Short-term rentals provide some of the easiest and most powerful tax savings opportunities available to investors. You can literally save six figures of federal and state income taxes in many cases. But you need to know the rules. And plan ahead. The paragraphs below give the low-down. And maybe the good news here? None of […] The post Short-term-rental Tax Tips and Tricks appeared first on Evergreen Small Business.
Short-term rentals provide some of the easiest and most powerful tax savings opportunities available to investors. You can literally save six figures of federal and state income taxes in many cases.
But you need to know the rules. And plan ahead. The paragraphs below give the low-down. And maybe the good news here? None of these tips are hard to use. Or too complicated.
Tip #1: Invest in Short-term-rental Properties for Profit
Let me start with a subtle but probably the most important point. Your short-term-rental investment? You need to be doing this to make money. As a way to build wealth. Maybe to prepare for retirement.
Vey frankly? The right way to plan this all out is that you will ultimately invest in multiple properties. Gain some economies of scale. Build expertise.
The reason this “pursuit of profits” angle is so important? The best and really the only big tax savings come when you invest in short-term-rentals for profits. And to grow your wealth.
Note: Section 183, commonly known as the hobby loss rule, and Section 162 set this requirement.
Tip #2: Average Rental Intervals of Seven Days or Less
The next tip: You want to average rental intervals of seven days or less. And for a simple reason: If your average rental interval is more than seven days? You probably won’t be able to use the big tax deductions your property or properties generate.
With intervals of seven days or less, you can probably get big tax savings if you (and your spouse if married) spend more than 100 hours a year. You may even be able to get big savings if you spend just a few hours a year.
With intervals of more than seven days? Tax law considers your short-term-rental a real estate trade or business. And in that case, Section 469(c)(7) of the Internal Revenue Code says you or your spouse will need to qualify as a real estate professional by spending more than 750 hours and more than half your work hours on real estate businesses if you want to deduct losses. That qualification? Obviously much harder for new and very part-time investors to achieve.
Tip #3: Track Your Time
A third really important tip. You need to track the hours you spend on your short-term-rental business starting with the minute you begin your search for your first property. Here’s why: Even if your average rental interval averages seven days or less, you also need to materially participate in the short-term-rental business.
The lowest-hour route to achieving material participation: Be the only person who spends time on the rental. For example, you’re single. You buy a property late in the year. Say mid- to late-November. You rent the property once for a week in December. And the only person who works on the rental—the only person—is you. (For example, if the property is a cabin in the woods? You do any maintenance. And you do the housekeeping before and after your guests stay.)
The most practical route to achieving material participation however? Spend more than 100 hours working on the rental and more time than anyone spends. You can combine the hours that spouses work. But some hours don’t count. (More details on that here: Grouping activities to achieve material participation.) And then this predictable tip: You want to document your hours—and the hours others spend.
Tip #4: Expense as Supplies Everything You Can
Assuming you’ve followed the first three tips, you’re ready to begin loading up your tax return with deductions.
And here’s the tip for doing that: Expense any individual thing that costs $2500 less as “supplies.” So, the $400 chair, the $800 sofa, the $1800 TV, and so on. Appliances, you should be able to expense too.
One caution: You can’t expense individual components of some bigger thing. For example, if master suite bed includes an $800 mattress, a $600 box spring, and a $1200 antique frame thing? You look at the total $2600 of cost to provide someone a place to sleep.
If just writing off as supplies seems funny? You should know that Treasury regulation 1.263(a)) says you can do this by making an election in your tax return.
Tip #5: Pay for a Cost Segregation Study (Maybe)
Another tip related to ginning up deductions. You maybe want to pay for a cost segregation study. That study, conducted by a civil engineer or consultant (so not your tax accountant probably), breaks apart the price of the building into real property and personal property.
Without a cost segregation study, you’ll depreciate the building part of the short-term-rental over 27.5 or 39 years. For example, if you buy a $1,000,000 property, you might call $200,000 of that land and $800,000 of that building. And you depreciate the $800,000 of building over basically three or four decades.
With a cost segregation study, probably, you might instead (in effect) look at the $1,000,000 of purchase price representing $200,000 of land, $600,000 of building, and $200,000 of personal property. That $200,000 personal property chunk you will write off in the first few years of ownership. That frontloads the depreciation into the first few years.
Note: We have a short-term rental depreciation calculator you can use to estimate what a cost segregestion study does to your depreciation deductions.
Tip #6: Consider Bonus Depreciation
By the way, if you do a cost segregation study? Consider using bonus depreciation to immediately deduct some large percentage of the personal property. The bonus depreciation percentage is slowly deflating: 60% in 2024, 40% in 2025, 20% in 2026 and 0 in 2027.
But if you can use bonus depreciation to create a big deduction? And then use that big deduction to save highly taxed income? That’s a no brainer.
Tip #7: Consider Section 179 Depreciation
Bonus depreciation, if it’s available, works best for frontloading depreciation. But some short-term-rental investors may be able to use a similar depreciation trick: the Section 179 election. A Section 179 election allows a short-term-rental business to deduct 100% of most of the personal property shown in the cost segregation study.
To use Section 179 for a short-term-rental, however, your short-term-rental operation needs to rise to the level of a “Section 162 trade or business.” That’s technical tax law concept that looks at your profit motive and then at whether you show continuous, considerable and regular involvement in the business.
Note: The Section 179 method of loading up deductions creates a depreciation recapture risk. Thus, confer with your tax advisor if you want to even think about using this tip.
Tip #8: No Personal Use
A quick caution: You should not use your short-term-rental for personal use. That use triggers Section 280A, a chunk of tax law that explicitly exists to limit or eliminate deductions stemming from a home or vacation home.
The one exception to personal use? If you stay at a property and you (or your spouse if you’re married) works full-time during maintenance.
By the way, if you go spend a week at the Hawaiian condo? And you work full-time during the regular work days but then “take the weekend off?” Now you have two personal days. And Section 280A will basically dial down your tax deductions because some of your use during the year was “personal.”
Tip #9: No Family or Friends
A related point: If you rent to a family member? That counts as a personal day, triggers the Section 280A formulas and probably limits your short-term-rental deductions.
And if you rent to someone at discounted rate? A good friend you don’t want to charge the regular full price? That then counts as a personal day, triggers the Section 280A formulas, and again probably limits your deductions.
A consolation related to tips #8 and #9. A few years down the road? Once you’ve burned off a bunch of the depreciation? You’ll be able to use the property for personal days, family or friends with less disastrous consequences. But not early on. (And also, just to say this, not if you use the Section 179 election described in tip #7.)
Tip #10: Invest Out of State (Maybe)
A final big, move-the-needle tip. If you reside currently in a high-income tax state and you plan to someday move to lower tax state? Consider investing in short-term rentals in that other state.
The out of state property’s depreciation creates deductions and tax savings on your, say, California state income return while you’re a California resident. But later on, when you reside in some no-income-tax state, say, Florida, you can sell the property without having to pay any state income taxes. Including to your original home state.
Closing Comments and Caveats
Part-time real estate investors often struggle to harvest tax savings from their real estate properties. But for investors willing to plan ahead and think outside the box? The Short-term-rentals tax tips and tricks described above can allow most taxpayers to shelter very large chunks of income.
The post Short-term-rental Tax Tips and Tricks appeared first on Evergreen Small Business.
