Mix Use Duplex as STR and LTR for Tax Filing

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Mix Use Duplex as STR and LTR for Tax Filing

Shyd Coloma
Rental Property Investor · Member since 2021 · 23 posts · 29 votes

Looking for anyone who has a duplex that is mix of STR & LTR and claim material participation for the STR side for the "STR loophole" to offset active W2 income? I recently had an email exchange with my CPA regarding my investment property that is a duplex where one side is operated as a LTR and the other side is a STR. 2022 is my first year with this investment property.

The average length of stay for the STR side for the year came out to 5.5 days so it does meet the STR criteria. We meet the material participation criteria as well since we self-manage the unit and set it all up in person ourselves. We have tracked and logged more than 500 hours and materially participated more hours on the property than the rest of our team (cleaner, handymen, etc.) and would like to try and exercise the "STR Loophole" to offset W2 income for 2022. My CPA is telling me that because this is a duplex, it might be "aggressive" to file half of the property as a STR and the other half as a LTR and I could be targeted for an audit since this is a gray area of the tax code. They haven't had clients with this type of situation arise yet. All their client's properties are clear LTR or STRs and not a mix. Recommendation from my CPA is that we file the whole duplex as a LTR, but then we obviously couldn't offset my W2 income if we went that route. We aren't able to claim REPS at this time. Looking to see if others have encountered this situation before.

I am reaching out to 2 other CPAs for a consultation as well, but looking for some anecdotal data from others to see if they have run into this issue in the past.

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Natalie KolodijBusiness Member
Moderator
Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
3y

I actually ran into this with a client last year. 

I paid for a consultation with a colleague who was the IRS technical advisor on code 469 for 25 years to offer some feedback and clarity because it is so unique. 

The long and short of it is this: 

There are two things your tax professional is going to need to consider and could provide nuance with set up. Deprecaition for a rental vs. non rental activity is based on specific rules. That is determined at the BUILDING level. There's an 80% of income rule, so even though you have both short and long term activites- the entire building may be depreciated at either 39 or 27.5 years, depending on analysis. 

Second- it is possible to have two activities within the same building. And they could be treated accordingly. You could utilize the STR loophole just connected to that specific unit. Your records and tracking will need to be impecable.

This is allowable because unlike the depreciation test, the rules here tie to the activity, with is not defined as an entire building. Think of other mixed use properties: storefront on level 1 with apartments above. 

Like Michael said above it defintiely COULD be seen as a red flag potentialy, just because it may look odd. But is defendable. So work with a good tax professional and see how plausable and beneficial it actually would be. 

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  • Timothy Reed
    Member since 2021 · 15 posts · 7 votes
    3y

    You would need to file them separately since LTR and STR and taxed differently. Unless I'm missing something filing them both as LTR is inaccurate and could have you end up paying penalties and interest later.

    If you have other STRs or are acquiring more I would suggest setting up a S-corp to run them under.

    0Reply
  • Russ Eisenberg
    Member since 2019 · 29 posts · 10 votes
    3y

    I am likely going to be in this situation next year.  @Shyd Coloma - It would be great if you would be willing to share what you learn.

    Also, do you have any conflict between the sides?  I am a little concerned about the mixed model, but for our needs it would be ideal. 

    Thanks,

    Russ

    0Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y

    @Shyd Coloma

    Trying to get a second opinion against a CPA from an online forum is not a reliable route. It's like trying to second-guess your doctor online. Even though I'm a tax professional with over 25 years of experience, I don't know your entire tax situation, and there could be important pieces you did not share. Also, I'm only responding to you quoting your CPA, as opposed to his actual statements.

    That said - I agree that reporting the two sides differently could be a red flag. However, it is how you are supposed to report it for accuracy, before we even consider the potential benefit to you. And then, it is possibly beneficial to you, on top of that. I'm saying possibly, because there could be some missing pieces in your story.

    Forgoing legitimate tax benefits in order to avoid red flags is not something I would recommend to my clients. As long as you have your facts straight to defend this position, I would not worry too much about IRS challenges. When you're in business, especially in real estate, being open to IRS challenges comes with the territory.

    2Reply
  • Russ Eisenberg
    Member since 2019 · 29 posts · 10 votes
    3y

    @Michael Plaks - Might I ask, in a split ltr/str situation with proper material participation but not REP status would I be able to deduct bonus depreciation for 100% of the assets against my w-2?  Or would i have to exclude the sq footage of value attributable to the LTR?

    Thanks

    0Reply
  • Shyd Coloma
    OP
    Rental Property Investor · Member since 2021 · 23 posts · 29 votes
    3y
    Quote from @Michael Plaks:

    @Shyd Coloma

    Trying to get a second opinion against a CPA from an online forum is not a reliable route. It's like trying to second-guess your doctor online. Even though I'm a tax professional with over 25 years of experience, I don't know your entire tax situation, and there could be important pieces you did not share. Also, I'm only responding to you quoting your CPA, as opposed to his actual statements.

    That said - I agree that reporting the two sides differently could be a red flag. However, it is how you are supposed to report it for accuracy, before we even consider the potential benefit to you. And then, it is possibly beneficial to you, on top of that. I'm saying possibly, because there could be some missing pieces in your story.

    Forgoing legitimate tax benefits in order to avoid red flags is not something I would recommend to my clients. As long as you have your facts straight to defend this position, I would not worry too much about IRS challenges. When you're in business, especially in real estate, being open to IRS challenges comes with the territory.


    I appreciate the response! My CPA was up front with me and told me that they've never had a client with this specific situation before. Their office is open to filing the property as 2 separate pieces since it does make sense for taxes and I have all the documentation to backup material participation and the split costs for the year. They did say it is aggressive and to know that it could increase chances of audit if we decide to go that route since this is a gray area in the tax code. They actually recommended that I ask around my REI network and see if I know of others who have done this before and they'd love to talk to them and their CPAs, so I decided to post in the forums to get insights. Unfortunately, everyone in my network has SFRs that are 100% STRs or LTRs and no hybrids like my situation.

    0Reply
  • Shyd Coloma
    OP
    Rental Property Investor · Member since 2021 · 23 posts · 29 votes
    3y
    Quote from @Russ Eisenberg:

    I am likely going to be in this situation next year.  @Shyd Coloma - It would be great if you would be willing to share what you learn.

    Also, do you have any conflict between the sides?  I am a little concerned about the mixed model, but for our needs it would be ideal. 

    Thanks,

    Russ

    @Russ Eisenberg - There have been a couple challenges like one guest throwing a party after hours especially after its clear in Airbnb guidelines and my house rules about no parties and quiet hours. But over 95% of the stays there were no problems, and I'm blessed that my LTR tenant has great pride of ownership in our property so he looks out for the property and has even offered to help maintain parts of the outside of the duplex to ensure my STR guests always have a great overall impression of the property upon arrival. If you have any detailed questions, feel free to message me!

    0Reply
  • Russ Eisenberg
    Member since 2019 · 29 posts · 10 votes
    3y

    @Shyd Coloma Thanks, just sent you a message.

    0Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    3y

    I actually ran into this with a client last year. 

    I paid for a consultation with a colleague who was the IRS technical advisor on code 469 for 25 years to offer some feedback and clarity because it is so unique. 

    The long and short of it is this: 

    There are two things your tax professional is going to need to consider and could provide nuance with set up. Deprecaition for a rental vs. non rental activity is based on specific rules. That is determined at the BUILDING level. There's an 80% of income rule, so even though you have both short and long term activites- the entire building may be depreciated at either 39 or 27.5 years, depending on analysis. 

    Second- it is possible to have two activities within the same building. And they could be treated accordingly. You could utilize the STR loophole just connected to that specific unit. Your records and tracking will need to be impecable.

    This is allowable because unlike the depreciation test, the rules here tie to the activity, with is not defined as an entire building. Think of other mixed use properties: storefront on level 1 with apartments above. 

    Like Michael said above it defintiely COULD be seen as a red flag potentialy, just because it may look odd. But is defendable. So work with a good tax professional and see how plausable and beneficial it actually would be. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
    Kolodij Tax & Consulting
    WebsiteView Page
    5Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y
    Quote from @Russ Eisenberg:

    @Michael Plaks - Might I ask, in a split ltr/str situation with proper material participation but not REP status would I be able to deduct bonus depreciation for 100% of the assets against my w-2?  Or would i have to exclude the sq footage of value attributable to the LTR?

    You will have TWO activities reported separately. One under LTR rules, and the other under STR rules. Whatever is attributed to the LTR portion will be locked due to your W2 income. Whatever is allocated to the STR part, assuming you pass material participation test, will be allowed as a deduction. So, no, not 100% of depreciation but only the portion allocated to the STR can potentially offset your W2. Whether it's allocated based on sq ft or on some other formula is a different topic.

    Also, you have a misunderstanding of the concept. Passive activity loss (PAL) restrictions are not for bonus depreciation per se, but for an overall loss that is a result of subtracting ALL expenses, including depreciation, from rental income.

    2Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y
    Quote from @Natalie Kolodij:

    Deprecaition for a rental vs. non rental activity is based on specific rules. That is determined at the BUILDING level. There's an 80% of income rule, so even though you have both short and long term activites- the entire building may be depreciated at either 39 or 27.5 years, depending on analysis. 

    This is interesting. And while, generally speaking, there is not much practical gap between 27.5 and 39-yr depreciation schedules for a small property, the distinction is nevertheless significant due to the special rules afforded to non-residential properties, such as expensing of roofs and HVAC.

    Yes, there's this concept that the property's character is determined at the building level. When the entire building is rented as part of the same activity, it totally makes sense. As would be in your example: storefront on level 1 with apartments above. 

    What I wonder is whether this still applies when multiple activities are splitting the use of the property. Is it possible that in this case we still have to "partition" the building, including for determining its depreciable life? 

    Note: I'm not disagreeing. I don't have a definitive answer one way or the other.
    0Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    3y
    Quote from @Michael Plaks:
    Quote from @Natalie Kolodij:

    Deprecaition for a rental vs. non rental activity is based on specific rules. That is determined at the BUILDING level. There's an 80% of income rule, so even though you have both short and long term activites- the entire building may be depreciated at either 39 or 27.5 years, depending on analysis. 

    This is interesting. And while, generally speaking, there is not much practical gap between 27.5 and 39-yr depreciation schedules for a small property, the distinction is nevertheless significant due to the special rules afforded to non-residential properties, such as expensing of roofs and HVAC.

    Yes, there's this concept that the property's character is determined at the building level. When the entire building is rented as part of the same activity, it totally makes sense. As would be in your example: storefront on level 1 with apartments above. 

    What I wonder is whether this still applies when multiple activities are splitting the use of the property. Is it possible that in this case we still have to "partition" the building, including for determining its depreciable life? 

    Note: I'm not disagreeing. I don't have a definitive answer one way or the other.


    That has been one of my thought points related to the additional flexibility on non-residential proeprty for depreciation. So this could be another point to be mindful of with regard to planning and how the buildinga s a whole will be classified. 

     I don't beleive we get to partition the building for depreciable life based on this wording :

    • Residential rental property. This class includes any real property that is a rental building or structure (including a mobile home) for which 80% or more of the gross rental income for the tax year is from dwelling units. It doesn’t include a unit in a hotel, motel, inn, or other establishment where more than half of the units are used on a transient basis. If you live in any part of the building or structure, the gross rental income includes the fair rental value of the part you live in.

    • It leads me to belive it is determination for the building. Otherwise if we could bifurcate the use this depreciation guideline woudln't exist. 

    I was thinking we could separate it too - but especially after speaking w/ Kelly who was the IRS 469 tech advisor he said nope it's always used at as an asset determination for purposes of depreciation. 

    The difference between the wording in 469  related to activity vs. structure for depreciation

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
    Kolodij Tax & Consulting
    WebsiteView Page
    1Reply
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