Last updated: September 2024
Short-term rental investors are uniquely positioned to offset their tax burden by employing smart tax strategies. Short-term rentals tax benefits are one of the major advantages when investing in real estate. One such tool, often referred to as a short term rentals tax loophole, allows non-professional property owners to reduce their taxable income by reclassifying rental income and offsetting it with depreciation and deductible expenses. Here are a few short-term rental strategies that Chalet highly recommends every STR investor investigate and discuss with their tax professional:
1. Cost Segregation
What is cost segregation in real estate?
Cost segregation is a tax planning strategy that allows property owners to reclassify certain components and improvements of their property from real property to personal property. This reclassification accelerates depreciation deductions, reducing taxable income.
How does cost segregation work?
A cost segregation study identifies and reclassifies building components (e.g., HVAC systems, plumbing, lighting) that can be depreciated over shorter periods (5, 7, or 15 years) instead of the standard 27.5 years for residential rental properties.
What are the benefits of a cost segregation study?
Accelerating depreciation increases deductions in the early years of ownership, providing significant tax savings upfront.
Can I do my own cost segregation study?
While the concept of cost segregation might seem straightforward, performing a quality cost segregation study is complex and requires the skills and experience of a trained engineer. Chalet has therefore partnered with the best cost segregation specialist in the US to ensure you get the best service for the best price. Get your free estimate and find out how much a cost segregation study would benefit you.
How much does a cost segregation study cost?
The cost of the study depends on the methodology chosen and the number of properties. However, a professionally conducted cost segregation study can start as low as $1,500 per property, saving you thousands of dollars in the process. Get our free cost segregation estimate and see how much a cost segregation study would cost you.
2. Bonus depreciation
What is bonus depreciation?
The Tax Cuts and Jobs Act of 2017 introduced 100% bonus depreciation, allowing investors to deduct the full cost of qualifying property in the year it is placed in service.
How does bonus depreciation work?
After conducting a cost segregation study, investors can apply 100% bonus depreciation to eligible personal property components.
What are the benefits of bonus depreciation?
This provision allows for substantial immediate tax write-offs, greatly reducing taxable income in the initial years.
3. Business Expense Write-Offs
As an STR investor, managing your properties qualifies you as a business owner, enabling you to write off many expenses. These deductions can significantly reduce your taxable income.
Common Deductible Expenses:
- Home Office Deduction: If you manage your STR from a home office, you can deduct a portion of your home expenses.
- Mortgage Interest: Deduct interest paid on loans used to acquire or improve rental property.
- Property Taxes: Deduct property taxes paid on rental properties.
- Insurance Premiums: Deduct premiums for property insurance and liability insurance.
- Repairs and Maintenance: Deduct the cost of repairs and routine maintenance.
- Utilities: Deduct expenses for utilities paid by the landlord.
- Supplies and Materials: Deduct costs for items such as cleaning supplies, linens, and guest amenities.
- Advertising and Marketing: Deduct expenses for promoting your rental property.
- Professional Services: Deduct fees paid for legal, accounting, and property management services.
- Travel Expenses: Deduct costs related to travel for property management and maintenance.
These business expense write-offs are a key part of any short term rental tax strategy, ensuring ongoing deductions that can significantly lower your taxable income.
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4. Other Tax Strategies
1031 exchange: A 1031 exchange allows investors to defer capital gains taxes by reinvesting the proceeds from the sale of one property into another “like-kind” property.
How it works? When you sell a rental property, you can reinvest the proceeds into a new property without paying capital gains taxes, as long as the new property is of equal or greater value.
Benefits? Defers capital gains taxes, allowing more capital to be reinvested.
Passive Activity Loss (PAL) Rules: Investors can use rental losses to offset other passive income. If you actively participate in managing your STR, you may qualify for certain exceptions that allow you to offset non-passive income as well.
Material Participation: To fully utilize rental losses, ensure you meet the IRS criteria for material participation in managing your rental properties.
Qualified Business Income (QBI) Deduction: STR income may qualify for the QBI deduction, which allows eligible taxpayers to deduct up to 20% of their qualified business income.
How it works: To qualify, the rental activity must rise to the level of a trade or business under IRS guidelines, which generally involves regular, continuous, and substantial involvement in property management.
Homeowner’s Tax Exclusion: If you convert a rental property to your primary residence and live there for at least two of the five years before selling, you may exclude up to $250,000 ($500,000 for married couples) of capital gains from your taxable income.
Conclusion
By leveraging these tax strategies, investors can benefit from the short term rentals tax loophole, significantly reduce their tax burden, and enhance their profitability. Cost segregation and bonus depreciation offer substantial upfront tax savings, while business expense write-offs ensure ongoing deductions. Additional strategies like 1031 exchanges, utilizing PAL rules, QBI deductions, and homeowner’s tax exclusions further optimize the tax benefits associated with STR investments.
Implementing these strategies requires careful planning and often professional guidance. Consulting with a tax advisor experienced in real estate and STR investments is crucial to maximize your tax benefits and ensure compliance with tax laws.
These strategies provide substantial short term rentals tax benefits, helping investors manage their tax liabilities effectively and enhance their overall return on investment.
