Unlocking Tax Savings: Short-Term Rentals & Cost Segregation Strategies with CPA Ashish Acharya

SPEAKER_01 0:07

Welcome to the Real Estate Explainer podcast where we talk about anything and everything real estate. I'm your host, Brian Kixwell. Today we've got a cease on the podcast. He's a CPA, the owner of investor-friendly CPA. He has a lot of clients who own short-term rentals, and that's what we're going to be talking about. The short-term rental loophole. Let's jump right into the episode.

SPEAKER_00 0:31

Thank you so much for having me, Brian. Yes, short-term rentals, STRs. Everyone calls them in tax world. Everyone calls them short-term rental loophole. I prefer short-term rental strategy because it is a real estate strategy and it builds your wealth while saving your taxes. I'm Assis. I'm a CEO and founder of Investor Friendly CPA. Our clients are 100% investors who do multiple short-term rentals. We had this one client, started with one property and has the 400 right now, short-term rentals. 400. Yeah. And you also have to get into the right time and everything, and he was lucky enough in the right market. So we focus on all the real estate investors. We put a lot of cost segregations that you do. So we know inside out of this. And by anyone, you have a lot of questions for me. But I want to make sure everyone goes away with understanding how to actually implement the sort-up rental strategy and also how to maybe have an LCM stuff and how do they factor into the sort-up rental? If they understand that, they'll be golden. And maybe some rules to actually meet the strategies.

SPEAKER_01 1:39

Yeah, let's jump right into it. The short-term rentals, I see a lot of clients, they'll come to me to do a cost segregation study, whether it's a new short-term rental or it's a property that they've had on their tax returns on their fixed asset schedules for a number of years. And the error that I see is a lot of short-term rental owners treat them just like they would a regular rental property, meaning just strictly a passive rental property. So you own one property, it's a long-term rental, and they're treating that asset exactly the same. Could you just speak to why that is the incorrect way to do it?

SPEAKER_00 2:20

This is the whole reason it's called loophole, is because luckily for investors like ourselves, the government has made this as a non-rental. If you really want to understand this in a simplistic way, is real estate in general has a lot of restrictions to fund tax savings. If you were to go and buy long-term rentals, just some operation, you have a $10,000 loss, most likely you will not use that loss to offset your W-2 income, let's say. But the good thing is compare that with other businesses. Let's say you open a food truck and then you go to something and you lost $10,000 because the first year operation, you can use that $10,000 loss and then offset your W-2 income. Long-term rental does not work like that. There's a lot of something called passive activity loss limitation. And you have to be a real estate professional status, and the people call it RECS too. So many rules, highly one of the highest audited uh tax strategies. But the good news what I'm trying to say is short-term rental is different. Even though it's rental in operation-wise, the definition is that if the property is rented less than seven days on average, you could have uh 14 days and one day and eight days and two days, and on average is less than seven days, Airbnbs, it qualifies as a short-term rental, STR, and then that is non-rental for in IRSI, it's non-rental. It's like in hotels and hospitality business. That's where the loophole is. It does not have to go through these passive activity loss limitation rules like a long-term rental. So if you're buying a short-term rental without understanding this, you're doing everything correctly. You're operating as a rental, you're making money probably because it's a short-term rental, but you're not fully using the tax benefit it can offer, like the food truck, or let's say, I don't know, the restaurant, or anything you can think of from a business perspective. You could open it and save taxes. If you run it as a long-term rental, there's no tax savings, or it's limited and you have to go through a lot of hoops, is what I'm saying.

SPEAKER_01 4:17

Yeah, and I tell clients that just look at as two buckets. You have your bucket of income, you have your active income or your W-2 income, or any other active type of income that you generate, and then you have your passive income. And traditionally, long-term rentals or real estate in general is a passive form of income. And that's where your hands are tied. You're not going to have your passive losses jump over into that active income bucket. They're stuck in their individual buckets. And the nice thing about short-term rentals is you can take that active income if you're actively managing the properties and have it help you offset your W-2 income. And that's super powerful because you don't necessarily need to be the real estate professional at that point. And you talked about that briefly. And I always like to talk about the real estate professional part because a lot of clients get it wrong too. Just being a real estate agent, that's not the only qualification. Or if you're not a real estate agent, that doesn't preclude you from being a real estate professional. You just have to be in the real property business. And I think it's so important to work with the CPA that is well versed in investment properties when you're looking at some of these strategies. So the next piece or the part that I wanted to cover selfishly is bonus depreciation strategy. And it's because as a cost segregation specialist, I have clients that are taking advantage of short life assets on a daily basis. They're using bonus depreciation to help offset their taxable income.

SPEAKER_00 5:57

I had clients who have saved $200,000 a year. This way running cost savings, not even in very expensive property, like in a modest property. If you could do that for the next five years and save $200,000, that's a million dollar of tax savings that you could have never had. Million dollars. People retire with less than that money. You could have just tax savings in front of this two costs. That's why what you do is so important, Ryan. You know this. We want people to talk to you and understand the cost segregation to do it correctly in a better way, so we can record it correctly, and they have these 200 pound laws that they could not handle. And that's what it comes from bonus depreciation. So just to recap, you already know this, and you already probably know this, but just to recap what bonus depreciation is, good. Normally, in accounting concept, in tax concept, what happens is when you buy an asset, you have to depreciate it over the life of the asset. Right? And if you buy a printer, you see you have five years to write it out. Not just right away. But the government incentivizes for the economy. I guess they're trying to help the business owners get more money back into the pocket. And they will give you this deduction, which you can write up everything at once. You buy a printer, boom, you can write it up. You buy a car, you can write it out. Things like that. Same way we can do the same thing with the real estate, but only if you cost segregate, which isn't what Brian, you do, right? You segregate the your real estate. When you buy real estate, uh you segregate your real estate between furniture, floors, lightning, and fixtures, and they can write those things up, is what we're talking about, bonus depreciation. And you can write up 100% if everything goes away.

SPEAKER_01 7:33

And I'd say even with 100%, I do have a lot of clients that'll still come to me and they think that they're writing off 100% of the asset. And I just always have to qualify it. When you're looking at doing a cost segregation study and accelerating depreciation on assets, you're accelerating the short life asset. So I always tell them, let's start on the outside of the property and look at what's outside of the footprint of the building itself, your driveways, your sidewalks, your fencing, some of the landscaping, all of those items are considered 15-year assets. So you'll be able to accelerate 100% of the short life assets or your site improvements because per the maker guides, they're 15-year property. And then when we go inside the property, we're looking at your interior improvements. Now that doesn't mean we're writing off all of your lighting or all of your interior improvements. We're picking and choosing the pieces that we can pull forward based on IRS guidelines. Think carpeting, removable flooring covers. Think about your appliances, think about certain equipment connections. And those are all going to be reclassified as five-year assets. And really, that's what we're pulling forward. The building itself, the structure and the structural components, such as the primary electric, the primary plumbing, your HVAC, hot water heaters, all of that is still going to remain in either 27 and a half year if it's residential, or 39 year if it's commercial. So you're not pulling forward 100% of the asset. You are able to accelerate up to 100% of the short life assets. So we're looking at bonus depreciation and using it. That's really what we're talking about.

SPEAKER_00 9:28

Can I ask you something, Ryan? So when you normally do this cost segregations, a lot of people will ask you this. If I have a commercial property, if I have a mobile room party, if you have a doctor's office, everyone has different, like an average that you could write off, let's say 40% of doctor's office because you have a lot of equipment in there. If you're buying with equipment, as you're in your profession, do you have a very high-level number that you tell people that you could get up to this amount?

SPEAKER_01 9:54

Well, I do have a, let's say, a general guide that I use. What I tell clients when they come to get an estimated benefit is I say don't use like an online calculator that will automatically populate the estimate without having someone put their eyes on it because there is so much variance in properties. For example, if you have a hotel, a garden style hotel that has no exterior site improvements, you're not going to have a lot of the 15-year property. But if you have a, let's say, a hotel that has tennis courts, it has a resort-style swimming pool, it has roads and fountains, all of a sudden the accelerated depreciation on those 15-year assets, because they exist, will really push the numbers up. When I'm talking to clients without seeing their properties, I'll give them a general range. Maybe on a residential property, so in a single family home, you might be looking at somewhere between, I don't know, let's call it 13 to 25%. And that's such a big range. And it's because without looking at that individual property or the condition that the assets are in, it's really hard to just give you a ballpark estimate of what you're looking at, especially if you're banking on getting that tax savings. The other thing that I would recommend is when you're looking at any estimates that come over, a lot of people will say, okay, you can expect to save $45,000 in taxes this year based on a 40% tax rate. And I just have to tell you that not everybody is at a 40% tax rate. So if your tax rate's 25% or 15%, then that $45,000 number that they just threw out there sounds great, but it doesn't necessarily apply to you. So when I look at rule of thumbs or specific numbers like that, I just say everything's individual. You really have to look at the individual property and the individual's tax rate to see how it really applies, because we just talked about active income versus passive income. And that's another big piece of it, is you need to have that conversation.

SPEAKER_00 12:09

100% agreed. And it gets even worse when the robber is in California and the million dollar of their 1.5 million goes to your land.

SPEAKER_01 12:17

Yeah. So the land allocation where you're looking at doing cost segregation studies is real because land is a non-depreciable asset that you have to back out. And the IRS is looking for a reasonable land allocation. They want to make sure that it's the highest and best use and it's reasonable for the area that you're in. And if you're putting a flat 10% land allocation on all the investment property that you own, you're just doing it wrong because if you have a property that's located on the beach in San Diego, it's not going to have the same land allocation as a property in rural Georgia. You just have to look at it. But on the other hand, if you look at the land allocations per the county tax assessors records in places like California, sometimes they'll assign up to 90% or higher to the land allocation. The problem with that is when you bought this property, whether it's a single family home or a $10 million hotel, it already had the building on it. It had all the structural components. It was already zoned. They paid all the permitting fees. So while that land might be worth 90% of the value of it, it's not because you have to do, you have to allocate it to the purchase price. So it's going to be a percentage. And what I'd say is take a look at the county tax assessors records, look at an appraisal, see if they gave you a number for a land allocation, look at market comparables, and also look at the RCN number. So the reconstruction cost new to see what it comes in at. Because if you can't rebuild that property for whatever it is, you're not going to assign it all to the land. So yeah, areas like California can get tricky. You just have to be very careful with land allocations. So the next question I wanted to jump into was material participation and passive loss limits. So this is another area that property owners, real estate investors, get in trouble with because they don't realize that just because they own the property, they think they can take the losses that we provide doing a cost segregation study and have it offset their active income. That's not the case. You have to pass several tests before you can do that. And as a CPA, I'd just like to have you speak to that point. I'd like to thank today's sponsor, CostSegRX, a cost segregation company. If you're interested in getting a cost segregation study, or if you'd like a free estimate, a benefit, log on to realestateexplainer.com and click the cost segregation link at the top of the page.

SPEAKER_00 15:22

That is the most likely the most careful thing you gotta plan in your strategy. We have been to some audits and I can defend everything else from tax perspective, but I cannot really defend the material participation if you're not gonna have the right documentation or you have not understood the rules. There are seven tests that we meet. And this again, I want everyone to understand this. Same rule applies to your food truck, your restaurant business, your call-sack business. It doesn't really matter. Same rule. It's a business, it's not real estate. If you materially participate in your business, then the losses from that business becomes non-passive. People say activate, but it's non-passive. And non-passive loss can offset your other non-passive income, which is WQ. Let's say our other businesses, right? That's seven tests. There's seven tests. Most people go through this three tests. The safe harbor, the golden is like 500. If you work 500 hours combined and on your shorter mentals, you're done. Doesn't matter if you have a proper manager, doesn't matter if you're a full-time employee scheduling your property, cleaning your property, doesn't really matter. 500 hours. But most people don't do that if you're just investing. So people will go and look at two other tests. And you have to really understand this. 100 hours and more and more than anyone else is the one test that people try to follow. For you to meet that test, it's 100 hours or more and more than anyone else. Meaning if your cleaner works 80 hours, you gotta work more than that. If your cleaner works 110 hours, you gotta work more than 110. You also have to track your cleaner hours. There's there are multiple court cases where the court said, okay, looks like you work 300 hours. Maybe your cleaner works less than that, but where's it? You didn't track it. So how do we know? Please make sure you're tracking your other people's hours too, if they're daily involved like that. Because the court will deny it. And then the easiest one, to be honest with you, the easiest one is called substantially all participated. Meaning there's no one else, you're the only one who's doing everything. So you don't have to drag any hours. Even if you spend five hours and you're the only one, you have made the material participation. No hour required, there's no threshold. This last point I made is one of the best get the credit. People don't talk about this. If someone comes to you, Brian, and says, Hey, it's already December, I'm gonna buy the property. Can I do cost it isn't any benefit? Am I gonna meet the material participation? What are you gonna say is this? Of course, you buy the property, let's say December 15th, you put it in the market, you're going in there, you're it's already in the market, you're doing all the bookings, you're cleaning everything, you haven't hired any cleaners here. Your wife is cleaning your kids, you're cleaning it, not kids, but your wife, and then you spend 10 hours decorating it, putting it in the market, everything's science. You have two bookings, that's it. You're done. There's no hour threshold, you made that substantially all participation test, meaning you did all the work. There's no threshold, and you can get the benefit. Boom, next thing happens, you can have a full-time property manager because you already did the cost exactly and you already got the benefit for that year. Plan it correctly, document it correctly, meet all those rules, and you'll be fine. And said Laura says what I do want to end this topic with one caveat there. You know, what IS will say is, and they have said this, I reforted, we won, but they have said, hey, all the hours you put before you put the asset in service doesn't account, which is absolutely wrong. We fought it, we won it, but they said, hey, let's say you go and buy the property, you do not put it in the market, you do all these renovations, you buy furniture, you travel to the property to fix the mailbox, but it's not acting, then all those hours start of hours, which is this there's not even word for that. But they said that, and you took months to fight then. So if you don't want to fight then, even though it's New York, right? Put it on the market right away.

SPEAKER_01 19:09

That's it. Is it's getting the property placed into service, and what that means is it's ready and available for its intended use. So if it's ready and available to be listed as a short-term rental, then you know, post it for rent, and then it's in service that day. And then the other thing that you said was absolutely perfect too. It's document everything. And I tell clients that is what we're trying to create is audit ready cost segregation reports. And what does that really mean? It means keep your closing statements, keep your appraisals, keep your purchase contracts, keep all of the documents that if you're involved in an exam and audit, they're going to ask for. And they're just asking for that information because the burden of proof is on you as the taxpayer. Because the IRS doesn't know how much you bought the property for. They don't know what your closing statement looks like. So they're asking you to prove to them, hey, based on the closing statement here, this is how much I paid for it. Based on the day it went on to whatever listing platform you have, this is the date the property went into service. So really documenting everything is just so important. And that actually jumped right into my next question, and that you answered it too. It's how do you keep clients audit ready and compliant? And we just dived into that. So I'll let you take it away.

SPEAKER_00 20:33

See, you do your own part. As an across education specialist, you're make sure you have those documents and you use appraisals and county records to come up with your allocation, all those things. For the client, though, you as a professional, you'll have all those information. You have a packet for them, you give it to them. You let's see your client saves that from DAX perspective to get the loophole and to get the strategy implemented. You gotta make sure hours are tracked correctly, detail as much detail as you can. Think what access you took after you did something, the receipts saved for that home depot trail, the flights and what you accomplished in doing the travel. As digital as you can be. You know why? Let me give an example. And with due respect, this is how IRS thinks. We had a client who bought a furniture, delivered to his primary residence, and then packed it up in a truck and took it out to his Airbnb and implemented and put everything in place and service. The IRS agent said, Oh, this furniture did not get delivered to your Airbnb. It's not business, you cannot deduct that. You have to understand from operational perspective, not everyone's gonna directly deliver to Airbnb. There might be you might not be even operational. There might be construction going on. You also gonna go. That is how they think, right? So you have to give you basically spoonful them documents. Okay, this is how I did everything correctly. If they think, they're gonna think wrong. So you gotta make sure you write on everything what you did not do. You place it in service you have your contracts, your Airbnb dates have listed, screenshot it, saved it. We give clients like guys checklist, you know, how to do everything. They need you need to follow that. Once you follow that, you'll have audit. You're gonna get audited. Is audits are random, but it's audit true is what we talk about. You have saved everything up, just slap it down on them, and you'll be fine. The other few things I'll tell you, you know what you Very big things you need to worry about is if you work with someone like Brian, they will be you know cross-iting system will be fine. If you go and do DIY, then you're in trouble. But if you work with Brian, cross-siding is fine. Hours track it correctly. Expenses and everything you do. Make sure you have receipts and everything. Tie any the hours I'm talking about. As detailed as you can be, is my right. People ask me, okay, how much rate book? I said, as detailed as you can be. You have to those three things. And on top of that, if you can understand how to structure your entities and stuff, that also helps because that's also audit press. One more example, your audiences will like one of the audits I was involved in. I just says, which is wrong. But this is what IS said. IS said, hey, you can not combine all the hours from all the crockeries as one activity to meet the material participation rule. Not right. You can actually. But they're saying in all these properties are separate businesses. How is that possible? You have 10 crockeries in 10 different states, and they're saying, no, they're 10 different activities, and you cannot combine them into one to meet material participation. But if you can combine them, you can really do train um, you can really meet the material participation and you can do tax planning around that, which I'm not gonna say right now. It's too much information. But now the what I'm saying is this if you don't want to fight higher, even your right, but if you do not want to fight them, you do one simple thing. Get LC and put all the properties in their wild. And by default, it becomes the one in the economic union, and they cannot fight back with you. Get one LC, you can have multiple LCs holding multiple properties for each property. That's fine. Talk to your attorney, but have one holding LC holds all the assets as in one activity, and then document your intention and your business documents as such, and you'll be fine. But man, you have to really, it's a loophole, and they're trying to get you from everywhere. You gotta really document it well, is what I'm trying to say. Like exactly what he's saying as well.

SPEAKER_01 24:19

And I know you've got a uh presentation or a seminar coming up tomorrow, actually, that talks about setting up corporate structures. And I think that's such a valuable thing, whether you have just standard rental properties, if you own a restaurant, a small hotel, whatever it is, it's making sure that you're structuring that entity correctly. And if you're buying multiple properties, especially as you start to bring in partners, setting everything up in the very beginning is just so critical. So, with that said, I'm gonna go ahead and wrap up the podcast. I think we really did a good job just covering certainly not everything when it comes to short-term rentals, but the basic four questions that I wanted to talk about. If the listeners want to get in touch with you, what is the best way for them to reach you to either get a consultation on your tax services or just to learn more about what you do?

SPEAKER_00 25:13

The easiest way you can get in touch with us is just to go to investorfriendlycta.com. That's our website, just anything you brought, anything you need right there. But as just so you know, I love Brian. If anyone who listens to this, just email me directly at assis and friendlyc.com. Again. Assis is my first name. You can put this in your notes. Email me directly to your questions. I'm not even charging you. Just ask questions. If you want to get a call, I'll answer your questions. We'd like to give. We don't like to charge every single one. But if you want to know more about how to implement this, I started here with Brian. Many of your CPAs or your tax advisors do not know. I'm more than happy to jump and tell you exactly what to do. I'll give you some guys you can do this on your own as well. Just email me. But follow us on social media, okay, on our Instagram, Facebook, LinkedIn, you just search Investor Friendly CPA. You'll find us. We give a lot of documents, good information, tax planning, about everything else, and just get in touch and we'll be fine.

SPEAKER_01 26:10

Perfect. Thank you for being on the podcast today.

SPEAKER_00 26:13

Absolutely. Thank you.

SPEAKER_01 26:14

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