CW 911 FBF - The Potential Perils of Using Your Buy and Hold Properties As Short Term Rentals

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Welcome to the Creating wealth show. This is your host, Jason Hartman, and we are at episode number 563. 563. Thank you so much for joining me today. Our guest will be CPA Brandon Hall. Yes, we're bringing a real estate specialist, CPA on the show. Mostly I reached out to him because he wrote an interesting article about Airbnb and I've been following with admittedly some degree of fascination at people, you know, doing Airbnb rentals. And, and really they're, they're almost in the hotel business. So it's not a, a very passive investment the way most of our listeners like to invest and really not be managing something all the time. But I've been really watching it very closely over the years and I've been, you know, I know many people that do this and, you know, say they like it and say they're doing well with it, but there is a huge flaw. Yes, a huge flaw. And it's not the management, it's the tax code. Some of these Airbnb people are in for a rude awakening. But by Uncle Sam. Yes, Uncle Sam is going to knock on the door and say he wants a lot more money that your Airbnb rental is not nearly as tax favored as the most tax favored asset in America, income property a la Jason Hartman, my way. So we'll hear about that with Brandon hall and he's going to talk about some other really good stuff as far as taxation for real estate investors and tax benefits and so forth. I'm going to have him back to talk in detail about unlimited passive loss exemptions and real estate professional at a future date. But we kind of touched on it here a bit and we touched on several different strategies that I think you'll like. It starts off with Airbnb. So if you think, hey, you know, I'm not an Airbnb guy, I don't care about this. Why am I listening? Keep listening. There's more. But wait, there's more, as they say on the infomercials. A couple things before we start on that. First of all, it was with great sadness to see the passing of Dr. Wayne Dyer a few days ago. That happened during our Jason Hartman University event in San Diego. And I had followed his work for many, many years. I remember actually in college learning about him when one of our assignments in one of our classes, my first year of college as I was starting as a real estate agent part time attending Long Beach City College was to read the book you, Erroneous Zones. And I remember I got his tapes on how to be a no limit person. And you know, that was, that was great influence. I was so lucky to discover all these great mentors at such a young age that they really changed my life discovering, you know, Zig Ziglar and Dennis Waitley and so forth at age 17. And then Earl Nightingale and Jim Rohn and later Wayne Dyer and you know, they're, they're all passing on. Dennis Waitley's still around, but all the others are gone. Sad to see that. And of course, you know, we lost Stephen Covey a few years ago too. He was a, another one of the greats. And you know, you might be thinking, well, Jason, why are these all men? Someone asked me that during one of my speech once and I, you know, I don't really know the answer. I guess men just like to get up on stage and talk more than women do. I mean, women do, but not as much. You know, if you look at the population of all these gurus and motivational speakers, they're largely male. And I have endeavored in, in the financial world greatly to try and get more female guests on the Creating wealth show. Sometimes I go to Jason hartman.com, well, actually I go There all the time. It's my favorite website. It should be yours, too. Anyway, sometimes I go there and I look at the podcast page and I look at all the guests and it's like, what is this, a men's club? It's ridiculous. Let's get some female perspective. But the fact is, just not as many women write books about financial stuff. It just is. Must be, you know, just the way society has sort of told everyone they should be in their role models. Or maybe it's just, you know, the differences in interest and brain. You know, I mean, there. There are actual physiological differences between the male and female brain. There's no question about it. Anyway, it's just kind of interesting. Something I've thought about, and we really do try to get more female guests on the show, so stay tuned for that. But today we got another guy. Yep. CPA Brandon Hall. Just a little recap on Jason Hartman University. We had that event for the very first time last week. One of our friends from a real estate forum that asked about it and said, can someone give me feedback on this event? And I said, trust me, nobody can give you feedback, was my reply, because I haven't even been to the event yet. Well, we did it last weekend. We did it in San Diego, and it was great. I mean, it was a good event. Everybody liked it. The evaluations were extremely positive. So thank you for all the kind words. And we really dove in to the fundamentals of real estate investing. How to do the math, the math of real estate investing. And nowadays, of course, we all use software to do this kind of stuff, or at least we use a calculator to do it. But it was really interesting to actually, you know, when you do the math yourself rather than just looking at what happens on the website. For example, if you go to jasonhartman.com properties, you'll see the properties there and it's all figured out for you. But when you do the math yourself, you really own it. You know, you own that number, you really understand it more deeply. There's a big difference between hearing something and actually actively doing something. So this was really our first attempt, and I think it was a successful one, at least by audience feedback at making things really interactive. So look for more of that in our future events. We're gonna. We're gonna really strive to make things more interactive. We did a fun game over the lunch break on the first day on Saturday where everybody had to build their own real estate portfolio. And I thought about that and how almost all the teams, except one Outlier Got a got the same answer, you know, but the next time we do that game, we're going to spice it up and make it a lot more in depth and more challenging. So look for that. Maybe we'll play it at our Meet the Masters event, which is tentatively slated for January, early January. I guess I can give the dates and we're going to have this on the website pretty soon@jason hartman.com events we don't have a hotel venue yet. Yet we're kind of looking at some different stuff. Maybe San Diego to change it up a little bit. I don't know. Maybe we'll be back in Orange County. We're thinking of Long beach or Los Angeles, you know, what do you guys think? Hey listeners, what do you think? Give us some feedback on that. You can just send that feedback to the reviews page. Reviews Jason hartman.com We set up an email address for our review screenshots. We appreciate your reviews so much on itunes and stitcher radio and SoundCloud. But we tentatively have Meet the Masters slated for January 9th and 10th. Save the date. That's our big annual event and we want to get a larger room this time because it always feels like that event oversells and we've got people, you know, sort of sitting in the aisleways and we want to make sure everything's comfortable. We do all of our events classroom style or schoolroom style. So you always have a desk in front of you and a place to write. I, you know, I went to a seminar in Las Vegas about two months ago, I guess Internet marketing type seminar and you know, we were so squished in no tables. It was so uncomfortable. I don't know, I like a little bit of space. I don't know about you, but we try to do our events in a more comfortable fashion but then we get limited by room size and last minute registration sometimes and that's always a challenge. So we're definitely going to a larger room for Meet the Masters. So that'll be up on the website soon. Jason hartman.com events but what do we have coming up? Well, our most exciting thing coming up is our trip to Providence and Newport, Rhode island, including a side trip to Martha's Vineyard and that's at the end of September here and it's going to be fantastic. It's coming up quick. It's a Venture alliance trip and the dates are September 26th and 27th. That's for the Venture alliance weekend and our side trip. Pretty sure that's going to be a day before it's going to be Friday the 25th. So a really good plan is to fly into Boston and just get an airport hotel on Thursday the 24th that evening and you can wake up and fly over to Martha's Vineyard with us. This is our tentative plan. On Friday morning the 25th, we'll spend the day in Martha's Vineyard. Heck, maybe we'll see Obama leeching off us taxpayers there. Who knows? We'll spend the day in Martha's Vineyard, then we will flip back to Providence. We'll get there about five. We'll meet everybody for dinner. You know, check into the hotel. We've got a beautiful hotel there in Providence. And check in, relax and go to dinner at 7pm We've got a beautiful dinner at this absolutely stunning, spectacular restaurant on Friday evening. I mean it is, it is stunning. I don't know, I looked at the photos online and I, I'm guessing The ceilings are 20, 25ft high in that restaurant. It's, it's just spectacular. Beautiful, beautiful restaurant. So that's Friday night. And then Saturday morning, well, you know, after dinner we may go out and have a couple of drinks. Okay, we may do that too. Which sometimes that's where the best conversations of all happen and the best business ideas and investing ideas happen at the bar sometimes. Then we'll get upset Saturday morning and we will mastermind together for about three hours and then our tour operator is coming to pick us all up and take us over to Newport. We're going to tour these spectacular mansions, some of the most spectacular mansions in the world in Newport, Rhode Island. There should be. I think we're going to. Our timing is going to be just about perfect for fall foliage. It's going to be beautiful. The then we'll come back and we'll have dinner. We'll have another spectacular dinner Saturday evening, Sunday morning we'll get up and we'll mastermind for a few hours and then we're gonna have a unique trip on Sunday afternoon and then adjourn the Venture alliance weekend. If you're interested in that, go to jasonhartman.com events. You can come to One Venture Alliance Weekend as a guest and then decide if you wanna join. If you join, your guest fee is applied toward your membership. If you join right after and we would love to have you. We've got some good new members that have joined and good new guests and we're gonna have some great speakers at that event. By the way, one of them, we've got a hard money lending speaker. You're gonna learn all the ins and outs of hard money lending and some really unique ways to do it, some hybrid approaches to do hard money lending. So that'll be exciting. And then I have a tentative speaker. I'm, I want to say we're 95% sure on this speaker, a young man who, he and his wife own 1800 units. He has 1800 units. And that's pretty amazing. But wait, there's more, as they say on those cheesy infomercials. Right? But wait, there's more. They did it in four years, just four years. So I hope we can have him there. I'm, you know, he said he was about 95% sure. He lives in Pennsylvania, so he'd be coming up for that and meeting us and in Rhode Island. So anyway, it's going to be a great weekend. I hope you can join us. Jasonartman.com events for that and Meet the Masters coming up, too. Not on the website yet, but it'll be on there soon. And we'll have early bird pricing, of course. Hey, without further ado, let's get to CPA Brandon Hall. We're going to talk about some great real estate tax strategies. So here he is.

Remember, you're listening to Flashback Friday. Our new episodes are published every Monday and Wednesday.

It's my pleasure to welcome Brandon hall to the show. He is owner of hall cpa and I reached out to him because he posted a really interesting article on the tax impact of Airbnb and short term rentals in general. And you know, there are, there's a small kind of little cottage industry going on of real estate investors who are building strategies around Airbnb. And of course, you know, our philosophy is long term, stable, simple rentals. You know, I thought we should talk about this because there are some very sneaky problems that can crop up when you do short term rentals and you're in the, you know, you're doing Airbnb and stuff like that. So Brandon's here to talk to us about it. Brandon, welcome. How are you?

I'm doing well. Jason, thanks for having me on the show. It's a pleasure.

Well, it's good to have you. So sneaky little issues with short term rentals that most people don't know about, do they?

Oh, yeah, yeah. You really need to know what you're getting yourself into before you jump into this business.

So tell us about that. I mean, you're, you're a buy and hold investor. You have long term investment property and your firm specializes in Real estate clients, you basically only take on clients who are real estate investors, it sounds like, Right?

That's correct. Yep.

Okay. And what happens with the Airbnb thing?

Sure. Yeah. So the biggest problem with Airbnb investors is that they can turn their passive income, their. That passive rental income into active business income. And what happens is when you do that, you subject yourself to a 15.3% self employment tax. And that's on top of all the other taxes that you already owe anyway.

Because essentially the irs, instead of viewing it as a passive investment, as they would view long term buy and hold real estate, you're saying.

Right, right, right.

This is viewed as a. More like a business. Like a hotel.

Exactly.

Like, like running something that's an active business. And of course, you know, people know that they, they need to be active. I mean, if you're doing short term rentals, there's a lot more management and a lot more engagement. And you had a story about your personal experience with one of your own investment properties. Please share that if you, if you'd like.

So, so, exactly. So the IRS is going to look at this like you are running a business, like you're running a hotel, like you're running a bed and breakfast, basically. And when you do that.

Your income is going to be subject to self employment tax like you are a regular business owner. Now, I own a triplex. It's a long term buy and hold piece of property and I'm all about what is the value of your time. I want to be able to spend 30 minutes a month on my property and have it cash flow seven $800 a month. That's perfect for me. That's why I don't get into Airbnb, aside from the tax aspect.

So, Brandon, you talked about that difference and I believe you said that managing your triplex takes you about a half hour a month.

Yeah. So my whole philosophy is set up business systems that basically automate everything for you. So I have a property manager that takes care of everything. All I'm doing every month is doing my bookkeeping and a bank reconciliation to make sure everything's in place.

Some investors I'm sure would doubt that you can really manage a triplex with a half hour a month. Care to address that at all?

Yeah, I mean, I honestly doubted it too. And I'm sure it'll be subject to change over time, but right now that's what it's trending at.

Fantastic. Good stuff. So tell us about your clients who are doing Airbnb rentals. I mean, do you have clients or people that you know or have even heard of? Maybe they're not your own clients, but you know, who, who buy a bunch of properties and they go the route of Airbnb or, you know, any type of short term rental. I mean, we're, we're kind of maybe unfairly characterizing Airbnb just because they're the big name in the field and they sort of founded this new industry of sort of Uber and Lyft kind of sharing economy for, for rooms and residences and so forth. But it's any short term rental, it doesn't have to be through Airbnb, obviously, right?

That is correct, yes. So I have a couple clients, they use Airbnb, they use a couple other websites out there and then they just advertise locally and it's all the same thing. I mean, a short term rental is going to be a short term rental regardless of what you use to get the tenants in. And we can talk a little bit about how to actually avoid being classified as an active business and, you know, shelter that income from that self employment tax.

Okay, so let's do that. But first I wanted to kind of, I was asking a question there of, you know, what do you think is involved in the management of one of these? Say, you know, because obviously with an Airbnb type of short term rental, you get a much higher rate and much higher nightly rate. Of course you're not occupied as often, ideally, or not ideally, but typically I should say that's the wrong word, you know, so you have a much higher vacancy rate in most cases and there's a lot more management and involvement. So, you know, can you share any of that experience that you hear from some of your clients or just people, you know, who've responded to your articles and so forth on this topic?

Yeah, yeah, absolutely. I mean, I can just share my experience with my clients. So I have a range of clients. I have some that want to be really active in the business and some that don't. So the guys that are really active, they're going to the rental every time that they're turning over units and they're doing all the cleaning, they're fixing things that are broken, they're rearranging everything to make it look nice for the next guy to come in. I also have clients that pay people to do that, and that's perfectly fine too. So there's a whole range of, you know, what actually goes into this stuff, but it's, it's pretty labor intensive compared to the typical buy and hold property. I mean, you got to get in there and really fix everything. You got to make it look like the pictures. Otherwise people are going to come in, they're not going to enjoy the stay. They might give you a bad rating, which hurts your income potential later on in the future. And yeah, just overall, you really got to make sure that you're on top of it. It's completely different ball game compared to the average buy and hold property.

Well, but people would say they've got a property that they rent on a short term basis and they hire all of that stuff done. I mean, my investors that do buy and hold strategy, you know, they're not swinging a hammer, they're not fixing up their houses, they're not cleaning it between tenants. If the tenant stays there a year, they're not, you know, doing any make readies. And they'll say, well, you can hire all of that stuff done. But you know, that would be like saying, I'm going to start a business and hire everybody and they won't ever bother me. I'll never have to manage them. They'll just run this company and make it hugely successful without any of my own attention. Kind of crazy, huh?

Exactly. Yeah. Well, I actually had a conversation with a client about a month ago. He was kind of going through that whole thing and what he was realizing is that he has regular buy and hold properties and he does hire out all the work and he manages the contractors, the property managers, all that stuff. And so he was going down the Airbnb path, the short term rental path. And what he was realizing is that he's not having to, he's not having these conversations once a month or once a quarter anymore. It's three times a month, four times a month. I mean, he's talking to cleaning services, he's talking to contractors, he's talking to the property managers, he's talking to schedulers. So it becomes much more time intensive, labor intensive. You just got to, like I said, I keep going back to just know what you're getting yourself into.

Some people say that. And of course you have to remember with short term rentals, they're furnished. Of course they have to be furnished. And not just furnished, but plates and silverware and everything, you know, has to be in there because it's got to be sort of viewed like a hotel almost. You know, with that there's just going to be a lot more stuff that breaks. People spill drinks on the furniture and the, you know, things like that. And it's just a, it's just a much more complicated scenario, right?

Absolutely. There's a lot of planning that goes into it. I mean, like you said, you have to furnish everything. A guy that's coming in for three days is not going to move a bed in, so you have to provide that for him. And that just goes, I mean all that's coming out of your pocket. It can play into the tax strategies, but ultimately it's just a lot more that you have to do to set this thing up. Now there's nothing wrong with that. I mean, like you were saying, it can be very lucrative. You do generally get higher rents, but you're also working on it more so than a typical buy and hold property.

And see what I've found is that even on these short term rentals where you know, and the rates definitely vary based on the season and all kinds of much more complex business factors, I mean it's like hotel pricing. You know, hotels have software programs that run their business that go out and compare rates of other hotels and spider them off the Internet and then have these pricing algorithms. I mean, I don't know if anybody really realizes how complex this is. When I was in young entrepreneurs organization, Yeo, now called EO for 10 years, I remember meeting someone who owned a software company that did this for rental cars and rental car agencies do this. I'm sure the airlines do this. I'm sure many types of businesses have this stuff and it's incredibly sophisticated where they'll go and they'll, you know, spider and get the rates off other competitor websites for whatever product or service they're selling. And it will, you know, suggest that their pricing do this and they do that and it's, it's really, it's really like Wall street, you know, the modern version of organized crime as I like to call it, because you know that it's, it's almost like high frequency trading, you know. And so with an, with a short term rental, I mean you've got to be constantly looking at what all the competition is doing to keep your unit rented. You've got to adjust the rates constantly based on seasons and so forth. And I mean there's a lot to this, you know, and, and what I find is at the end of the day, I should really say in this case the end of the year in talking to people that do short term rentals and comparing them to long term buy and hold investors, it kind of works out about the same. It seems like most of the time, you know, because if you're, if you're occupied in your short term rental, you know, 280 days per year out of 365. And you get a higher rate, but then you have higher management fees and also more of your own time, which is never factored in. All of that just. It kind of just seems like it's a walk. Gosh. What I've noticed, but I don't know, you're doing the tax returns for these people. So what do you think?

Yeah, so I've actually compared that on tax returns because I'm interested. That's part of being a real estate savvy cpa. You can see these strategies that people are implementing and figure out which one works. And it is kind of a wash. I mean, I will say that the short term rental guys do typically earn more, but like you were saying, time's not factored in. They're not factoring their time in. So what's interesting is when you put it on a How much time did I put into my buy and hold property versus how much time did I put into my Airbnb property or my short term rental property? Now let's compare our net operating income and you will find that it'll be about the same.

Yeah, that's really interesting. Okay, so just circle back for just a moment and then I want to talk to you about some other things, just maybe some general real estate and tax strategies. But circle back for just a moment as you did in the beginning, and explain the difference with a short term rental. The IRS basically views it as though you're running a business. And when you're running a business, you are supposed to not saying everybody does it. Okay, but you're supposed to pay this additional self employment tax, right?

That's correct. So the big difference is when you have a buy and hold property, you report that property on schedule E. When you have a short term rental property, you're going to report that on schedule C.

Unless you're able to have an average rental period of over 30 days or you have an average rental period of between seven and 30 days, but you're not providing substantial services. So what it really boils down to is what is your average rental period per property? And there's a couple ways that you can calculate that.

Sorry, there's not a couple ways. There's one way you can calculate that.

So basically what you do is say you have a two bedroom house and you rent out one room for an entire year. Well, that's 360 days. And there's one rental period. Right, because it's one whole year. Then say in the other room, you're renting it out every month. So you have 30 days, that's your rental period, but you have 12 of them. So now you have 13 rental periods for this property because you got the one year lease and then the every 30 days guy and you have 720 total days rented. So if you do 720 days rented, divide that by 13 rental periods, your average rental day is 55 days. So since you're 55 days, you're over that 30 day threshold and you're not going to be considered a short term, it's not going to be considered a short term rental. So really what you're looking for here, if you're investing in these short term rentals, you absolutely do not want a rental period less than seven days. If you have a rental period less than seven days, the IRS is going to say you're a business regardless of what you try to claim. And you'll have to report that on schedule C and you'll be subject to self employment tax.

And would you say that a lot of people aren't doing this now? I mean, I guess you have no way of knowing. But, but you know, are they going to be, are there going to be a lot of audits coming our way as our broke, overspending, drunken sailor government is looking for more money?

I would assume so. That's kind of the way that I think it's going to go. Especially since Airbnb has gotten so popular and these short term rentals, you know, we mentioned the Uber stuff earlier. As those sharing apps become more popular, the IRS is definitely going to hammer down on the short term rental stuff. So I mean, I have a couple clients that came to me and they've been reporting their short term rentals on schedule E for years and we have to go back and amend those tax returns because they are reporting them incorrectly. You don't want to be audited and have the IRS come in and assess tons of penalties and fines because you've been misreporting your short term rentals. And we talked earlier about all the things that these short term rental guys have to do. Taxes is the last thing that they think about and it's unfortunate because taxes is really going to have the biggest impact on your margin and that needs to be one of the first things you think about. But a lot of people wait till April 15 to start thinking about it and by that time it's way too late.

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Are there any other aspects of this that people should know? For example, the holy grail of tax benefits. I think income property is the most tax favored asset class in America. And the holy grail of tax benefits is depreciation. Because it's a non cash or phantom write off. I just love depreciation write offs and they're the best thing ever. And to take full advantage of them, you need to be classified as a real estate professional. Not everybody can do it, but it's a, that's just, you know, a huge gift if you can do that. Do you have the same thing on your, on your Airbnb type of properties? I would assume that you would because it's a business and it, you can depreciate business equipment.

Yeah, yeah, absolutely. And you know, with your Airbnb you even have the, I mean you can do it with regular rentals too, but with Airbnb you, you're going to be furnishing everything, right? So we talked about furniture. So you can depreciate the furniture that you're furnishing. You can write off the silverware, the plates, the cups, anything that you are putting into the rental, you can either depreciate or expense. And that's going to be the big, that's going to be the nice thing about Airbnb rentals is that you are going to get that extra depreciation every month.

Right. But you know, I want to just say, I mean, what's the depreciation schedule for that stuff? Five years or seven years maybe? Probably five.

Yeah, yeah, five, seven years.

Okay, so here's the problem though, folks. That really isn't that good a deal unless I'm missing something because you're probably going to have to replace it in five years anyway.

If you want to get premium rent. Certainly, you know, I've rented condos and things and places that, you know, were tacky as hell, frankly. It seems like in ski places a lot of that is true, you know, whether it be Tahoe or, or Aspen or whatever. Even high end Aspen? Well, Tahoe is pretty high end too. You know, you, you get these ski condos seem like they were furnished, you know, quite a few years ago. They're pretty, pretty tacky looking, a lot of them. That's, that's why I like hotels personally. But yeah, you know, so maybe it'll last you longer, but certainly it's not going to last you longer and get you top rent. And hotels, they remodel pretty Pretty often, if they're, you know, if they're going to expect, you know, good room rates.

Yeah, well, one thing that I do with a lot of my clients is regardless of whether it's a short term rental or a long term buy and hold, we look at personal property items and we try to figure out which ones that we can deduct onto the new De minimis Safe harbor.

Tell us what that is. You can't use words like that on this show and not explain them. The de minimis. Okay, folks, here, here we come. Drumroll for the De minimis Safe Harbor.

So the De minimis Safe harbor allows you to deduct low cost personal property items and then also components of tangible property. There's a threshold. You can deduct up to $500 per invoice or per item. That per item is key. So what I have a lot of my clients do, if you have a contractor say he's, I don't know, coming out and doing repairs or whatever.

You want to have your contractor itemize everything that he's done, especially to get below that $500 threshold, because just say that he lumps everything into one sum and it's $1,000, you can no longer use the safe harbor. But if he's itemized everything in each line, items, 250. Now we have some flexibility. If those items are personal property items or components of tangible property, then we can deduct them currently. So going back to the short term rental thing, if somebody's furnishing their, their rental with, with furniture or appliances and things like that, you can generally, I mean, unless you're buying nice furniture, you're going to be able to deduct that in the current year under this safe harbor.

Very interesting. Okay, so in terms of just real estate in general or any other tax tips that you want to share with people. Brandon, becoming a real estate professional, we've done shows on that. You know, complicated. Not everybody can do it. If you can, it's phenomenal. You know, if you want to share any comments on that or any other things that, you know, maybe real estate investors can take advantage of that they might be overlooking.

Yeah, yeah. I mean, I can, I can talk about all that. The real estate professional is going to be very difficult to qualify for. Impossible. If you have a regular job.

Yeah, but I don't think it's very difficult. I mean, you know, if you, if you don't have a regular day job or you have a spouse who doesn't have a full, full time job. Okay. You know, 750 hours and 500 material participation. What's so hard about that? Why do you say that's so hard?

Right, right. Well, the big problem is the 500 material participation that needs to be solely for your rental properties in order for you to pull these out and make them active instead of passive. That tends to be hard to do, especially if you're using property managers, if you're not doing the rehab, but rather acting as a general contractor. I mean, you can do it, but you have to be smart about it. And a lot of people.

They won't spend enough time in their rentals to satisfy the requirements. Now, I have an example. I have a realtor client. She works 1500 hours a year, so she qualifies as a real estate professional. She meets that $750 or that $750 hour threshold, but she doesn't materially participate in her rental. She only participates 200 hours a year, and she has a portfolio of like 20 rentals. And there's nothing that I can do other than, hey, we need to do a better job of tracking your hours. Just track everything. And then we'll go back through and do a little audit before we report this come tax time just to make sure that we're capturing the right hours. But it comes out to be 200 hours, and there's nothing that you can really do there to substantiate material participation.

Is there a number of. I mean, I know, I know there's not, but, you know, this is an opinion, obviously, you know, you keep a log, you keep good records, and you try to be as inefficient as possible so you can spend more hours. You know, think like a union member who's basically leeching off the system, who doesn't want to upgrade and use computers. They want to use clipboards because it'll take longer and they can get paid more. You know, and I'm sort of being obviously very sarcastic here. You do understand that, right? But, you know, that's. That was the battle in California's with the longshoremen in Long beach when they went on strike. One of the things they were striking over is that, you know, the businesses wanted to install computers and computerize everything, and they said, no, no, no, no way. We gotta use clipboards to log in the inventory because it's really inefficient and we can get more hours that way.

Yeah, yep.

And that literally was the battle. I hope you listeners remember that. And that's how bureaucrats think. Okay? Certainly in government it's that way too. So with that in mind, I mean, how many properties do you think you need to be able to justify 500 material participation hours? I mean, can you do it with a dozen properties maybe?

Oh yeah, yeah. I have a client that did it with one.

No way. Come on.

Yeah.

What kind of property was it though? And we should be talking not properties. We should say units. Number of doors probably is a more accurate way to say it.

So it was a triplex, three units. He essentially did the rehab and he does all the management himself. And yeah, he was able to substantiate it. And you know, the big key was that he did the rehab and put it in, put it into service in the current year and then he just continued doing all the repairs himself. He was just. Yeah, he counted all of his hours and it worked.

Has he been audited though? They keep believing him that just on three units you're spending 500 hours a year. I can see it in the initial period when he did the rehab, I could see them believing that. You know, a lot of, lot of time there, but on an ongoing basis. That surprises me.

Yeah, so he has not been audited.

Yet and yeah, well, see every, everything's okay until you get on well.

Yeah, but in, you know, in future years he's going to continue picking up properties. So we thought that it was okay to go ahead with this. But. Yes, that is a great question. If you're going to pick one property up and then not do it, then it's probably not the best bet.

Okay, so in the rest of the world, other than your three unit guy, what do you think? 10 units, 8 units? 12? I don't know.

Yeah, I mean, I would say anywhere between 10 to 20 units. I mean it really, really just depends on. It depends on where you're buying the properties. I mean, if you're going out of state for these properties, you're going to have a property manager that can do everything. Like me for instance. Right. I spend 30 minutes a month.

So if you have local properties, then you tend to spend more time managing those properties because you don't need a property manager at that point.

And by the way, we teach people how to self manage long distance, which if you asked me several years ago if I could do that, I would have thought you're crazy. And it happened to me by default. I've told the story many times on the show. You know, self management long distance is very possible with today's tools and technology. And you know, I use an agent in between for make readies and turnovers and releasing, but no manager, you know, it really can do it. A lot of times it works out better. In fact, one of our bigger clients who has about 70 units, he talked about at our last annual Meet the Masters event. I can't remember the exact number, but somewhere around half of his properties were self managed. And he found those to be easier to manage because you don't have that third party in there. And sometimes it's, it's harder to manage your manager than it is to just go direct, you know, disintermediate the managers. So, you know, I'm not saying it's for everybody, I'm just saying it's an option. And, and you gotta, you gotta know what you're doing.

Yeah, yeah, I'm definitely have to check that out.

But yeah, if you have managers, in other words, the point you're making, if you have managers, it's the IRS is going to have a harder time believing that you're spending as many hours and you're materially participating in the property. And I, my managers do it differently by the way. Some will ask me to actually sign every lease and some just sign them for me. Okay. And you know, some managers want you more engaged and you can also manage that relationship and tell the manager how engaged you want to be. And if you're trying to qualify as a real estate professional, be more engaged. You know, make tenant decisions. Some managers, they just re rent it and don't even ask about the tenant, which admittedly could be a bad experience. But sometimes the manager is just really good and they know what they're doing and you know, they do a great job. So it, it depends. Obviously every situation is different, but. Yeah, that's pretty interesting. Okay, go ahead, what else?

Yeah, so some other tactics that we use, we do segmented depreciation. So you basically break out the property into asset classes and you depreciate it at different rates. So we look for easy things like personal property like your stove, your fridge, we'll break that out and we'll depreciate it at a quicker rate. You can also break out structural components.

Otherwise known as cost segregation.

Yes, cost segregation. Yeah, you can break out really anything. I mean you can break out walls, floors, things like that. But generally at that point you need kind of like a feasibility study, an engineer to come in and say, hey, this is the remaining life, this is what it's worth. With the personal property items, it's nice because if it's new, you can just pick up A Sears catalog and compare what the replacement cost would be today, and that's your fair market value.

What is it, like 1972 here? The Sears catalog. You're joking, right?

Is Sears even still in business?

That was funny. I gotta. I gotta bother my guests here and get on your nerves, folks. Go get the Sears catalog, and after you're done with that, open up the Yellow Pages.

There you go.

Yeah, sorry, Brandon, I couldn't let you get off the hook on that one. Gotta give you a hard time. I mean. I mean. I mean, folks, I feel like I'm talking to my mom here. And she wouldn't even say that. My mom would have said, google it.

And you sound like a pretty young guy. I don't know your age.

Yeah, yeah, yeah. Well, hey, you know, I grew up around Sears.

Well, I remember the Sears catalog, too. Okay, but, you know, a long time ago. Yeah. Okay. All right, so what were we saying?

Yeah, so segmented depreciation, cost segregation. If you have new. At new personal property items, you know, you can pick up a. Don't pick up a Sears catalog. Go to Sears and.

Or go to Home Depot or Lowe's, but.

Okay, yeah, or go to Home Depot, anything like that, if you have older assets. So say you buy a property and it comes with an old stove, old fridge, or just look it up on ebay, look it up in the classified, see what it would go for today, and then break it out that way. That's your value that you're gonna apply to that property.

Yeah, excellent. And so cost segregation studies. I mean, I just did one a few months back on a big property, a big apartment complex that I had. You know, it seems to have really paid for itself many times over. But let me tell you, that was expensive. I mean, to have. We had a CPA do it, and that must have been about, I don't know, $12,000. I think it was. It was a lot of money. And it was a lot of paperwork, too, you know, I mean, is there a sort of rule of thumb for that? Because you can do it on little residential properties. You could take a single family home and do cost segregation and say, look, the dishwasher can depreciate on a faster schedule, the air conditioner depreciates on a faster schedule, and you can really break it up in a little house. I mean, mostly done in big commercial properties. But do you do those? What does that cost?

Yeah, so I've never actually engaged in a feasibility study. I typically refer my clients elsewhere, but those are the guys with the big multifamily properties that are doing those, because like you said, they're expensive. I mean they're anywhere from five to $20,000. For the smaller guys, we typically just look at the easy things that we can pick off. So that's the personal property items that we've already talked about and then anything that, anything that's not really structural but could be something that's easy. So like H VAC units, we can pick up the floors. You can typically estimate floors pretty well, but yeah, and it does require a lot of work and a lot of studying and a lot of paperwork.

But for a single family home though, is there sort of a cost range someone should expect for that? You know, if, if one of our investors listening contacts you and says, hey, we do cost segregation study on my one single family rental property, what are you going to tell them that'll cost? I'd assume it'd be pretty cheap on just a single house.

Yeah, yeah. I mean for something like that. Again, it, it depends on how, how much in terms of property we're trying to find here. But it would probably range from, it would probably start off around $500 and it could probably go up to 2 to 3,000 for a single family. That's going to be more in the higher end single family range. I mean, you got to come back and look at it like If I'm paying $2,000 for a feasibility study, is it really worth it if you own a single family home? Probably not. Unless it's one of the higher end single family homes.

Yeah, yeah, that's why. And hopefully nobody owns higher end single family rentals. That would make sense because the lower end ones make a lot of sense. Okay. Anything else you want to share with investors before you sign off? Brandon, how about your website?

Yeah, yeah, absolutely. You can find me at www.hallcpallc.com.

Just feel free to reach out if you have any questions. I always make time just to answer questions and happy to jump on the phone with anybody that wants to talk.

Any other tips or suggestions?

Tip wise, I would say everybody needs a home office. If you can justify it.

You open yourself up to a lot of tax deductions with a home office. So definitely go that route if you can.

And then at the end of the year, so towards like November ish, look at your rental properties and figure out how much income you're going to show for the year. And if you're going to show income, figure out if you can buy tools that you can use in the business next year. If you can, you can buy that before December 31st so you can deduct it in the current year or if you need to make any sort of repairs on your rental properties and if you can, make those before December 31st to reduce your income and then also your tax liability.

Yeah. Excellent. Good stuff. Well, thank you so much for joining us folks. That's Brandon Hall. Remember, taxes are the single largest expense any of us have in our lives. So do not be bored by taxes. Make sure you learn how to pay a minimal amount of them legally and patriotically. By the way, this is what the government wants you to do. They want to incentivize certain behaviors. Providing rental housing is something the government likes to incentivize. So let's do what they want us to do and get a tax benefit for doing it. So thanks for joining us and we'll talk to you soon.

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