Short Term Rental Tax Loophole for Physicians

[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.