct ?

1 Reply

Jon Martin

Member since 2022 · 1k+ posts · 1k+ votes

2y

@Ron Singh IIRC even with 80% depreciation you don't get to claim all $600k of the entire building value. Not every component of the building qualifies for the accelerated depreciation. The cost seg ends up qualifying 20-25% of the building value, so for your example you would be allowed 80% $120-150k as a deduction for 2023. The remaining 20% would be divied up over the next 26.5 or 38 years.

Disclaimer: Not a CPA and this is not tax advice.

1 Reply

Michael BaumPro Member

Olympia, WA · Member since 2016 · 8k+ posts · 7k+ votes

2y

Hey @Ron Singh, I would get with your CPA on this. It is a bit complex for us non CPA/tax attorneys, but I belive that @Jon Martin is correct.

1 Reply

Ron Singh

CA · Member since 2014 · 244 posts · 47 votes

2y

Quote from @Jon Martin:

Quote from @Lisa Marie:

So, along that line, I would like to know how many people on this thread have actually done cost segs on their properties and how much W2 income tax you saved from that.

I paid $600 for a cost seg that will take $60K (80%*75K) off of my taxable income for 2023. I won't say what my W2 income is but I will say I expect to save over a quarter of that of that amount between fed and state taxes. So yeah, absolutely worth it. I can also say that the money I save by self managing, even when broken down per hour, is not far off from my "hourly wage" based on my salary. I look at it as a side hustle where I pay myself.

Like @Ryan Moyer said I can utilize that cash now to invest in more properties and kick the can down the road, potentially past my time on earth. That cash is worth much more to me now in the scaling stage.

As for your "better off in the stock market" comment, your analysis is flawed because it is based on an equal cash vs cash assumption. Most people do not have that kind of cash to put into the market, but maybe we can scrounge up 15-20% of that for a down payment. That's the power of leverage in real estate, where I can pull the returns of a $1M investment with 20% of the cash. I can't do that at Charles Schwab.

Regarding what you said about not investing solely for the purpose of utilizing cost seg and bonus depreciation, sure, I would agree that your decision to invest in an STR should go beyond that and should work in its absence. In a related example, I was looking to get in to a property before year end to lower my tax bill further. Then I realized that if I don't have enough cash to invest in a property for 2024 tax year, then I am better off waiting until then because another cost seg will lower my tax burden within a reduced tax bracket for 2023. Whereas in 2024, that bonus depreciation, even at 60%, will be worth more if that's the only property I buy between now and the end of 2024. So yes, there is nuance and people should take a close look at their situation to see if it makes sense, but at the very least the first seg I mentioned is an absolute no brainer for me.

Great points

curious on 60k segregated value , what is the value of building just to get an rough idea.

I need to deduct similar amount in 2023, and trying to see how big of a property I have to buy to come close to your deduction numbers.

0 Reply

Ron Singh

CA · Member since 2014 · 244 posts · 47 votes

2y

Quote from @Ron Singh:

Quote from @Jon Martin:

Quote from @Lisa Marie:

So, along that line, I would like to know how many people on this thread have actually done cost segs on their properties and how much W2 income tax you saved from that.

I paid $600 for a cost seg that will take $60K (80%*75K) off of my taxable income for 2023. I won't say what my W2 income is but I will say I expect to save over a quarter of that of that amount between fed and state taxes. So yeah, absolutely worth it. I can also say that the money I save by self managing, even when broken down per hour, is not far off from my "hourly wage" based on my salary. I look at it as a side hustle where I pay myself.

Like @Ryan Moyer said I can utilize that cash now to invest in more properties and kick the can down the road, potentially past my time on earth. That cash is worth much more to me now in the scaling stage.

As for your "better off in the stock market" comment, your analysis is flawed because it is based on an equal cash vs cash assumption. Most people do not have that kind of cash to put into the market, but maybe we can scrounge up 15-20% of that for a down payment. That's the power of leverage in real estate, where I can pull the returns of a $1M investment with 20% of the cash. I can't do that at Charles Schwab.

Regarding what you said about not investing solely for the purpose of utilizing cost seg and bonus depreciation, sure, I would agree that your decision to invest in an STR should go beyond that and should work in its absence. In a related example, I was looking to get in to a property before year end to lower my tax bill further. Then I realized that if I don't have enough cash to invest in a property for 2024 tax year, then I am better off waiting until then because another cost seg will lower my tax burden within a reduced tax bracket for 2023. Whereas in 2024, that bonus depreciation, even at 60%, will be worth more if that's the only property I buy between now and the end of 2024. So yes, there is nuance and people should take a close look at their situation to see if it makes sense, but at the very least the first seg I mentioned is an absolute no brainer for me.

Great points

curious on 60k segregated value , what is the value of building just to get an rough idea.

I need to deduct similar amount in 2023, and trying to see how big of a property I have to buy to come close to your deduction numbers.

Tagging gurus:

@Michael Baum, @Ryan Moyer, @Nancy Bachety, @Arda Bircan

Trying to see if you can share any rough idea on how big of a property would qualify for 80k-100K in deduction?

As segregation takes items into account like appliances, roof, building material etc.. would it be okay to estimate below:

>> 500k property value (150 land+350 built), can provide around 80K in max deduction on year 1 ?

Would it differ or matter if property is being used as short term(i.e airbnb) Or Longterm rental ?

can shortterm rental allow any additional deductions as compared to long term ?

0 Reply

Sammy Habbaz

Accountant · NY · Member since 2021 · 15 posts · 11 votes

2y

Quote from @Ron Singh:

Quote from @Jon Martin:

Quote from @Lisa Marie:

So, along that line, I would like to know how many people on this thread have actually done cost segs on their properties and how much W2 income tax you saved from that.

I paid $600 for a cost seg that will take $60K (80%*75K) off of my taxable income for 2023. I won't say what my W2 income is but I will say I expect to save over a quarter of that of that amount between fed and state taxes. So yeah, absolutely worth it. I can also say that the money I save by self managing, even when broken down per hour, is not far off from my "hourly wage" based on my salary. I look at it as a side hustle where I pay myself.

Like @Ryan Moyer said I can utilize that cash now to invest in more properties and kick the can down the road, potentially past my time on earth. That cash is worth much more to me now in the scaling stage.

As for your "better off in the stock market" comment, your analysis is flawed because it is based on an equal cash vs cash assumption. Most people do not have that kind of cash to put into the market, but maybe we can scrounge up 15-20% of that for a down payment. That's the power of leverage in real estate, where I can pull the returns of a $1M investment with 20% of the cash. I can't do that at Charles Schwab.

Regarding what you said about not investing solely for the purpose of utilizing cost seg and bonus depreciation, sure, I would agree that your decision to invest in an STR should go beyond that and should work in its absence. In a related example, I was looking to get in to a property before year end to lower my tax bill further. Then I realized that if I don't have enough cash to invest in a property for 2024 tax year, then I am better off waiting until then because another cost seg will lower my tax burden within a reduced tax bracket for 2023. Whereas in 2024, that bonus depreciation, even at 60%, will be worth more if that's the only property I buy between now and the end of 2024. So yes, there is nuance and people should take a close look at their situation to see if it makes sense, but at the very least the first seg I mentioned is an absolute no brainer for me.

Great points

curious on 60k segregated value , what is the value of building just to get an rough idea.

I need to deduct similar amount in 2023, and trying to see how big of a property I have to buy to come close to your deduction numbers.

Tagging gurus:

@Michael Baum, @Ryan Moyer, @Nancy Bachety, @Arda Bircan

Trying to see if you can share any rough idea on how big of a property would qualify for 80k-100K in deduction?

As segregation takes items into account like appliances, roof, building material etc.. would it be okay to estimate below:

>> 500k property value (150 land+350 built), can provide around 80K in max deduction on year 1 ?

Would it differ or matter if property is being used as short term(i.e airbnb) Or Longterm rental ?

can shortterm rental allow any additional deductions as compared to long term ?

Assume 80% is building. 400k. Assume 20% is personal property eligible for bonus. 80,000. Assume you close and PIS when bonus is 80%. 64,000.

No additional deductions. The difference is that in a LTR you need to be a real estate professional to offset active income. For an STR you can half a separate full-time job.

1 Reply

Chad McMahan

Residential Real Estate Broker · Sedona, AZ · Member since 2017 · 751 posts · 504 votes

2y

Quote from @Arda Bircan:

Investing in short-term rental (STR) properties and using the STR Tax Loophole is one of the few tax strategies that can save physicians with a fairly high W2 income 6 figures in taxes without working full-time in real estate.

It is difficult for a physician, or other professional to become a real estate professional as they can't spend half of their working hours in a real estate business. This is where the short-term rental tax loophole can help. To ensure you can apply the tax deductions against ordinary/active income, you have to materially participate in the STR business.

Material participation tests are the rules the IRS uses to determine if you worked on your short term rental business on a regular basis during the year. There are seven ways to accomplish this, but the 3 most common and easiest material participation tests used to shelter income for physicians are:

1. Your participation in the activity for the tax year constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year.

2. You participate in the activity for more than 100 hours during the tax year, and your participation in the activity is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year.

3. You participated for more than 100 hours in a regular, continuous, and substantial basis during the year.

The goal is to use your short-term rental for non-passive losses. Because non-passive losses can offset non-passive income/ active income. If you can meet the criteria, your short-term rental will save you significant amount of money on taxes. That’s the first big component of a short-term rental tax strategy. The second is depreciation.

Depreciation for Your Short-Term Rental Tax Strategy

you need a savvy real estate CPA who's going to lead you through leveraging depreciation for your short term rental. You will have your CPA do a cost segregation study on your property. That cost segregation will reclassify certain components of your property from 39 year life (depreciation life for an STR property) into 5 and 15 year life. 5 and 15 year property can generally represent anywhere from 20-30% of a property's purchase price.

So, if you had a $1 million dollar property and did a cost segregation structure, anywhere from 20-30% could be resegregated and fully depreciated. This would give you a $250,000 deduction. This is powerful because your losses are non-passive, and that tax loss can be used to offset taxes on your W-2 income.

Steps to take in order to shelter your W-2 Income

#1. Buy a short-term rental.

#2. Materially participate in the rental.

#3. Obtain a cost segregation study.

#4. Use accelerated depreciation the first year.

#5. Claim paper losses from your business.

#6. Hire a real estate CPA who understands how to use the tax deductions from your short-term rental and apply it to your ordinary income.

What’s Changing About Depreciation for Short Term Rentals & Why it's the time to act NOW.

Certain aspects of this strategy will phase-out over the next few years. 2022 was the last year of 100% bonus depreciation. It is currently slated for a phased approach to decrease the percentage every year for the next five years. In 2023, it dropped down to 80% bonus depreciation. So, if you were going to get a $250k deduction, you’d get $200k in 2023. In 2024, it will drop down to 60%. The $250k deduction would become $150k. Still sizable, but the power of the strategy will decrease.

This feels a bit like click bait.

A loophole in the law is a small mistake which allows people to do something that would otherwise be illegal.

This is kind of like saying I utilize a special real estate purchase loophole for my clients, allowing them to reduce their cash at COE with seller concessions. This is not a real estate "loophole", it's just a strategy that sometimes makes sense, and sometimes does not make sense.

Quickly deducting more depreciation can be great, but then you miss being able to deduct as much depreciation, later. It depends on when you are showing more profits and what category those profits fall within. Basically ask your CPA, etc, about what they recommend, based on your P&L projections, and do that. It doesn't need to be any more complicated or mysterious than that.

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Short Term Rental Tax Loophole for Physicians

Short Term Rental Tax Loophole for Physicians

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