Posted Wednesday, May 8, 2024

We have written several different articles about various real estate investment considerations including cost segregation, fix and flips, short-term rental loophole, 1031 exchanges, among other things. As such we have created the real estate investment mini portal which is a collection of snippets from other content on our website.

WCG CPAs & Advisors receives about 3-4 emails or phone calls per week from people saying, “I am jumping into real estate investing and need some guidance.” Cool! But there are several paths to the coveted real estate investor name tag, and this article walks you through the common ones plus some other tidbits.

This article discusses

• buy and holds
• fix and flips
• fix and hold (sometimes called fix and can’t sell, so BRRRR it up)
• vacation rentals including the AirBNB Host Reporting Guide from H&R Block
• short-term rentals
• rent arbitrage (subleasing)
• NNN leases
• holding companies

We also do some light reviews of 1031 exchanges, real estate professional designation and cost segregation. We have separate articles that take a deeper dive into these real estate matters.

Real estate investment is one of WCG CPAs & Advisors core competencies, and as such we get asked a bunch of questions on rental property tax deductions. Most of those questions involve travel expenses, depreciation, repairs versus improvements and short-term rental loophole deductions. Before we get into all that, let’s take a moment and review some basics in taxpaying life.

Build Wealth
Your primary goal when considering rental properties and real estate investment is to build wealth. Yes, you want the rental activity to have a minimal tax footprint or even offer some tax reduction on other income such as W-2 or self-employment income. However, if you approach buying a rental property solely as a tax-reduction endeavor, you might be chasing the wrong rabbit. Saving taxes is just icing on the wealth-building cake.

Tax Deduction Themes
There are some over-arching themes and concepts for all rental property tax deductions which are the same as general small business deductions. The rental expense must be-

1. Ordinary and necessary (IRS Publication 334), and
2. Paid or recognized in the current tax year, and
3. Directly related to your rental property, and
4. Reasonable, and not lavish or extravagant (IRC Section 162 and IRS Publication 463).

Agenda
From there we discuss travel deductions since it is a bit complicated frankly, depreciation, repairs versus improvements, Bolton / Tax Court Method, vacation rentals with personal use, and a bunch of other exciting things.

Investor Patrol is a wonderful tax service for those who don’t need all the business advisory bells and whistles, but desire pro-active tax planning and scenario-based decision making assistance from an experienced tax consultant. Have a quick tax question? Need to know the depreciation rules as you furnish that new short-term rental? Want to kick around Real Estate Professional designation? Wondering what your April tax bill is going to be in August?

Investor Patrol is like ski patrol… you might not use it, but you sleep better knowing you have it. We offer three typical versions aptly labeled Houses, Hotels and Monopoly. However, each of these can be customized to fit your unique needs.

The general gist of the STR loophole is quite simple. If the average stay of your guests over the course of the tax year and only considering actual rented days is 7 days or fewer, and you materially participate in the activity, then your rental activity is not deemed passive. Taking this one step further, and since your investment into the rental property is considered at-risk, losses from this type of activity are not limited and may be deducted against other sources of income such as W-2, K-1 from an S Corp, investment income, etc. Yay!

In our short-term rental loophole article we also discuss-

• Passive Loss Limitations (Form 8582)
• 39.0 Years for STR Depreciation
• Schedule C versus Schedule
• Gaming the System
• The 7-Day Crackdown
• Tracking Time
• Partnership Entity Benefits for Real Estate Investments

If you are a real estate professional as defined by the IRS and you materially participate in your rental activities, you can claim 100% of your losses and you are not capped by passive loss limits. But wait! There’s more. When the Net Investment Income Tax (NIIT) was introduced along with the Affordable Care Act, the real estate professional designation became an important tax planning tool all over again. Huh? The NIIT is charged on all portfolio (interest, dividends, capital gains) and passive activity income (rentals). However, if you are a real estate professional your rental income is no longer deemed strictly passive and as such is not being taxed by the net investment income tax of 3.8%. That could be huge!

So, how do you become a real estate professional? It is not enough to simply own rentals or have a real estate license. There is a two part test… hours spent and material participation.

How does all this black magic work? With a cost segregation report, all the bricks are figuratively torn down and put into different piles. Some piles are eligible for instant depreciation (unlike the hominy grits in My Cousin Vinny), one pile might be a 5-year pile and the remaining pile might revert to the 27.5- or 39.0-year typical rental or business use depreciation.

Technically and with full-on geek-speak, cost segregation separates property elements that are “dedicated, decorative or removable” from those that are “necessary and ordinary for operation and maintenance of the building.” These piles are called asset classes and they are maintained separately within your property’s depreciation schedule.

There is a depreciable property value of about $500,000 where things change. Below that value, the statistical reliability and therefore predictability is very good, and most cost segregation reports can rely on basic property vitals such as address, age, price, square footage, etc. Conversely, if your property is above $500,000ish, then a “full” cost segregation report is needed where a specialist with an appraiser’s mind analyzes every component of the property and essentially does the brick and pile thing mentioned above. Appliances, floor coverings, window treatments, among several weird things are considered 5-year property. Decks, driveways and landscaping are considered 15-year property.

In other words, you are identifying certain elements of the property that are eligible to be depreciated using a shorter period of time.

Are there pitfalls and problems? Yes.

Do you need help with launching your real estate investment portfolio? Are you wondering if you qualify as a real estate professional? Not sure if spending $5,000 on a cost segregation report is worth it? Need some clarification on the material participation rules? Let’s chat!

WCG CPAs & Advisors is thrilled to partner with BiggerPockets. They coined the BRRRR strategy by taking the original Buy, Rehab, Rent and Refinance and added the 4th R for Repeat. Love it! As Mae West says, “Too much of a good thing can be wonderful.” Let’s not forget another quote where she says, “You only live once, but if you do it right, once is enough.” We digress… but not too far off.

To help with creating a good thing and living life right, BiggerPockets has several podcasts aimed at different audiences, live webinars with Q&A sessions and a massive library of self-help videos and materials. They also have calculators and software recommendations to assist real estate investors in making sound decisions, sure, but also to efficiently and effectively operate their rental properties.

How does WCG fit into all this?

WCG CPAs & Advisors is your real estate investor and rental property expert. We are a boutique yet progressive CPA firm serving clients in all 50 states.