Airbnb Tax Advice Directly From My CPA Part 2 | The STRR Podcast #62 | Tim Hubbard

Welcome to Short Term Rental Riches. Quick actionable ideas to help you along your real estate investment journey, but with a specific focus on short term rentals. Welcome back to the Short Term Rental Riches podcast. Happy you're here again as always. And I'm happy to have Amanda Hahn back with me again for the second part of this two part series. She's with Keystone cpa. She's my tax advisor and my accountant. And we covered some really good topics last week. So if you missed it, make sure, make sure you catch it because it will be relevant to you if you're a short term rental investor or you're a real estate investor in general. So I'm excited to be back for the second part covering again some really, really important topics. Without further ado, let's jump back in. I talk about leverage all the time on the podcast, especially with interest rates now. They're just unbelievable, you know, and if we can lock them in for 30 years. So that is, that is a great point. Now we do have some things to consider when we're depreciating the real estate though, and that's when we want to turn around and maybe sell the property later on. Do you want to explain how that works? We have to add it back in.

Yeah. So the way it works is when you take depreciation, you are basically reducing your cost basis in the property, right? So let's say I bought the property for a hundred thousand, I took 20,000 depreciation, now my remaining basis is 80,000.

Right?

That's what I've paid for that I haven't depreciated yet. So later on when I sell that property, let's say I sell it for $100,000, right now I have a tax gain of 20,000 because I already wrote off that first 20. So later on when I sell it, part of that becomes taxable income. Even given that though, it is still beneficial to take depreciation because you still delaying the taxes into a future year when you actually sell the property. Whereas you know, today we're getting a tax saving which is more money for me to reinvest in the interim. But also we know with respect to real estate, at least currently we still have the ability to do a 1031 exchange which just that let's say I do want to sell this short term rental in a couple years, then later on if I replace it with other rental properties, I should be able to defer the taxes on the gains as well as the depreciation that I took already. So you know, that's a huge benefit for real estate investors that you know something that there's been talks that might go away and we're hoping that that will stay around for a long time.

Fingers crossed. Because that is a big one. That is a big one. And we've talked about 1031 exchanges before. Another way you might be able to, and correct me if I'm wrong, but you might be able to defer it is if you invest in an opportunity zone, is that another potential option?

Yeah.

So currently, to the extent you sell property and you have capital gains, you can delay the taxes. If you invest that into an opportunity zone, it could be opportunities on real estate, could be a business located in the opportunity zone.

But for the most part, when we have clients that are reinvesting in the ozone, it is as a passive investor in other people's deals. I think I only have one client who's kind of actively doing their own opportunity zone. Just because there's a. A lot of work that needs to be done. It's more than just buying a property that's located in the zone. You have to actually do significant improvements to the property in order to get the tax benefit. But yeah, that's, you know, that's. So that's a great point. In terms of tax deferral, you would. Looking at 1031 Exchange, Opportunity Zone, there's also offset strategies, right? Let's say that I'm selling this, this rental property and I'm not ready to buy yet. I'm not ready to buy another property within the next six months. Well, if before the end of the year, I do end up buying more real estate, even though it's outside of the 1031 exchange period, as long as it happens within the same year, I can still use depreciation, cost segregation, write offs from that new rental to reduce the taxes on the rental that I sold to. Right? So you can offset it outside of a 1031 exchange as well.

You know that the tax world is always changing, right? And it's so. It can be really complicated. I know a lot of times I get confused and that's why it's just so important. It's something that I think a lot of people leave till the end of the year, right? And they're like, oh, how can I figure this out? But, but really it's something that we need to be thinking about all the time. Especially if we're getting into big investments or planning on selling or buying or whatever we're doing. It's really something that we need to Consider the whole way through. And one of the things that you taught me early on was just doing filing an extension. I used to never do that. Can you explain that real quick? Just filing an extension?

Yeah, yeah, I know.

So I think some people are just kind of afraid of the concept of extension, but it's actually something, you know, obviously the IRS allows you to do. So, you know, the benefit of having an extension, I mean, one for if anyone knew who's not organized yet. And, you know, as you get into more and more real estate, there's a lot more things to account for. And so it takes longer. Right. You can't really just close your books a month after you rent. It takes longer to get everything in and make sure you're capturing your expenses. So the benefit of extension is that it gives you more time to analyze all the numbers and get everything right rather than pushing it through the April deadline. The other benefit that we really like about extensions is it gives you insight into that following year. So right now we're trying to figure out, okay, if we already. If I haven't filed last year's returns yet, if I know, okay, later, eight and six months later, I know, oh, I was going to do a cost segregation, but I might sell this property after all. I might not do a 1031 exchange. So now we have that hindsight and we say, okay, knowing what I know today, how do I want to file last year's return? And those are things that sometimes it's impossible to answer. Right. You don't even know the answers to that by February or March or April because some of those transactions come to your head or become available to you later on in the year. And the transactions in that year might impact how you would want to file the previous year's tax return. So that's another benefit of doing extensions. I will say, though, there are some things that come with extensions in that the IRS allows you more time to file your return, but you don't get additional time to pay the taxes, which means you're going to owe taxes. You do want to pay them before April 15th to try to avoid or minimize any potential penalties.

Right. Which would just be an interest charge on the amount that you potentially owe.

Yeah, yeah.

So something like that.

Right. So if you owed something by April, but you don't pay until June, then there's two months worth of interest and penalties. And yeah, I know some investors do weigh the cost of that against, you know, the cost of them to borrow money, like with money loans and things like that. So yeah, that certainly is a consideration as well.

Yeah, I remember I used to just, you know, try to cram everything in before that deadline. And then it's like, you know, you file your taxes and two weeks later you discover something else that you could have potentially written off. You know, maybe some plumbing renovation for a thousand bucks. Well now to go back and amend it. One that it's just a pain in the butt.

Right.

And can be costly.

Yeah.

So it costs you money to maybe.

Amended, you know, paying to do redo the work and also more importantly, the increase in audit risk. Right. Whenever you have to do an amended return, you need to tell the IRS what changed and you know, why do these change? And so it's come, you know, just kind of the process of explaining, oh, okay, I forgot a plumbing receipt. And all that just raises an eyebrow that you otherwise maybe didn't need to. So that's certainly something to, you know, take into consideration too.

A lot of people, when they're starting out with short term rentals or investing in general, they. And this is what I did is I bought a fourplex, right. So I lived in one unit, renovated the other ones, rented them out, which is both your primary residence but also an investment property. But because it's an investment property, you get to write off the percentage of the investment. Right. Now you also have some benefits with it being your primary residence, where you get your personal tax exclusion, I don't know what they call it, but 250,000 if you. On capital gains.

Yes.

You want to just explain kind of how that might work if someone out there has a smaller multifamily property, up to a four plex, and they're either renting it with short term rentals, but it's also primary residence.

Kind of some things that we do see that a lot as well, like I said, especially people starting up or people who, you know, single that are able to kind of move around quickly. So, yeah, the way it works, I mean, in a simplistic example, right. That, you know, if it's a, let's say it's a duplex, one unit is a rental, one unit is a primary home. So on the unit that is a rental property, you know, it's treated like any other rental, short term rental, where you're taking, you're taking depreciation on the property, you're writing off all the costs associated with that property, including rehab, furnishing and all that. Now the other side, that other part of the duplex, which is your primary home, you're still writing up the mortgage interest and property taxes as your home. And if you have a home office in there, right. Let's say one of the rooms is office, you're writing up a home office like normal. And then the benefit is eventually if you were to sell the property, part of that gain would be tax free, assuming that you lived in that unit as your primary home for at least two years and three years within the date of sale. So, so you, you know, as a single person, you exclude up to 250,000 if you're married, up to 500,000. And then the other part, that's the rental portion. You know, if you sell it for gain, you could potentially do a 1031 exchange. So that's super powerful where some tax free, some tax deferral and then writing off on both parts of that duplicate.

You know, even if it wasn't a duplex or a four plex, but maybe they had a guest house and they were renting the guest house, that's still going to sort of function the same way, right?

Yeah, yeah. So that's a similar in terms of, you know, eventually when you sell the key is, you know, for that to be primary home for at least a minimum of two years in order to.

Primary home gain, exclude.

Mark your calendars, everyone. That's an important day. I, you know, I've done that before and I, I mean it's amazing if, and especially all the money that we've been printing and inflation and asset prices are going really high. So a lot of people have a lot of equity in their homes right now. And to be able to take that tax free, man, that's just a, that's a really powerful one for sure.

Yeah, yeah.

And you know, you can use that. It's not a one time deal, right? So, so you can that strategy over and over again, right. Live here, you know, for two years and move into another place, live there for a couple years and sell it. So we do have clients who kind of use that as a strategy in going forward as well. And I think, I mean you're exactly right in that, you know, it's, I mean it's no secret the government has been printing money and you know, at some point we're gonna have to pay. We have to pay, right?

I know it's crazy.

So it is really important to spend the time to think about. I know people don't like to talk about taxes because it's, you know, could be very scary and unpleas. But I think, you know, you've seen like, you Know from your own experience how tax savings could be so impactful.

Right. When you, when it's done correctly.

So impactful doesn't have to be the super scary thing. And you know, and going back to what you're saying about leverage, you know, if you can save $10,000 in taxes, that could be $50,000 more of real estate. Right.

If you're using the right, right.

If you're 20% down, yeah. Taxes super, super important. I highly encourage anyone out there, just spend more time on your taxes. You should be tax planning.

Right.

I think people are often scared too. Just tax planning itself sounds really scary. But I think, you know, from working together, it's really the, I mean, our goal is not for you or any investor to become a CPA and understand everything there is to know. I think even today some of the things we talked about, you were like.

Wait, I didn't know.

Yes, it's true. This is very true.

But really the, the job of an investor is to just have the basic knowledge. But, but really the, the key action item is just to make sure that you are updating your CPA and your tax advisor, as trans. Before transactions occur. You know, here's what I'm thinking. What are my options? What's the tax? Just so you don't get a surprise, you know, tax bill at the end.

Right.

And that, that's really all you need to do.

So quick example, real life example of this. Right now I'm selling some condos. And before we decide to sell them, I emailed you and said, hey, Amanda, I'm looking at selling these properties. I think this is what they can go for. This is what I owe, you know, and then we were able to get a rough estimate of what my tax burden would be either in the current year or potentially in the future years. So this particular property we decided to sell next year. So it's supposed to close. No, we're in next year already.

So it's supposed to close in one week. So right after the new new year turned. But that basically gives us a whole year to do some more planning. We have a limited time if we're going to do a 1031 exchange, but we have other ways to expense maybe some of the income, the capital gains from a different spot.

Exactly.

So that's exactly what we're talking before about, you know, if you know, so first step is, okay, what is the potential taxes? And then you as an investor make the decision. Do I want to do a 1031 exchange? Do I want to go into A different business venture. And if so, then are there offset strategies from my new business? Right. If it's a laundromat, if it's a startup business, are there offset strategies where I can use this to offset the real estate gain? So yeah, that's, you know, timing is key too.

Right.

Like if you're selling at the beginning of the year, you have all year and if at the end of the, you know, before the end of the year, you say, hey, I do want to do more real estate, then great, you buy more rental properties and then that can be used to offset the gains on the properties you're selling in January.

Let's see, let's just talk about some of the basic expenses. Someone, someone's investing in real estate or investing and you know, real estate to turn into a short term rental, we get to, we have a lot of expenses or a lot of different things we can write off. And so for the short term rental, that can be the furniture, of course. Yeah, I'm also furniture.

For furniture, you generally don't need a cost segregation because it's something that you are buying yourself. Right.

You're going, oh, right, right. Okay.

Cost segregation is usually for the kind of the internal components of a building. Things that you and I don't, you know, we can't break out maybe visually.

Or, you know, so that's, but that.

Would be like cabinets, like built in cabinets and stuff like that. Flooring.

Exactly. Yeah. But yeah, I mean furniture is, you know, furniture, fixtures, appliance is a huge one. Especially for short term. For short term.

Right. And now there, there's a, there's a point there where you can either write off all of that expense in the first year or you have to depreciate. I think it's 2000 something or what is that?

So.

Yeah, that's a good question.

So the 2500 is the DE minimis rule which says, okay, if you have an improvement that you're making to the real estate, but if it's under $2,500, you can write those off immediately.

The full expense.

Yeah. As an expense. Now for furniture, fixture, appliance, things like that, currently at least those are considered, usually considered five to seven year property. So even if it's over that dollar amount, we can take what's called bonus depreciation, which essentially results in the same answer of immediately writing off all of it in the first year you place it into service.

Two different terms used a little bit differently, but the result is the same.

Okay, so we've got all of our furniture, any improvements. But we also have a lot of smaller type expenses like consumables and toilet paper and cleaning products and things like that that we're going to be able to expense.

Yeah, right.

Those usually are just considered supplies, you know, operational supplies. Write those off. The only things that we, you know, we talk about depreciation. Those are things that have a useful life of longer than a year. I know people are hoarding, you know, toilet paper and stuff, but.

Probably you're going to use all that up in the year.

Right, right.

Do you have a short term Airbnb guest, like hoarding your toilet paper stash?

I'm sure that we had more toilet paper disappear than we normally would. I wasn't monitoring it roll per roll, but you know, we recently went to a hotel supplier and purchased like just, I don't know, like thousand or something rolls at a time. So.

So you are the hoarder then.

I am the hoarder now. Yeah, that's right. But wow. Yeah, toilet paper got really expensive there for a moment. Especially if you're ordering on Amazon, which is what we had historically done. I mean, yeah, it went through the roof. And you can't rent a rental with no toilet paper. So.

Okay, so we got our supplies, we've got our furniture costs, any renovation costs. Now on the loan side, we get to write off any origination fees or an appraisal. And also interest, right?

Yeah, so the interest you write off immediately, the loan costs, you know, all the loan costs that are associated. You know, appraisals, origination fees, closing costs, those are generally amortized. So loan fees are generally amortized over the life of the loan. So you have a 15 year loan, you write off over 50 years. If you have a 30 year loan, it goes off over 30 years. But yeah, I think, you know, just in comparing short term versus long term rentals, you know, the first year startup cost is obviously, you know, higher. Usually speaking for short term versus long term, just because of the furnishing and supplies and all that you have to stock.

But really, you know, from a cash.

Flow perspective, we see much better performance in the short term rentals. And also from a tax perspective too, like, you know, long term rentals, you know, I mean, if you make under 150,000, it's fine. We don't really care about real estate professional or any of that. But if you make over 150,000, you're really, you know, the goal would be to try and qualify as real estate professional status versus for short term Rentals, you know, again, the, you know, you don't have to worry about real estate professional. You just need to want to meet the material participation, which is 500 hours. Yeah. There's actually seven tests I won't go over, you know, all of them just because a lot of them are very difficult to qualify. But the two most common ones, one is the 500 we talked about. The other one is actually somewhat easy still. So the other one is if you can't spend 500, then you have to spend at least 100 hours in the short term rentals, and you have to spend more time than anyone else in the short term rental property. If you have a cleaning crew, for example, that goes in, you have to compare that. How much time is Tim spending versus how much time is the cleaning crew spent? Right. If you got gardeners, you got repair people, property management company, that's what you're up against. Your time versus their time. So that's the second tier. We have some clients that try to go under that, but I think the strongest one is to try to go for the 500 hour.

And I mean, this is all sort of new or relatively new, I guess I should say. And so actually determining that, like if you had a housekeeper's hours versus like a receptionist hours, for example, someone answering calls and answering messages, I mean, I guess it's kind of hard to really prove maybe the one spending more time than the other. I don't know.

It.

Yeah. And that's the thing.

Yeah. I mean, the short term rental space is so new. Right. In general. And so the tax side of it, the auditing of it is also new as well. So. Yeah, that's one of the hurdles that I see in court cases where you say, okay, well how do we prove how much time the cleaning crew was there or how do we prove how much time the property management company was there versus Tim's time? Right. It's a difficult question to answer, but I think the downside of it is when it comes to taxes, what I always say is the taxpayer is guilty until proven innocent. So it's always upon us to prove our case. If you can't get the hours records from your cleaning crew, for example, then the next best thing to do is to be able to get a reasonable amount of hours. So we say, okay, well, reasonably speaking, Right. If you talk to different people, from Molly maid, as an example, how many hours does it take to clean a three bedroom, two bath, 1200 square foot. Right. And then you go from there. You can say, okay, you Build a case to say, okay, this is how much time on average it takes. I didn't track how much time Cindy spent, but here's on average and this is how much. But yeah, I mean the tried and true is still, you know, to have people track hours. And unfortunately a lot of the new changes in the tax world in the last couple years has been hours driven. Have this recurring question like how am I going to get the hours from my management company or from my cleaning crew.

Yeah, that's a tricky one. You know what else might be kind of tricky too? And I guess I haven't asked you about this yet because I'm not personally doing it, but this is model of lease arbitrage, which those are still short term rentals, but someone's actually leasing an apartment or a house or whatever it is and subleasing it. Now I would assume they still get these same write offs in terms of furniture and consumables and all that. But if they're not buying the property, then they don't have the depreciation expense right. On the building anyways.

But is there anything else they might want to, you know, for those, the listeners that are doing the lease arbitrage model that they might want to consider with?

I mean, I think, yeah, we do have clients who are doing the arbitrage and doing very well in that space. So certainly, you know, something to look into if it's, you know, you don't have enough capital, right. To go and buy a bunch of real estate or maybe you just don't want to.

But yeah, the main benefit, or I.

Guess the, you get the benefits, the material participation, the ability to use those losses to offset other income is the same as a regular short term rental that you own. But the big difference is like you mentioned, no depreciation on the building because we don't own the building. Right. But in lieu of that, we get to write off the rent that we're paying to the actual property owner. So it's still some benefit. It just comes in a different form. We call it rent expense rather than depreciation expense.

Well, what else do you think we should know about? Is there anything that we've missed? I know that the topic of taxes is so big and there's so many different ways you can go with it, but is there anything that you seen maybe that we haven't talked about?

Well, I just want to say, I know like we were talking earlier, short term rental is still fairly, a fairly new space, right? I know, not for you. Not for you. And I. But it's fairly new to a lot of people, real estate industry as a whole. And I think we'll continue to see changes in both, you know, practically speaking in terms of how they operate and also from tax treatment. As more of these get audited, they might define more of some of the questions we talked about. How do we prove the time of the workers that we hire and things like that. So it's really important to just make sure you are staying up to date with, you know, your tax advisor and getting kind of the latest in the various tax treatments and things like that. But I think for investors, I know like you, taxes, there's so much to talk about. But the key thing to remember is that you don't have to become a cpa. You don't have to memorize any of the rules or you don't even have to understand 50% of what we talked about today, but just kind of know enough to have a good conversation with your own tax advisor. But I think most importantly is to keep that line of communication open with what your transactions are, talking to advisors about that before you do it and being proactive throughout the year. What are some things I need to do? We talked about real estate, some of the benefits. We need to track our expenses, we need to know what the appliances are. So make sure you have a system to track those. Just because you now know it's deductible doesn't mean automatically your CPA will deduct it. You need to track those things or have a system bookkeeping, bookkeepers to track it. We talked about material participation, the hours you need, whether 500 or 100 hours, you need to know what to track and how to track it and have those systems in place. So I think that's the main action item from an investor's perspective to be doing during the year.

And I think a good thing that can help out with that is using QuickBooks online. Because if it's linked with your bank accounts, if it's linked with, with your credit cards and let's say you buy a new appliance, well, then that's going to show up in your QuickBooks and there's going to be a transaction there that you're going to need to label one way or another. Right, exactly.

That's why I mean, I love, you know, as I think for me as.

An investor and a business owner, I love the concept of systems, right. Systemizing, automating. So yeah, what you described with QuickBooks is a really great example, not to say that Everybody needs to go out and use QuickBooks. You know, for someone like you've got lots of properties, partners, all kinds of stuff, then yes, QuickBooks makes your life so much easier. But for smaller investor, if you're not into.

Those kind of software, even if you're using Excel. Right. It's better than not. When you spend money put into Excel, download your statements into Excel format, kind of accomplish similar things.

Yeah, it just depends how much time you want to put in or how much you like. But I don't like the bookkeeping side. I mean it's like I love numbers and investments and like looking at projections and things like that. But the tedious like everyday transactions and with short term rentals there's tons and thousands, you know, you get rents coming in every day and so it's a lot to organize. But if you're diligent with it. Yeah, I agree. You can use Excel. You can use whatever works best for you. As long as you're tracking it is the most important thing. Well, thank you so much Amanda. It was really great having you on as the first interview guest, first interviewees. So I'm sure people appreciated getting a break from my voice. It's been over a year now, so nice to have you on. And for anyone that wants to get more information about you or find out about Keystone cpa, what's the best way for them to get in touch with.

Our website is the best way. We have tons of great information and tax updates and things like that. So. Www.keystonecpa.com that's K E Y S T O N e c p a.com and you mentioned earlier our book. So anyone who wants even more information, check out our book. It's on BiggerPockets and Amazon as well.

Thank you so much. We'll have to do it again in the future because taxes are always changing. Right.

So yeah, I love to. I'll for sure come back if we see some major tax changes this year.

That'd be awesome. Well, thank you so much and thank you for all the help over the last few years too. Really appreciate it.

Thanks. Take care.

Want to get on the fast track to financial freedom through short term rentals. Well, it all starts with the properties you acquire, but you want to make sure that you acquire the right properties. I want to give you my ebook that will show you how to do just that. There is no charge. It's my gift to you for being one of our subscribers. Just go to restmethods. Com, that's Rest Methods.

Com.