Bonus depreciation to reduce w2 income tax

Tax, SDIRAs & Cost Segregation
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Bonus depreciation to reduce w2 income tax

Rashid Khalil
Member since 2022 · 88 posts · 29 votes

I and my wife are w2 employed and am in a high tax bracket. after 13 years of paying high taxes and living in the cave, I am now aware of this real estate investment/cost segregation/bonus depreciation, etc. so i have listened to several podcasts / YouTube and read a couple of books on the subject.

with a full-time job it's unlikely to get REPro status, only way forward seems STR as the requirements to qualify to seem less stringent.

I am looking for 2 M investment with 500 down and expecting roughly 25-30 % of price value as accelerated depreciation, accounting for nearly 500k which can save me 175 k in taxes on w2. 

I wonder what my options are other than STR ? will syndication or commercial RE or apartment complex or something else can get me the opportunity to reduce w2 income from my employment?

also if i switch in future years my STR to LTR will i be returning the captured depreciation back ?

i will appreciate your valuable comments and thoughts.

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Jenny Zhang
Member since 2022 · 38 posts · 26 votes
3y

I am in the same situation. However, with how the market is going and the expected not-so-great economic condition, taking the risk in STR in attempt to save taxes can be damaging. I am a CPA specialize in taxation. I won't do it in this economic condition unless you are fully confident that STR you are acquiring is going to be an income producing property. It is not worth it to loss the real cash to save tax. I haven't found one STR that give me that confidence yet.

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · Sarasota, FL · Member since 2017 · 5k+ posts · 3k+ votes
    3y

    Any LP interests will not help you for now.  

    You can change to STR to MTR or LTR if you have to because of the operational decision - HOA/city restriction or losses for STR. Not because you used the loophole and converted to LTR after saving 200k in taxes.

    It is worth talking to your tax advisor. 

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  • Jon Fletcher
    Member since 2021 · 174 posts · 56 votes
    3y

    Hi @Rashid Khalil. I am in a similar position to you. I have W2 taxes that cannot be offset by my Long-Term Rentals ("LTR's"). Nor do I qualify for Real Estate Professional ("REP") status because of my W2. I recently purchased a Short-Term Rental ("STR"), which I will use to offset my W2 taxes with a Cost Segregation Study and Accelerated Depreciation. This is the only strategy that I am aware of that allows you to offset your W2 taxes.

    1Reply
  • Jenny Zhang
    Member since 2022 · 38 posts · 26 votes
    3y

    I am in the same situation. However, with how the market is going and the expected not-so-great economic condition, taking the risk in STR in attempt to save taxes can be damaging. I am a CPA specialize in taxation. I won't do it in this economic condition unless you are fully confident that STR you are acquiring is going to be an income producing property. It is not worth it to loss the real cash to save tax. I haven't found one STR that give me that confidence yet.

    3Reply
  • Bonnie Griffin KaakePro Member
    Real Estate Consultant · Denver, CO · Member since 2021 · 667 posts · 389 votes
    3y

    @Rashid Khalil  and @Jon Fletcher Jenny Zhang has some great points above. Also, be sure to check the city, county and HOA to be sure a STR is allowed. Many do not.

    In addition, keep in mind that just because you have or change to a STR, does not mean the depreciation can be used against your W2 income. It is not automatically an active investment. There is a lot of work required of an owner of a STR to qualify as materially participating in the management of that property. You have to put in at least 100 hours per year and more than anyone else who maintains that property. Next, you need to know that if you change from STR to LTR or vice versa, you will have to have your CPA/tax professional do a 3115 Change of Accounting form, which they hate doing, to switch from 39 year depreciation (STR) to 27.5 year (LTR). 

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  • Rashid Khalil
    OP
    Member since 2022 · 88 posts · 29 votes
    3y
    Quote from @Jon Fletcher:

    Hi @Rashid Khalil. I am in a similar position to you. I have W2 taxes that cannot be offset by my Long-Term Rentals ("LTR's"). Nor do I qualify for Real Estate Professional ("REP") status because of my W2. I recently purchased a Short-Term Rental ("STR"), which I will use to offset my W2 taxes with a Cost Segregation Study and Accelerated Depreciation. This is the only strategy that I am aware of that allows you to offset your W2 taxes.

    i am very happy to hear from you, nice to know i am not alone. if you don't mind i would like to build on some info from you,
    1. how far is the place you bought for STR from your residence,
    2. are you managing yourself or hired a STR management company
    3. what type of property you bought, condo / SFH etc 
    4. location and price point 

    if any of these questions are too intrusive, please disregard them.
    thanks a lot



    0Reply
  • Rashid Khalil
    OP
    Member since 2022 · 88 posts · 29 votes
    3y
    Quote from @Bonnie Griffin Kaake:

    @Rashid Khalil  and @Jon Fletcher Jenny Zhang has some great points above. Also, be sure to check the city, county and HOA to be sure a STR is allowed. Many do not.

    In addition, keep in mind that just because you have or change to a STR, does not mean the depreciation can be used against your W2 income. It is not automatically an active investment. There is a lot of work required of an owner of a STR to qualify as materially participating in the management of that property. You have to put in at least 100 hours per year and more than anyone else who maintains that property. Next, you need to know that if you change from STR to LTR or vice versa, you will have to have your CPA/tax professional do a 3115 Change of Accounting form, which they hate doing, to switch from 39 year depreciation (STR) to 27.5 year (LTR). 


     thank you Bonnie, valuable information. 

    yes qualifying for deduction even with a STR involves work but relatively speaking it is much less than other options.

    with regard to your point about 3115 exchanges, please guide me if possible, what happens to the bonus depreciation losses that were claimed as STR in case of such a transfer, would it be reversed as gains or will stay settled ?

    thank you

    2Reply
  • Rashid Khalil
    OP
    Member since 2022 · 88 posts · 29 votes
    3y
    Quote from @Jenny Zhang:

    I am in the same situation. However, with how the market is going and the expected not-so-great economic condition, taking the risk in STR in attempt to save taxes can be damaging. I am a CPA specialize in taxation. I won't do it in this economic condition unless you are fully confident that STR you are acquiring is going to be an income producing property. It is not worth it to loss the real cash to save tax. I haven't found one STR that give me that confidence yet.


    I agree I think there is a likely leg lower in housing in the next 6 months if unemployment spikes. I think 2nd half of 2023 could be a good opportunity. I am also concerned about STR model reliability therefore I am trying to find a market with the potential for change back to LTR. which markets are you interested in ?

    0Reply
  • Jenny Zhang
    Member since 2022 · 38 posts · 26 votes
    3y

    I want also make a point. IRS will likely to be on your return if you have a large W-2 but with rental (STR) to offset a big part of it. I would suggest to be very careful and perfect your documentation on everything. I know there are CPAs out there selling this "strategy", all I want to remind my fellow here is that, be cautious how you handle it. I have been in tax for 17 years, once IRS on you, they normally stay watching for at least 3 years. Good luck!

    3Reply
  • Rashid Khalil
    OP
    Member since 2022 · 88 posts · 29 votes
    3y
    Quote from @Jenny Zhang:

    I want also make a point. IRS will likely to be on your return if you have a large W-2 but with rental (STR) to offset a big part of it. I would suggest to be very careful and perfect your documentation on everything. I know there are CPAs out there selling this "strategy", all I want to remind my fellow here is that, be cautious how you handle it. I have been in tax for 17 years, once IRS on you, they normally stay watching for at least 3 years. Good luck!


     true that. if i go that route i will make every effort to exceed the requirements and documentation of material participation. IRS review is almost guaranteed.

    0Reply
  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 4k+ votes
    3y

    In my opinion, those that are looking to take advantage of having their Short-Term Rental being treated as an 'active' business(non-passive). They would already have some sort of experience in real estate investing.

    Otherwise, the 100+ hours that you are spending on your STR will likely be at a negative hourly rate / low hourly rate.
    Your time potentially would have been better off trying to start a business in the field that you practice and generating $200+ an hour which you could funnel into LTR's.

    Just my opinion.

    best of luck.

    Syndications in your case will likely not work since you will likely be considered passive in the investment.

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  • Bonnie Griffin KaakePro Member
    Real Estate Consultant · Denver, CO · Member since 2021 · 667 posts · 389 votes
    3y
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    1Reply
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