Pro Real Estate Tax Advice Directly From My CPA (Part One)

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 we have a really special episode for you today. Something different, something that we've never done before. I'm going to be interviewing Amanda and she's been my CPA for about the last five years, so thought it'd be much better just to bring the expert in. We've talked about taxes before in the past. It's a super, super important topic and none better than Amanda herself to give us the answers. We're gonna break it down for you guys and let me give you a bit of background about her because she has been an investor for a long time.

She is the author of Tax Strategies for the Savvy Real Estate Investor, which you can find on Amazon and it's got hundreds of reviews so highly suggest you guys check it out. And she's also been a speaker on talks at Google, CNBC's smart money talk Radio. She's been authored or has publications and money magazine, realtor.com, allbusiness.com so really, really excited to have Amanda here. Welcome, Amanda.

Hey, thank you so much for having me, Tim. I'm so excited to be here and talk about short term rentals. It's definitely a good space to be in from what I see, you know, as a cpa.

Yeah, totally. Yeah, you get to see, you get to see the actual numbers, don't you?

So.

I say, like, you hear a lot, you know, sometime you hear these real estate experts talk about, you know, how good of a return and you never really know how good it is. But I can say for sure I really know how good it is because no one makes up income numbers when it comes to filing taxes. So we actually do get to see properties that have good returns. And definitely short term, the short term rental space has been one of the highest returns from what we're seeing.

Yeah.

Well, I'm really excited to have you here. You know, I, I've been working with Amanda for, like I said, like five years now, and which is about the time that I started with short term rentals. So I was referred to her by another fellow investor. And I love that about Amanda and her partner Matt. And they're both at Keystone. CPA is the name of their company. And the fact that they're also real estate investors just makes it that much better because we kind of have the same perspective on everything. So, yeah, we've been working together for about five years and which is really when I started with short term rentals. So I guess you could say Amanda's seen on the back end the growth that I've had. And.

Like she said, you know, they can be some pretty powerful numbers.

Yeah, yeah, I would say, yeah. You're probably one of the first clients we had in the short term rental space, you know, sort of a pioneer. And it's been so good to see how much you've grown and just kind of giving back and helping the community and helping other people through your program, you know, in the podcast with how you do those things. Because I have a lot of clients where I encourage them to get into short term rentals space where they're kind of afraid of the work involved, the time involved. So I think it's, it's really, really great what you've done to give back. And you know, as I shared in my email with you recently, I had another client who just said, hey, I found out Tim's your client. I loved his course. It's so great. I said, wow, what a small world. That everything's come full circle. So, so excited to be here to talk about, you know, short term rental and all the related tax benefits.

Yeah, totally. I, you know, we focus on short term rentals here, but we also talk about real estate in general and the two go hand in hand. And it is a bit of a gray area for a lot of us still for lenders on the tax side everywhere, because short term rentals are. They're like this new concept at least when people think of Airbnb and so really glad to have you on. We've got a series of questions and we'll jump through it. We'll try to just give a good summary of things that we should be considering, things we need to keep an eye out on and just some of the benefits of investing in real estate when it comes to taxes. We've talked about things like 1031s in the past and depreciation, but I haven't really dug fully into it. One, just because I'm not a tax professional.

So.

Really happy to have you here, Amanda. Well, I guess, you know, when we think of short term rentals versus a traditional rental, a short term rental is more of a. It's more set up like a business. Right. I mean, it's. We've got people coming in and people leaving and business income versus passive income is taxed differently. Is that, is that right? Or you want to talk about that point.

Yeah, a little bit. So I think first I just want to take a moment to define short term rental from a tax perspective because I found that to be a point of confusion. Whereas for a lot of investors, when they hear the word short term rental, usually you associate that with like Airbnb, vrbo, those kind of platforms. But just because a property is rented out on one of those platforms does not mean it is a short term rental for tax purposes. So for tax purposes, it's really defined by the average number of guest stays during the year. And so what it means is if you look at how many days was rented out, this property was rented out for the whole year, you divided by the number of guests that you had throughout the year. And if that average is seven days or less, that's what's a short term rental in the eyes of the irs. If the average is eight days or more, then even though it might be on Airbnb and things like that, it's still considered a regular long term rental property. And so that's a key difference because we are starting to have people who are investing in different parts of the US where they literally will have the summer months where it's one guest that's staying there for 30 days or even two, three months, in which case, even though to us mentally we think it's a short term rental, but it might not be.

But yeah, for most people that are.

Doing the Airbnb VRBO, where the guests are staying 2, 3 days, 3, 4 days, then those are short term rentals for tax purposes. And there's really two different tax treatments. One which applies to most of our clients and most investors is that there's just regular short term rentals. And from the tax perspective it means that it's, you know, it's treated just like any other long term rental property, except that when it comes to the ability to use some of the write offs and deductions to offset other non rental income, it's a little bit easier threshold. And we'll talk about that in a moment. But there's this other method where sometimes a short term rental operator might go into an avenue where becomes like a hotel or bed and breakfast type of a scenario where you're doing more than just, you know, renting out the room, but you're also providing a lot of added services like airport pickup, airport drop off sites, you know, food and beverage delivery service. So beyond just like the water and salt and pepper. So in that scenario it is treated like a whole different business where not only do you have to pay income taxes, but you also have to pay self employment taxes as well. Just like if you're operating a hotel or you know, a laundromat for example. But so, so from a tax perspective is not as ideal because you're paying a little bit more taxes. Practically speaking, we really don't have a lot of clients in that space where they're doing hotel type services. Most people are just when they come, we get it all cleaned up. When they leave is the next time we'll go in the property and do any kind of work. So those are just regular short term rentals.

And that's something. I don't offer a lot of those additional services just because we've talked before. And I know that changes the, the tax structure, but also just from an operational standpoint, if you're starting offering all these other services, it creates a lot more operations. I know it is a lot more common with big vacation rentals. Sometimes, especially if it's in a remote area, maybe it's a foreign person coming in or international guests where they want to pick them up. So for any of those of you out there that have larger vacation rentals or are currently offering other services, you know, just want to double check those things to make sure you're not changing your tax structure basically.

Right? Yeah, I mean there are, you know, even if you are someone who is offering those services, there are different strategies that you can use to reduce taxes from that kind of income. But it's just, you know, it's different than I would say 95, maybe even more than 95% of investors and clients we see are just regular short term rentals. You know, again, they might have, you know, water and snacks and all that, but it's, they're not really offering additional services like you would get at a hotel. You know, for example.

That's interesting that the IRS considers it, what did you say, eight days or less or seven days or less?

Seven. Yeah.

Seven days or less. Yeah.

Because most cities and regulations are, you know, they usually use like a 30 day period and say, okay, it was anything less than 30 days. And that short term gas, if it's over 30 days, then a lot of times we can bypass a lot of the regulations and stuff with cities.

Yeah.

And that's where you have different definitions of, you know, this, the occupancy tax from the city's perspective and then the income tax from the IRS perspective and then versus what we think as investors.

Right.

If I don't have someone who signed A year lease, therefore it's a short term rental to me.

Yeah, it's, it's pretty nice to get the longer term gift, you know, 30 nights or more where they're paying the nightly rates. But you're bypassing, you know, the city regulations. You have less housekeeping, you have less all of it. So that's like ideal, you know, And I think the way just the world is, especially right now with everyone being able to work from home, that we're seeing longer term stays. And I think that that will continue to be a trend.

Yeah, I totally agree. In fact, that's something, you know, personally, Matt and I have talked about is, hey, you know, now that we've been working remotely, maybe after tax season, we, you know, just try to live in Colorado for two months. Right. It's different than being travel for a couple weeks and that's it. So now we have this opportunity to really be immersed in, you know, wherever you want to stay longer for the short term vacations. I certainly see that as a, maybe a shift.

And the crazy thing is that, you know, that's a worldwide thing because the whole world's gone to remote working, you know what I mean? So, so people that wanted to really experience maybe a totally different culture coming in. I was in Brazil when they started locking everything down and I ended up staying, I was in an Airbnb. I ended up staying there for like several months just because I couldn't travel, you know, back to Colombia, in the U.S. you know, I guess I could have came back to the U.S. but so, yeah, I think that those extended stays are just, they're more and more common and it's kind of exciting. At the same time, the hotels, unfortunately, they've had a real tough time with this because they've gotten regulated much more than an individual short term rental. I think things for short term rental investors are going in a good direction. So we have this thing, Amanda, with taxes and it's a huge tax savings when you become a real estate professional. Can you explain that and what that means exactly and how we can get that status?

Yeah, certainly. So real estate professional, really the benefit from a tax perspective is that if.

You, or a spouse, if you're married.

If one of you can qualify as real estate professional for tax purposes, that means when you have rental losses, your rental losses can be used to offset not just rental income, but also other income you might have. So if you have a business that you operate or, or if you have W2 income you're making now, the rental losses can be used to offset W2 income. Normally, in order to use any excess rental loss to offset non rental income, your income has to be under 150,000.

Combined as a married couple.

So.

This becomes kind of a hurdle for some of our clients who are high income earners, high W2, but also have rentals on the side and you know, even though it might be really great cash flow, but after we write off things like, you know, car expenses, cell phone, home office, depreciation, after we write off all those things, you create a big loss. So the question just becomes how can we use that to offset income from these other sources. And so from that perspective, it's really important for someone to try to qualify as real estate professional. Of course not everybody is able to meet that status immediately, but that is generally a longer term goal for investors, you know, everywhere that we meet.

So in order to be a real.

Estate professional, a couple of things have to happen. One, the person has to spend more time in real estate than their jobs. So you know, if you're someone who's working a full time job, 2100 hours, it's going to be fairly difficult to say you're spending more hours than that in real estate.

Right.

So it's almost like working eight hours a day at your job and eight hours a day in real estate. And that's where kind of that difficulty comes in. So the rule is at least 150 hours and spending more time in real estate than your job and then you have to spend at least 500 hours on your rental properties. So from that perspective, again, you know, not. Although the benefit is huge, not everyone is able to easily qualify as real estate professional status. And this is kind of a good segue into the short term rental space and where the short term rentals have a little bit of an easier thought threshold to meet versus long term rental properties. When it comes to short term rentals, the way the IRS looks at it is they say, okay, well you can use the losses from your short term rentals to offset W2 and other income even if you don't qualify as real estate professional.

Okay.

Oh really?

Yeah.

But I didn't, I didn't.

Okay, you didn't know that.

I didn't know that. But yeah, I guess I've just been doing real estate the whole time, so it hasn't been right. But that's really good to know.

Exactly. So that not as applicable if you're just someone doing real estate anyway, you don't really care. But let's say that you had Another full time job, you're just doing short term rentals on the side.

Right.

So the IRS has a rule that says, okay, if you're doing short term rentals, you can use the losses from that short term rental property to offset other income, provided that you materially participate in in the short term rental property. So you don't have to be a real estate professional, but you do have to meet material participation, which is kind of maybe what you're alluding to earlier, similar to active participation. So to meet material participation, there's a couple different tests. One of the most common ones that people can meet is spending at least 500 hours on the short term rental properties.

Okay.

So if you spend 500 hours on the short term rentals, then you can use the losses to offset W2 income even if you don't qualify as real estate professional status.

And those hours could be anything from, you know, time spent messaging guests, or working with housekeepers, or ordering supplies. Anything related to that short term rental, correct?

Yeah, yeah. Managing the rental property, managing the guests, the checkout process, the cleaning process.

Right.

So things related to the short term rental itself. And so, you know, a good example of how this benefits someone is, let's say that, you know, Tim, if you, you know, you're working full time at a W2, you just had, you know, two short term rentals, right? And there's no way you're going to spend over 2,000 hours on the rentals because you mean that's the amount of time you're spending at work. So it's going to be very difficult. And so the loophole around that is, well, are you at least able to spend 500 hours on the short term rentals? And if so, so then you might be able to use those losses from the short term to start to decrease tax from W2 income.

Okay?

So that's one of the biggest reasons that we're seeing more and more people get into the short term rental space. Maybe at first not for the cash.

Flow, but for the tax piece of it.

Taxes. You know, our two basic expenses are living expenses and taxes generally for everyone.

Right.

And so if we can eliminate as much tax as we legally can, then, you know, that's a huge, huge plus, you know, and for someone that maybe is a high income W2 earner and they're paying 30, 40, 50% now even of their wages, if they're able to expense another thousand dollars, they potentially are saving 4, $500.

And you know, right now we have bonus depreciation. That's still available. And it's very beneficial for short term rental operators because, you know, one of the things that most of us have to do is to furnish the short term rental, at least in that initial year. So a lot of the furnishing, the fixtures, appliances are eligible for bonus depreciation. So it's not uncommon to have a pretty big tax write off in the first year of putting a short term rental in place. And you know, also just with the property itself, right? If you, if you're rental, let's say, you know, the building you bought for $100,000 in the first year, your depreciation could be anywhere from 15 to 30,000 of a tax write off. And so, you know, if you're at, you know, 50%, you're saving 7 to 15,000 in taxes just on the building depreciation. Then you add in the furniture and the home office. So it could be, you know, a fairly significant tax savings.

You know, last year was the first time that I personally did the bonus depreciation and it saved a ton of money. I couldn't, I couldn't believe it.

And we'll leave, I'll leave a note in the show notes for Scott's information. He's who helped us with the cost segregations. But do you want to explain a little bit more about kind of how that process works, what depreciation actually is and how that cost segregation is helping us save more in taxes.

So depreciation, basically one of the biggest tax benefits of real estate investing is that the IRS allows us to take a tax deduction for what they consider depreciation of a property. The IRS perspective is, okay, you buy a building and over time the value of that building will go down and therefore for tax purposes we get to take a write off. Of course, as investors we know that's not true because over time the value of the building actually increases. But again, that's just, you know, irrelevant, right? You get to take a write off over time on the purchase price of the building for the real estate. So that's normal depreciation. You know, for, for, for regular rental properties, 27 and a half year for short term rentals is 39 year. The, the strategy of the cost segregation though is to take a look at the building, this hundred thousand dollars building, and instead of saying it's all building that, you have an engineer or a consegregation firm go out and look at the components of the building. And so what they'll do is they'll say, okay, this hundred thousand dollar building is actually made up of 30,000 of flooring, 20,000 of cabinets, 10,000 of drywall. And when they break out those different components, then us as CPAs can come in and take a faster depreciation. So that's how you arrive at what you're saying, like, wow, what a large deduction that I have on this rental property.

Yeah, I couldn't believe it. I mean, we were even depreciating things like the landscaping, which I would have never, never thought of, you know, like, but trees have a certain life and you know, or. And one of the cool things about, you know, depreciation is it's not actual expense that's coming out of our pocket. Right. It's like a ghost expense, you could say.

So yeah, we call it paper write off because it's not cash outlay. I mean, normally, you know, let's say you're a short term rental investor, you want to have tax write off, you need to spend money, right? You need to pay your cleaning crew more, you need to be doing more marketing. So this money cash outlay you need, the benefit of depreciation is that there's not a current cash outlay. It's basically a paper write off based on the schedule the IRS gives us. The other part that's really great is depreciation is based on the purchase price of a property and not the down payment. So let's say you gone, you buy a short term rental for $100,000.

That's a great point.

Even if you put no money down, your depreciation is still calculated based on that hundred thousand. So you're taking a write off now for using leverage right of the bank.

That is a great point. And yeah, I talk about leverage all the time on the podcast and 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.

Wow.

We just covered a lot and there's so much more to cover. I thought we should break this into two episodes. So stay tuned until next week. We're going to be covering a whole other host of good topics, of relevant topics that you should definitely be considering whether you're investing now or you will be soon. And just to give you a little preview, we'll talk about what you should be doing if you're living in one of your investments. So if you have a 4.5 and you're living in one units, well, there's some things you should consider. We'll talk about the typical expenses you should be writing off all the time related to your short term rental, but also just real estate investment in general. We'll talk about lease arbitrage and how that may change your taxes slightly. And then probably one of the most important things, we'll talk about how you can use your experience and your time spent managing a short term rental to help offset income you earn from either a W2 job or from another business you have. So stay tuned until next week. I hope you have a wonderful day. Talk to you soon.