In this instructional video, the Incite Tax presenter explains how real‑estate activities are taxed and how the choice of business entity (LLC or S‑corp) affects tax outcomes. The talk distinguishes passive income (e.g., buy‑and‑hold rentals) from active income (e.g., fix‑and‑flip, short‑term rentals that provide substantial services) and outlines the different tax treatments for each. For buy‑and‑hold properties, rental income is reported, ordinary expenses are deducted when incurred, and depreciation, interest, and property tax are common deductions. For fix‑and‑flip projects, the IRS treats the property as inventory; costs become part of cost‑of‑goods‑sold and are only deductible when the property is sold. Short‑term rentals can fall into four categories—business or passive, with or without material participation—determined by average length of stay, the level of services provided, and the taxpayer’s participation. An average stay under seven days can allow ordinary loss treatment if the taxpayer materially participates. Material participation is satisfied by meeting any of seven tests, the most common being more than 500 hours or a substantial share of participation. Providing substantial services may reclassify a short‑term rental as a hotel business, triggering self‑employment tax (15.3%). Holding properties in an LLC provides flexibility; the owner can elect S‑corp status to avoid self‑employment tax when the IRS deems the activity active. The presenter emphasizes that all related expenses are potentially deductible, encourages viewers to ask questions, and notes the IRS’s aggressive stance.
Chapters
Accounting and tax outcome of real estate properties. In real estate, you have passive income or active income, and based on the activity you're doing, you want that specifically held in an LLC or an S corp. Now, whether you are fixing and flipping or have another real estate business, whether that's buy and hold or many of the other things you just saw, you are allowed to take tax deductions. This is not an all-inclusive list, but I wanted to show it to you for sake of illustrating It doesn't matter the passive or active activity you're doing. All these deductions are still deductions. It just means that whether I'm buying and holding or flipping as a comparison, I'm able to take those expenses differently. In a buy and hold scenario, you have income when you receive rental income. Expenses, if I'm buying something physical and it's more than $2,500, we really need to call that an asset. If it's less than $2,500, I expense it. All those other expenses, you would expense these as they come up. And you expense them when you spend the money. We've also, you know, depreciation, interest, property tax are the 3 most common that you likely will see on almost all buy-and-hold properties. And this is considered passive. Now imagine instead of buying and holding that same property, you bought it to fix it and flip it. We receive income when we sell the property. There is no income until that point. And it's not rental income anymore, or they just call it sales proceeds. When you're fixing and flipping, the IRS basically treats you as if you're selling widgets, some sort of physical inventory product that you paid money for and that you're selling at a higher amount than what you paid to create the widget. It's just a much larger widget, right? A little bit more complicated, but it's a home. It becomes inventory. So everything is inventory. All those deductions, all these things, if I'm fixing and flipping, These types of expenses are all gonna be considered inventory, which means I don't get a tax deduction in the year I spent it unless I sell it in the same year. It's only an actual expense when I sell the property. So you'll have your sale proceeds minus your cost of goods sold, which was every dollar you put into that property, repairs, improvements, all those things, contract labor. If you had interest expense, all those things are going to be part of the COGS calculation when I'm looking at how much taxable gain did I make off of this. A short-term rental property can either be classified under tax rules as a business short-term, a passive short-term, and either of those can be with or without material participation. So technically there's 4 classifications of short-term rentals: business short-term with participation, business short-term without, passive short-term with, Passive short-term without. How do you determine what is the type of rental property? We're looking at average length of stay, were substantial services provided, and did you as the taxpayer provide material participation? Average length of stay is as simple as taking the number of days you had renters divided by the number of renters. So in this example, you see here, There's 165 rental days and there's 27 unique renters, which means the average stay was 6.11. 7 is the magic number. If you're less than 7, then you have an opportunity to claim ordinary loss treatment if you materially participated. If it's more than 7 days, then this is a passive activity. Passive activities don't give you ordinary loss treatment. Ordinary loss treatment happens if your average stay on your short-term rental is less than 7 days. The next criteria is substantial services. Here's a list of things that are considered substantial services. Now, providing more benefits to help you stand out, it's not a bad thing. You want to have a reputation of people enjoying their stay with your property. Just be careful because if you go over the substantial service, Then the IRS is going to treat you like a hotel business, which is different than a real estate business. There's a chance the IRS comes in and basically says, this is active income, pay us our self-employment tax, which is 15.3% on top of your normal income tax. And the third criteria is material participation. That allows you to treat the losses as ordinary income. This is good for us because ordinary income or ordinary losses offset all your other income. In order to materially participate, you must qualify under one of 7 tests. This is what we call an or test because it's just one of the 7, and most of them are pretty pointless to mention, so I'm only going to mention the 2 most common ones. Are there more than 500 hours participated in that, in the activity? And of all the participation in that activity from all participants, Was your effort substantial? Ultimately, what we're trying to do is avoid you paying unnecessary self-employment tax or having your loss— we're trying not to limit that loss on your taxes. Having your properties inside of an LLC is super important because it does give you flexibility. Let's say I have a property, it's a short-term rental, and I'm pretty sure I'm not providing substantial services. If the IRS comes in and says, actually, we determined that you are, I can elect to treat that entity as an S corp. So I'm now going to protect myself from the self-employment tax scenario. If I don't have it held within an LLC, I don't have that flexibility. I'm going to put this here. You can pause it and look at it. If I have a short-term rental, I'm in the business of real estate. And so any of these expenses you see listed here are up for grabs because if If you can relate it to your business, then it's a write-off. If you have any questions, don't hesitate to reach out to us. We want to help and support you. I already mentioned this at the beginning, but in case I mumbled through it, the IRS sucks.
