Understanding Bonus Depreciation and the STR Loophole for Tax Savings

0:00The big deal with short-term rentals is most Americans are W2 income earners. And they are not full-time into real estate in some shape or form, right? That would be something like and we can discuss this too if you want real estate professional status. But because most people are working a full-time W2 or both spouses are working a full-time W2 or they've got their other business, it's just really hard for people to meet the actual real estate professional status. And again, we can get into that in a second. But the beauty of the short-term rental and why this is so common and probably the most common kind of tax strategy for our clients and W2 earners in general is because the time requirement is so much less.

0:38And so basically, if I can just take a second to explain the short-term rental strategy, I think that's where we're headed. Really in general, it's essentially two different steps or two different requirements. And step number one is basically you have a property that has an average stay per guest of seven days exactly or less. So that's very typical vacation rentals. You've got a property in Miami or wherever it is, right? And you have on typical, you know, just weekend stays. That's very typical for Airbnbs in these vacation rentals. Okay. So great, we've met the first step.

1:08Great. On average, I've got a couple rentals during the year and I met that. Now step two is the part where why most people move into this in my opinion. Step two is then material participation. And as you evaluate the material participation test that we have from the IRS, there's really seven. And if you're a W2 income earnner trying to say, what is the lowest requirement that I need to achieve in order to successfully meet kind of this short-term rental tax strategy or loophole, not everyone loves that word. Basically, what we talk about most is the 100 hour rule.

1:40Okay? Because the contrast to that, the kind of second most common in my opinion is the 500 hour rule. But that's a lot of time, right? If you've got a full-time W2 job over the course of, say you work 50 hours a week, that's 10 hours a week, you have to put into your short-term rental over the course of the year. However, with 100 hours and more than anyone else, that's a huge caveat to the uniqueness of this specific test that we have from the IRS, 100 hours and more than anyone else, typically you can achieve something like 100, 150, 200, which is hundreds of hours less, right, than the 500 hour test.

2:13Now again the big caveat there is you have to have more time than anyone else. So you will probably see from us, you will probably see online and we can discuss here if you want that having someone like a property manager is going to make that difficult because now you have to compare your time right 100 hours and more than anyone else. So 100 hours is like a minimum threshold. You have to get more than anyone else. So property manager, cleaners, handyman, contractors, whoever it is. Okay. So if you start to hire out all these things to other people, number one, you are getting less time.

2:48So it's making it harder for you to get to 100 hours over the course of the year. But number two, you also are now competing with more people who are now accumulating more hours, right? So, the more that in especially the year that you want to meet the short-term rental loophole, and I'll explain kind of what in benefit this is in just a second, Kirby, and for listeners, but basically, if you can get this test and you can manage it yourself and do as much as possible in the first year, number one, you're going to more easily get the hours, but number two, you have less to compete against. Okay? So, there's a lot of strategy there, and we can always discuss that too, Kirby.

3:20But ultimately, people are like, "Okay, well, what's the benefit of meeting this?" That's kind of a common issue and question I get. Why do I want to meet this? Because that $35,000 that Kirby and I just went through in our example, that tax savings is zero. If you do not meet the short-term rental strategy and do a cost s, okay, if you do this wrong, that is $35,000. That's an actual reality that could be in your bank account if you have a short-term rental, you meet the short-term rental strategy, you have a cost segregation study done, you do all the requirements correctly on your tax return. All these things have to come together.

3:51If we mess up on one of these, we don't meet the short rental strategy, you don't meet the time requirements, you don't have a time log, all those things, then that tax savings is poof, gone. And there's a there's the way I tell people is there's about 10 ways to do this right. And there's 80 90 ways to do this wrong. And so what we want to do at our firm when people work with us is help people stay on the straight narrow path to get this done right. Because if you start to veer off into any of these directions of personally using it, you don't get a cost sake, you put it incorrectly on your tax return, all these things, then it's all for nothing, like you do it incorrectly or it's illegitimate, you get audited and you lose and you have this interest and penalties and all these things and it's just it just blows up.

4:28So, we want to be proactive in that. Say, "Hey, here's exactly what you need to do in order to get this right." So, you got to meet the short-term mental loophole in order to get these losses to offset things like your W2 income. Okay? So, if you're making 500, $400, $300,000 a year, and like we went through in our example, we're accelerating a $100,000 loss, like Kirby was saying a few minutes ago, now we're paying instead of 500,000, 400,000. And that's where the tax savings come in at $35,000 in a tax refund potentially. So, — I know I just had a huge monologue. I'm I always get very excited and animate about this stuff, but what questions should I wrap into there?

5:04— It's a it's it's it's a great explanation. And one thing I'm I think a lot of people would be curious about is that 100 hours. What what qualifies for that 100 hours? — Yeah. So it really falls into kind of three main buckets. You could say really tude if you're going to play it safe just for kind of this general comments here. Number one is going to be essentially management time. So that's that's kind of why you'll hear online or kind of from us like be careful hiring a property manager because you're going to get a lot of time there especially in the first year.

5:36So that's going to include things like you know speaking with guests that's going to include things like managing or doing the cleanings. Actually that's more the second thing excuse me setting up the listing right so kind of the advertising getting it up there on Airbnb VBO things like that. That's going to include things like you know getting the pricing right. That's going to include, you know, talking to guests and doing all that kind of communication and making sure things are set up appropriately. Okay? So, the advertising, the management, all that kind of stuff on just a regular basis as guests are there. But then another kind of second key kind of bucket that I put people into is really the physical work.

6:11And so that's like the getting things set up as in like you put in the furnishings, you go and buy the, you know, decor, you go and buy all the things there. And maybe you've got some things that need to get fixed or some improvements or you're going to add more amenities. Kind of the physical work. So you've got basically bucket one is kind of the management, the taking care of it, talking to guests, getting things set up, the advertising, and then really kind of bucket two to keep it simple is really the physical work, the cleaning, the repairs, the improvements, the setting it up, the furnishings, all that kind of stuff. Those are kind of the main two.

6:42Sometimes depending on their situation and if they have management, we could include other things like, you know, buying the property, the financing, getting that going and things like that. But there are certain things that you want to be careful around especially if you've got a property manager like you know travel time or quote unquote education hours where hey I read a book on the short-term rental I went to this conference is that material no it's not material participation in general and things like that so it's really got to be like true work that adds value and is necessary for the operations of this property right absolutely management and absolutely the kind of physical work that needs to get done so does that help that answers — yeah absolutely yeah and and My wife and I work on this together.

7:23And I think a lot of spouses do. We file jointly. Yeah. Our taxes. So, is this 100 hours individually or 100 hours collectively between the two of us? — Yeah. Great question. So, if you're married and filing joint, it is then both of you combined. If it is something where you're married filing separate or single, yeah, then it is kind of looked at individually. But yeah, that is one of the beauties actually of B basically being married is you guys are seen as one taxpayer instead of two.

7:54So yeah, if we're married filing joint now the time requirements, it is kind of combined which is beautiful. And it even kind of taking that further if you've got multiple short-term rentals and you've got say two, three, four properties that all meet the average stay less than seven, you can actually group them together to help you meet now material participation as well. So it's not just combining you and your wife if you're married. Now, it's combining the number of properties that you have too. So, this can be something that kind of as you grow and scale can theoretically in some ways get quote unquote easier in order to meet the time requirements.

8:26It can be difficult the very first year depending on how passive or kind of involved you're going to be. But absolutely, just to answer your question, yeah, it's it's the two of you if you're married filing joint. Correct. — That's great because I hate the setup process. I I that's a part of the process I despise. We just finished a 5 unit and I think my wife could qualify for 100 hours just setting up that five unit alone. And I I opted out of that process. So so that's good to hear that it's a a combined total. I'm curious, do you think it's too late for somebody who wants to take advantage of this in 2025?

9:04Do you need to start earlier or what what do you typically see for that with your clients? Yeah, another super common question I'm really getting this time of year is kind of the same same thing here. The short answer is no. It's not it's not too late and and don't feel bad if like this is completely new to you. Then it's like well you didn't know about this before. The only people that I give a little bit of shaming to is people who have known about this for like a year and it's like why didn't we get started like 6 months ago, seven, eight months ago. If you knew about this, why are we procrastinating this?

9:37Because now like you're even thinking right now just logically you've got less time to do this. You've got less time to find a property, identify a market, all those things. Yeah. Like what what were we waiting for? Maybe there was a financial reason or you had to, you know, store up cash and those are all legitimate reasons, but just for those of you procrastinating, it's like, yeah, you had a better chance of doing this and getting this implemented for this tax year had we kind of started or you had started kind of looking at this sooner. But yeah, it's totally still possible to do. I have just as an example Kirby I had a client who I think he closed on it like right around Thanksgiving November and this was you know two years ago and got it up and running kind of very shortly after that I think within a week or two and he met the short-term rental loophole tax requirement.

10:19So, it's not impossible. If you're just starting to look and you're just starting to put together capital, that can be tough if you're kind of starting from square one. But, if you've got the capital, you've got some of the financing, you've identified your market, all those things, and you're kind of, you know, already looking and identifying properties and putting in offers, it's definitely not too late. Just depends on then how quickly you can turn over the property to get the furnishings in. How quickly do you need to do any improvements? If it's a fix or upper and it's going to take months to do all this, obviously, it's going to be more unrealistic. If you've got a good decent property and it's mostly up and running and ready to go, totally realistic to do that.

10:52Absolutely. — Got it. Got it. That makes sense. And how do you determine if a like what price point it makes sense to do a cost seg study? Is there a certain threshold that you're like, you know, under certain amount of it's it's just not worth the cost of a cost seg. — We look at kind of two things. One is absolutely the price. So, the purchase price, but number two is also like the tax bracket that the individual is in. So, if you're in the 30s, that 32, 35, 37, I mean, you could you honestly could go as low as like we'd say like 150, 200, especially with 100% bonus depreciation being back.

11:33And but part of that as well is what is your kind of expectation? Is this something that you can only do this year? Are you going to add in a bunch of improvements next year or something like that? Are you going to not meet the short-term rental loophole requirements this year, but you can meet it next year. So, the timing specifically of the cost sag is going to be important there of what's really going to go on with the client. But yeah, I'd say just to answer your question specifically, probably that 150 200. But then the other component of that too is what type of study are you going to get done? There's really I break it down mentally into kind of two different buckets.

12:05One is you have something that's more of a do-it-yourself. Oftentimes they call this like a software study. Those are much cheaper, right? Because you're just kind of doing it yourself. You're paying for this software and boom boom you plug in a bunch of numbers and it spits out the report. You don't have to get any sort of engineer involved. And then there's option two, which is the more like I was just kind of alluding to an engineered study, which is, hey, you have a professional engineer do these and those are going to be just a lot more expensive, right? Kind of the more do-it-yourself software options, those are usually going to be around 750, so several hundred.

12:36But the engineered studies because someone's going to have to really take the time manually do it blah blah blah and whatever those are usually going to be like no less than like 3,000 2500 and could be thousands of dollars more depending on who you use size of the property all that kind of stuff right purchase price where it is all that so depending on like for example let's take two extreme examples if you've got someone who's like hey 32% tax bracket and they are going to have a $200,000 property I would probably typically push them towards a software study.

13:08However, if we've got a million dollar property and we've got someone in the 37% bracket, I'm usually pushing them towards the engineer. Right? You've got a higher tax bracket, higher purchase, and just the additional few thousand is likely going to yield more tax savings than the additional incremental cost going to the more expensive price and more expensive cost segregation study. So, that's kind of like some of the delineation that we think here. Just depends on kind of what's really going on. — Yeah, that makes makes a lot of sense. And for people listening too, I'll I'll put a link to a a a little bit of a hybrid between do-it-yourself and an engineered study that I found to be the most cost effective company out there.

13:47I'm using them to do a cost seg this year for one of our properties. So I'll put that link in the the show notes too if you guys if someone's looking for someone to do a study for them. But what I mean bonus depreciation I know we talk about it typically in terms of you know the short-term rental loophole and real estate but this can be applied to other business equipment and even vehicles right to help offset taxes. — Correct.

14:18Yep. And and really yeah bonus depreciation or section 179 those are obviously two common ones. And the reason that especially so like let's say you do have like an equipment business or something like that where you own equipment and then you know lease it out or something like that. Yeah that's not something that you typically need a cost segregation study for right because the whole piece of equipment is eligible for the section 179 or bonus depreciation 100%. But the unique thing about real estate specifically is that not by default do you get those numbers right?

14:52You have to get a study done by a professional according to the IRS to get those kind of specifics around your purchase price breaking down the components into that 39 5 and 15 year property. So that's kind of the unique thing with real estate is there's so many components just within your purchase that you don't get by default. It's not on the closing statement. It's not like hey the IRS sends you some, you know, depreciation schedule. You've got to pay a professional to get that done. But vehicles, you know, equipment, all of that stuff. You buy a vehicle for over that 6,000 pounds, you know, gross vehicle weight rating. Yeah, by default that's eligible for if you use it for 100% business, obviously you can get that full deduction immediately.

15:29You don't need a cost segregation study to get that number. It's just the purchase times your percentage you use it for business and that's your deduction. So there's no special study. It's just real estate that needs that extra study. But yeah, absolutely totally applies to other businesses, vehicles, equipment. Absolutely.