All Forum Posts by: William C.

@William C.

I personally would not be concerned about this structure's permit status for tax purposes. Our tax code tries to be blind to legal compliance outside of taxation. To give you an example, you're supposed to report your business income for tax purposes even if the source of income is illegal.

The most serous concern for me would be the one raised by @Chris Seveney: insurance. And with STRs, the risk of an insurance claim is higher.

Quote from @William C.:

Unique situation. I can provide more info as needed. Proposed strategy is to purchase a property that has both permitted and non-permitted, but livable, structures. Use one of the non-permitted structures as a STR (it's currently successfully being used this way by the owners). Do a cost seg on that non-permitted structure and use the STR loophole to utilize those losses for tax off-setting purposes. Any opinions on tax legality of this?

 Big Red Flag: For a cost segregation study, the asset must be depreciable under the IRS rules, and that typically means it must be a legal, capitalizable structure.

Typically, Non-permitted = Non-depreciable: If a structure wasn’t legally built or doesn’t meet code, it’s questionable whether it qualifies as an asset with a determinable useful life under IRS guidelines.

Also If the unit is illegal to rent (because it's unpermitted), you’re again treading into risky territory. Even if it’s "currently being rented successfully," that doesn’t make it compliant or safe from penalties if caught.

We will not even get into the liability and insurance component, but this is one way to get sued and be sued personally in a way insurance would not cover you.

@William C. If you and your spouse earn $300K in W-2 income and operate a short-term rental (STR) with average stays under 7 days, actively participate, and run a cost segregation study that creates a $60K loss, that loss can offset your W-2 income—even without qualifying for real estate professional status. This would reduce your taxable income to $240K. Assuming a combined federal and state tax rate of ~38%, you'd save around $22K–$24K in taxes—not the full $40K you currently pay. Any unused portion of the loss can carry forward to future years to offset STR or other non-passive income if material participation continues.

This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

@William C. that's pretty much the way it works. But it's tricky.

The two main things to focus on? Average rental interval of 7 days or less... and you and your wife materially participating (by the way, not actively participating that's something different).

If you get a cost segregation study done, as a guess you can maybe deduct 20% of the purchase price for 2024 tax return. You will also probably be able to deduct nearly 100% of the furniture by applying the Section 263 de minimis safe harbor.

But you need to be careful of some mistakes that blow up the strategy even if you get the above stuff right. For example, you do need to not get entangled in the Section 183 (aka "hobby loss") rules. And you need to not get limited by the Section 280A mixed use dwelling rules.

Tip: If you're doing the STR truly, truly, honestly, honestly to build wealth and earn a return on your investment? You don't need to worry about Section 183. And as long as you have zero personal use, don't discount the rent to people, don't rent to family members, you don't need to worry about Section 280A.

The depreciation would directly offset your taxable income at least at the federal level, not sure about your state. So $60k in depreciation losses would lower your taxable income by $60k

Combined W2 income of $300,000 should generate more than $40,000 in taxes, especially with state taxes added. You're looking at some wrong number to measure your tax burden.

Losses do not offset taxes, they offset taxable income. So if you really have a $60,000 loss, you would be paying taxes on $240,000 of income instead of $300,000. That may lower your tax bill by maybe 20,000.

Quote from @Sean Graham:

Quote from @William C.:

Quote from @Sean Graham:

Quote from @William C.:

Wild idea based on a property in my local market. Is it allowed to purchase a property with our primary home that has a detached ADU on the same tax lot. Live in the primary. Rent out the ADU as a STR (7 day stays or less). Perform a cost seg study on JUST the ADU. Anyone out there with experience in a similar situation? Thanks for taking a look.

Yes. This is common in California  

Thanks for the reply. Any tax knowledge of if people doing this strategy are able to take the losses from the cost seg study (on the ADU) to offset their W2 income? This would be via STR loophole, not REP status.

Yes, absolutely! Here is a podcast episode I recently did with BP on this 
https://www.biggerpockets.com/blog/rookie-521

Thanks! On it. Going to give this a listen and get back with you.