How are you creating paper losses?

[Jeremy Horton]

I am starting to realize that tax losses are maybe the most important part of investing in real estate. There's cashflow, sure, but you will likely not retire from your 9-5 on cashflow (you'd have to majorly scale). But we can essentially create cashflow by creating paper losses. This is primarily aimed at W2 workers, especially higher income earners. 

Cashflow can be harder to come by these days whether that's high sales prices, interest rates etc. So how can we create more cashflow? Through losses. Now there are the normal expenses from a rental property - maintenance, management fees, repairs, loan interest, insurance etc. We have those across the board. But the BIGGEST of these is depreciation. 

From what I can tell there are 2 ways to use depreciation. If you're investing in LTRs you (or your spouse) would need to qualify as a REP. This would essentially disqualify W2 workers. Point being that being a REP will allow you to deduct from your W2. 

Secondly is investing in an STR. The STR is considered an active business as long as you "materially participate" by meeting 1 of 11 rules (the easiest probably spending 100 hours AND more than any other person).

Now we've decided to invest in an STR so we can take those active losses. What's next? Cost segregation study. So let's say we buy an STR for 750,000. the key here is ideally getting something with a higher building/land ratio. Let's say for example it's 75/25 here. So we have the building valued at ~560k. From here we can generally cost seg 20-30% of the buildings value - let's use 25% for the example - 560k * .25 = 140k. So we can deduct 140k from our W2.

Let's say we had a taxable income of 250k this past year - we would pay ~52k in taxes. Now let's apply our STR cost seg study so we'd reduce our taxable income from 250 - 140 = 110k. And looking at the tax calculator we come up with ~15k. So we've saved 37k in taxes annually or $3083/month. That is an extra 37k in your pocket. Another way of looking at it is 37k/250k = 15%. You've just gotten a 15% raise.

If we don't do a cost seg - 560k/27.5 = 20363/year or $1700/month. Still significant. 

So if your STR breaks even, you're still coming ahead 3k/month or 1.7k/month. Not only that, but it's a great vehicle to pass wealth down as well.

Is there something I'm missing here or does this make sense to do every couple years. Buy STR, cost seg, save a little down payment, buy STR, cost seg and repeat. Anything I seem to be missing here (it's been a late night!)?

[Chris Seveney]

Have to respectfully disagree that tax losses are the most important part of real estate. You realize that you are deferring taxes not eliminating them. depreciation gets paid back when you sell the property. Yes there are 1031's and other options you can follow but for the average investor most never do a 1031 as its complex. 

Also regarding STR, that is like operating a business and most fail at it. The most important aspect of real estate is the old adage "location, location, location"