The Real Estate Tax Secret The Rich Keep From You

It's only the real estate professionals that get to bring these losses over on their rentals and offset their other income, their ordinary income, their business income, their W2. And they're lucky that it's amazing. But the rest of us, we get them bottled up. This where is where the short term rental loophole came in. I freaking heard about this from Mark.

35% of 400 grand is $140,000. I just got a tax write off for 140 grand. I only put down 100 grand. And it's cash flowing. I'm building value, I'm building wealth. And the tenants are paying down my mortgage. You know what's fun, everybody? Do you think we're just preaching this to the choir? I'm sitting in an Airbnb that I'm working on right now.

Like, we don't talk about this. We do this. This is what we do.

Welcome everybody, to this week's episode of the Main Street Business Podcast. My name is Mark Kohler. I'm here with Matt Sorenson talking about the beauty of the short term rental. So exciting.

Yeah, it is exciting. We've all stayed in one, but what's better than staying in one, Getting a tax deduction. A massive tax deduction for owning one.

Why not? Yeah, I mean, and you can even stay in your own Airbnb because you're going to be there fixing it, which is called a fix up day, and have the tax write offs to boot. Incredible. So lots to unpack here. The Airbnb short term rental didn't even exist maybe six to seven years ago. People were just starting to figure it out. And lo and behold, there's a unique tax loophole that still exists. We don't know how long that'll last. Where the tax write offs can be seen significant. Now try and unpack it all today. A little bit of tax. A little bit, yeah. How to be careful with the Airbnb? The last thing we want all of you to think is, I'm going to just go buy a rental. Yoo hoo. You know. Whoa, whoa, whoa. Lots to go through here.

Yeah, I remember this. The scene in the movie the Firm where Tom Cruise, the lawyer, the tax lawyer, by the way, is meeting with this client, Sonny something, I forget his name. And Gene Hackman's kind of the senior partner there. And they're trying to explain to him how there's this amazing tax loophole that if this guy doesn't jump in right now, it's going to get closed out next year because Congress and the IRS Hate it. And they're like explaining it to him and the guy's not getting it. And Tom Cruise goes into a bunch of expletives about how this guy's going to feel if he doesn't jump in and get this tax loophole while it's still available. It's a pretty classic scene. So that's what we're saying here guys. This loophole is still here, but we don't know how long it's going to be. Now if I could set the stage, Mark's really the expert on this. But if here's, Let me say why this matters, is that okay if I just kind of say why this matters?

Because.

Because let's take Matt Sorenson, real estate investor, own rental properties. I have losses on the rental properties even if I'm cash flowing properties going up in value. I get tax losses on the, on the real estate. Now what happens on my tax return and many of you listening is that those losses get bottled up over here with all your other rental properties and you can use them later. When I sell a property or something, those losses do come back. But I'd really love to use those losses to offset my other income in my business or other income I might have on my 1040. Now if you're a business owner like me that's not in real estate, you're not a real estate professional Even you're a W2 employee. I can't take those losses and bring them over to others to my other income. All these real estate losses get stuck. It's only the real estate professionals that get a bring these losses over on their rentals and offset their other income, their ordinary income, their business income, their W2 and they're lucky that it's amazing. But the rest of us, we get them bottled up. This where is where the short term rental loophole came in. I frickin heard about this from Mark Kohler so.

Well, I think Matt, you set the stage perfectly because a lot of people hear about real estate professional status and get excited about buying rentals. Rentals are a good investment anyway. That's we're going to talk about that point too in the risk and why. But we don't want to just chase a tax deduction. We'll come to that in a moment. But I like the way Matt presented that because we are going to have these suspended losses that are just a carry forward until we sell rentals and we still want to take advantage of those rental losses and capture them and hold them because they're like A warm blanket. We're going to be able to use that blanket when it gets cold out there when we sell one of those rentals. So we want those. But there's actually two ways you can take those write offs without having to be a real estate professional. The first one is you have your own building, you rent back to your business. That's called a self rental. I think we've got a show in the past on that. We should probably dedicate an updated show to that. That's when you buy your own rental, rent it to your business, and Matt and I do that. And those losses are completely deductible. And that's when you may do a cost segregation and really harvest some big write offs on that. For self rental, the second option is the short term rental, the quote UNQUOTE Airbnb, the 800 pound gorilla that really owns the market. So the Airbnb is a way where you don't have to be a real estate professional. There's a couple tests here or criteria and then you can unlock those losses and use them, as Matt said, on your other income. So those are the two big reasons and why we love them. Should I explain the write off or should we get into the beware statement first?

Let's explain the write off so people know how they can get the thing. You know, how does it work? Is it going to work for me? Because it's not like a gimme on any short term rental. You've got to do a couple things to make sure it works. So if you're like, well, I bought a short term rental or I'm converting a long term rental to short term rental. Okay, but that doesn't automatically mean you're gonna get this. And in fact you gotta deliberate. You gotta be intentional about this is what I'm saying.

Yep. Okay, so I'm gonna do some math here and I'm just roughing this out so everybody can get a good sense of what this means and. All right, let's say you how the rule works and I'll unpack it with an example is you buy a rental, short term rental between now and the end of the year. First rule is it has to qualify as a short term rental, which means the average stay is less than seven days of any tenant. So what you would do is if you put it in service and you rent it out five times for 15 nights total, then that would you take your total rental nights divided by your number of people that booked, it would be 15 divided by 5. Your average stay would be 3. Okay, we're good. Now if someone tries to show up and go, hey, I want to rent it for the whole month of December and have a family reunion, you're going to go, whoa, whoa, whoa, that may not work with my math. So you got to be careful of any tenant that wants to rent it more than seven days in this first year. So this is kind of your first year game. So number one, it's got to be less than seven day average rent rental per of your tenants. Number two, you've got to place it in service before year end. You can't buy a short term rental and be working on it all fall and not even have a tenant by December 31st. So you got to make sure you rent it before December 31st and then have that average day. Number three, you cannot provide substantial services. This is a big deal. What that means in practical point of view is you can't act like a hotel. And most Airbnb's get this, you know, they have, they clean once, they don't clean daily. They don't do turn down and put little chocolates on your pillow. They, you stay there, you leave, they clean it. There's no concierge services or anything that would look remotely like a hotel. So you cannot provide substantial services. Now some Airbnbs, once they've been in the game for a couple years and they've already harvested the write off, they may want to provide substantial services because they get a higher rental rate and they've got an S corp doing the deal, whatever. But that's a topic down the road. But you want to provide, don't provide substantial services. Now the fourth criteria here is the big one, because you do not have to provide, you don't have to be a real estate professional, but you have to put in at least 100 hours working on it, which shows material participation. You just didn't live in Minnesota, buy a Airbnb in San Diego and go woohoo, I did it. You have to do 100 hours of work between now and year end. And that could include the shopping for the rental, closing on the rental, setting up the services, buying the furniture, doing the little painting and fix up and clean up. And once I hit that fourth criteria that I put in 100 hours more than anyone else, which is easy to do in that first three months, it qualifies for a loss that I could use against any other income. Now the strategy here is you would then do a cost segregation, really harvest a bunch of depreciation and I'll do Some math here, but you harvest that depreciation and I can take it right now on my 20, 23 tax return. Then next year I don't have to do 100 hours. I could turn it into a long term rental, a midterm rental. I could just do hire a property manager to take care of it. Yeah. But this year I've got to show the 100 hours more than anyone else, get the write off, which is nice because you're getting, you're going to get, you get familiar with it, set it up, game it, get it going and then hand it off to a property manager January 1st and you get the write off. That, that is the magic, my friends.

That's freaking awesome. And that, I mean, see there's like, it's kind of a good investment strategy too. I like how you tied it back at the end there because there is like this process of going through that, having to put in the hours. It's like if you're doing this right, you're actually gonna put that many hours in. You know what I mean? Like, and you know, some of us are a little less hands on. You know, we're like, I'll just hire it out. And I get that. But especially if this is something you're new to, you're gonna want to spend that, those hours in there getting to know, understand the property, getting the process down, getting the right people involved. So, but let me say this too, just so make sure everybody understood that. When Mark said there's a cost segregation, what we're talking about is we're going to accelerate depreciation expenses as much as possible. That's using what's called a cost segregation analysis. Usually we're not going to tell clients to do that because what happens if I did that for the regular client? If Matt Sorgent just did that with one of his rental properties, I do a cost seg. Great. It gets bottled up over here with all my other rental properties. I'm doing left and right here, like our trifecta. So if you're watching the video, you know, but you know, so it's get bottled up there. But I do want to do a cost segregation. If I can accelerate the losses over here so I can use them against my ordinary income in my business or my W2 or something else. And so that's the genius of why this short term rental loophole has been very popular. Particularly my business owners, high income earners that have been great income and they're like, oh, I also want to build assets, but we Love this in the trifecta, right? Making money, trying to save taxes over here as we're building wealth and earning that wealth, creating assets over here where there's a short term rental, accelerating those tax benefits. Come back over here and reduce the tax liability. I mean, it's a freaking awesome strategy, right? It just connects all these pieces.

It does. It totally works together. And we're going to talk about the risk and rewards and why here in a moment too. But let's get into an example. And you know what's fun, everybody? Do you think we're just preaching this to the choir? I'm sitting in an Airbnb that I'm working on right now. Matt even was like, aren't you back today to the home office? I'm like, no, I'm still buried at this Airbnb. And this is an Airbnb in California we're bringing online hopefully by the end of the month. And we've got a couple more we're looking working on in Scottsdale, Arizona, because it is the capital for the wedding party.

Bachelor parties.

Yeah. What are called the bachelorette parties. Yep. I was gonna say wedding shower, but there's the bachelorette party. The bachelor party, it used to be Nashville Scottsdale has now become number one. So people are showing up, renting, Airbnb's, having their bachelorette parties, yada, yada, yada. Anyway, so for you technical accountants out there, this is called the Dash 9 election. You're gonna group those three rentals together. In my example, you get to work on those rentals and your hundred hours counts for all three because you group your short term rentals all together. So it's not a hundred hours per property, it's 100 hours on that group of short term rentals. And Matt, I think last night you were working on your short term rental.

Yep, I got one Right now it's converting from a long term to a short term rental. And so, yeah, so I'm in, I'm in the mix too this for 2023. And this is, you know, whether it's frankly all the tax strategies, you guys hear us talk about doing an S Corp or an LLC for your rentals, LLCs for your, your properties. Short term rental strategy, self directing your retirement account. Like, we don't talk about this. We do this. This is what we do in our own business and tax planning and investing. Like, this is just. And so, you know, we're like the, the chef that eats the food coming out of their own kitchen, you know what I mean? So this is cool. And, and I think, you know, we want to be smart about it, too. And I think that was one of the cautions you want to hit at the outset too, Mark, was don't just go buy a. Make a bad investment to try to chase the tax loss. And so you've still got to make sure this is an awesome Airbnb property itself, that the cash flow on it, that the appreciation. You see all the other benefits of real estate investing. I mean, those are the two primary things. Sure, we love the tax benefits of real estate, but I'm not going to buy anything because of that. That's just a sweetheart deal sweetener at the end. If that property doesn't cash flow or I don't feel like it's got amazing appreciation, or even better, both, I'm not buying that thing.

Yep. Now, a book that Matt and I are reading, Stay and I'll give you do an example here and show you the actual deduction you're going to get. But right here, I'll just hold up for those that are watching on YouTube. Dan Rustein. He's going to, I'm going to be interviewing him next month. He's been out of the country all summer and he's got the number one bestselling book on Airbnb's and how to optimize your cash flow. And so I've got several spreadsheets I use to analyze our rentals as we're looking at them and how much cash flow, how much is property management, what's my average stay. Learning all the techniques about dynamic pricing and getting the most views on Airbnb. Hiring a professional photographer. This guy's freaking a genius. His book is phenomenal. I gave it to Matt was like, no, you got to read this. And so he's got checklists of what to put in your Airbnb. Are you going for a luxury or stamp Anyway, so. But first and foremost, I just want to reiterate what Matt said. A bad decision doesn't make a good tax deduction. Let's make sure we understand why we're going into this market. We want to create cash flow. We want to use opm, other people's money. We want to use leverage. So powerful. Okay, so let me give an example. Let's say you go buy a $500,000 Airbnb. Now, 500 in some markets might be a little low. It could be a little high. If you're going for a luxury Airbnb trying to average two to 300 a night, you're going to be in this range, but let's just say you're a $500,000 Airbnb. Could be on a golf course by a lake, somewhere like that. San Diego, it'd be a shack, you know, whatever. But 500 grand in the equation, let's just say we go acquire it and we put down, oh, 10%, maybe you put down 20%. So I put down a 20% down payment of 100 grand. I get a mortgage for 400 grand and then I run my spreadsheets and I go, okay, I'm going to cash flow. This is it. Going to cash flow over and above my debt service, property taxes, yada, yada. And I want to be shooting for my personal analysis north of 5 to 10%. I want to be in the least over 5% because I know I'm going to get appreciation, the tax deductions, the cash flow. But just on basic cash flow, I want to be over 5. Some might call that a cap rate. I want to make sure my cap rate or my cash flow is definitely positive. Then everything else is cream on top. All right, so I buy it for 500 grand. I put down 100, and I'm now in the game. Well, when it comes to the tax deduction, you've got to take the land off the table. So I've got a building, it's on land. So I take out 20% for land. So that's 100 grand that comes out. So now I've got basis. The building is worth 400 grand. This is where Matt talks about the cost seg. Now, when we run a cost seg, averages are at about 35%. About 35% of that building could be accelerated in not over 27 and a half years. I can accelerate that or 39 commercial property, whatever. I all these different rules, but I want to accelerate as much depreciation as I can. Statistics show we're going to be between 30 and 40%. So I'll take 35%. 35% of 100 and 400 grand is $140,000. I just got a tax write off for 140 grand and I only put down 100 grand. And it's cash flowing. I'm building value, I'm building wealth. And the tenants are paying down my mortgage. Oh, my gosh. Is that like.

Talk to me Streamy. Yeah. So that's the awesome tax strategy. And I love the numbers because, you know, I've always. I love real estate. You know, Mark loves real estate. We're real estate fans. In terms of wealth building, it's been a great strategy. We've done all the consults, we've seen the business owners, we've seen the investors, we've seen how they've built wealth. And real estate's just been like a. Just been a tried and true method, you know, and so getting those assets in our portfolio and getting this amazing tax deduction at the same time as you're earning income in your business, your profession, whatever it is, is tough, you know, and we always felt left out of this party on all these great write offs that we get that the real estate professionals get. And this is our ticket. This is our ticket. And like, you know, Tom Cruise was saying, you better get in on this tax loophole before Congress comes and bleep, bleep, bleep, bleep, bleep, blah, bleep, you know, shuts it down.

Now, now, let's take it next level. Here's next level. Next level is you go, why am I doing this? Okay, people, you want to think bigger picture. What our tax lawyers like to do in a consult is go, what am I going to do with that $140,000 deduction? Maybe you've got an old 401k that you want to self direct and convert to Roth, and you go, I could convert 150 grand to Roth, buy an Airbnb and pay zero tax. So now I can offset a gain with a strategic acquisition. And people were in September. You got plenty of time to pull this off in the next three months. I am. And so I'd like to bring on four Airbnbs before you're in. We'll talk about risk here, too, but. So if I can pull off 100 to 200 grand per Airbnb now, I could sell some other asset. I could sell another business. I could sell real estate. I could also do a Roth conversion. So we've got all these other things I can offset with this write off to, again, build wealth because we're in it for the long haul. It's not get rich quick. Get rich quick. I want to, like, bring it all together.

Yeah, and this is where you got to be a little analytical. You know, I know a lot of you get passionate about things and. But you got to be a little analytical here. And, like, Mark's got his spreadsheets. You know what I mean? Like, pencil out the numbers. That's what I do. Like, I like putting pen to paper, but I, like, pencil everything out. And you got to think, what is the rental income? I can get on this. Is it better as a midterm rental? Is it better if I do book it out a month at a time and I wouldn't get this deduction? Is it better as a long term rental? Am I, do I want to go through the work of doing an Airbnb? Is my time okay. Getting thrown into this for this? You know, there's all these little considerations I think you got to make, but Airbnbs have been very successful. A lot of people had success in short term rentals. I know the market's a little more competitive now, Right. It's definitely more competitive. And if you don't have one in New York. Right. I guess New York City's like shutting it down. Of course. So just make sure you're kind of running the numbers first as you're getting into this, because the tax deduction is just one of those columns in terms of the numbers and the payoff that you're going to get.

And I, like, I was telling Matt this because Matt's bringing one Airbnb online and I'm like, you're going to hit your hundred hours because you have to do 100 hours and more than anyone else. So if you have family doing 91 hours, you better do a hundred.

Yeah. You're a property manager. You hire some third party to start doing all the work for you. And that's why I love how you talked about it, is just do it in year one is the time you got to acquire the property and get it all set up. You're going to invest the time anyways, do the cost seg, Throw all that expense into that year one anyways.

Yeah.

I mean, that's the genius of how you've.

Yeah.

So concocted this structure.

Yeah. So it's. And you got to think of the numbers. That's why I was going to the hours in, because sometimes it's more efficient. Like if you're at Costco, I'm going to buy three packages rather than one. I'm going to get a better deal. And in the big picture, I may go, oh, I'm going to go with two Airbnbs or three. But because as a bundle, it's going to be easier for me because now I can spend 30 hours on each one. But I make my Dash 9 election and I bring the whole thing together. And here's the risk issue. Our Airbnb's mostly around the country are down. Some of the areas have been oversaturated with Airbnbs. Hoas have gotten sick of them. Some communities are embracing them, some aren't. So you gotta be very, very strategic where you go. Find out what the climate is politically in the area. And if it's in an hoa, when I was shopping for Airbnb's, if it was in an hoa, no way. Can't do it. Because that HOA controls your destiny. So you're going to be looking strategically at that. But here's the beauty that Matt alluded to. I only have to do the short term rental the next three and a half months. That's it. So as long as I can cash flow and break even. See, I could say I'm going to break even cash flow in 2023 and then convert to midterm and drop it into a midterm pool for traveling doctors and nurses in January. That's fine to get the write off. I only I don't have to be in Airbnb forever so I can look at a market and go, the Airbnb market's not great. All midterm and long term works for me. I still get great cash flow, but I can, I can suck it up and create a furnished rental. So now when you go to midterm and long term in January, you've got a furnished rental and you wrote everything off and you already cash flowed and broke even, plus you got the write off. So you want to be thinking, what is my game here in the short run, midterm and long term.

Love it. Love it.

Well, wow.

It's a great strategy. Now we're gonna have Mark's. When's that scheduled? We got a couple weeks out the, the author of the Airbnb book. And this is gonna get into some of the practical steps on getting it set up and analyzing a property too, and determining how much you can get on it. Because that's a big question. I think a lot of people have. And even, even for me, as I've been going from, okay, I know I can get as a long term rental, but what could this property do as a short term rental? So a little more trickier to figure out and analyze, I think.

I know, I just love it. And, and this is the book for those that are listening. I didn't say the title. Optimize your BNB the definitive guide in ranking to ranking number one on the Airbnb search, Daniel Rustein. So he's going to be joining us. We're going to go into some of that, but I think just some of the important points here, like five tips to five star reviews, interior Design tips Cleaning team checklist the dynamic pricing for the perfect price during this time of the year Slow season strategies Creating safe How safe is your Airbnb? And now from a legal point, I just want to throw this out for those that may be dying to ask you do not put an Airbnb in your S Corp. Even though it's a short term rental, it still goes in an LLC for asset protection and reported on a Schedule E as an echo or a 1065. So don't get sucked into the theory. I've got to run it through an S corp. You don't. I'm not. You don't have to. So that's the beauty of this loophole is it gets treated by the IRS as long term in certain ways and short term in other ways and it's completely asset protected with a typical llc. Freaking. Love it.

Love it.

All right.

All right guys. Well, thanks everyone for tuning in. This is an awesome strategy. I always love coming when I'm learning something new and I'm kind of. I've been beefing up on the short term rental loophole this year. Of course a lot of our clients have used this and you know, it's been popular out there. But I think Mark's done the best job at like really connecting the strategy right now, especially here at year end where you can really get a cool tax deduction and then next year decide what you want to do moving forward. You know how that what's your strategy on that rental property going to be. So now make sure you're getting over the Main Street Business Podcast. You can Google that. Main Street Business podcast. Go to mainstreambusiness.com, click the podcast link and you can submit questions. Because we've got an open forum coming up. I don't know if we'll do it next week or the following week, but we do love getting your questions, whether it's on this, this topic or anything else on taxes, legal planning, building wealth, your estate, running your business, any of those things. We love filling those questions in our Open Forum podcast. So make sure you're getting over there to get those questions in.

Yeah, and we're not going anywhere. Thanks everybody for listening. If you've enjoyed this, please share it, give it a five star. It really helps the tribe grow. We're all in this together and there's no other tax and legal podcast doing what we're doing with as many downloads. So we really want to be the leader here and we want to make you look good too. So please favorite us as your Favorite podcast. And we're going to be making you money. Bam.

Yeah. Yeah. One of the last thing I was going to say we have forgotten to mention this earlier is we have our rehab special in our law firm, KQS Lawyers going on right now. So for any of you that set up the wrong entity, you're not sure what you set up. You got one piece of paper from online, you did an llc, you think you need an S corp. You haven't done your minutes in three or four years. You have no idea what you're doing. We have, it's called the Rehab special. We come and rehab your situation. We go in and fix your entity, we look at your documents, we look at your non entity, if you don't even have one at sea. And here's the situation we need. We have discounts going on this month to get some of that work done. So get over to kqslawyers.com you'll see the Rehab special right there on the page. And there's some incentivized pricing going on right now, but make sure you get in now because that doesn't go on forever. So get over there and we'd love to help give you a little discount and get your business in order, get your trifecta done and, you know, just get you through rehab.

Love it. All right, thanks, everybody. We'll see you next week. And next week's going to be open forum. Please get to Main Street Business podcast. And when you submit a question, we're going to try to hit as many as we can. We need to do more open forums. We just. There's so many great questions out there and you don't know what you don't know or what to ask sometimes. So it's a great show to listen in. And you're like, oh my gosh, I didn't even think to ask that. So we'll see you next week and we'll be trying to answer all your questions. See you then.