CPA said you can only do Cost Segregation on STR property

Tax, SDIRAs & Cost Segregation
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CPA said you can only do Cost Segregation on STR property

Noah Laker
Real Estate Broker · Sacramento, CA · Member since 2021 · 518 posts · 408 votes

I'm a real estate broker and my client is a high W2 earner, taking advantage of the "STR Loophole"

His CPA told him that he can only do cost segregation on properties which are active STR's.

My understanding was that, if he obtains REP status through any one of his properties, that he can take advantage of depreciation on any investment property, even if that one is not an STR. Am I missing something?

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Kory Reynolds
Accountant · NH · Member since 2019 · 269 posts · 288 votes
1y
Quote from @Johnny McKeon:

Sorry to hijack,  I own 12 apartment buildings with 53 apartment units in the Phoenix Arizona Metro, I self-manage everything. I don't have a W-2 job. I'm also a realtor.

with the real estate professional tax status. Can I use cost segregation studies I've done on my apartment buildings to not pay any self-employment taxes on my real estate commissions?

I keep getting mixed answers I don't know why this real estate professional tax status is confusing to me along with cost segregation and bonus depreciation no matter how much I read about them


 If you qualify as a REP you can utilize those losses to offset your Income subject to Federal Income Taxes.  However, you can actually end up in a spot where you have no Federal Income Tax, but you still owe Self Employment Tax.  Rental losses are not self-employment income losses - so they don't offset the assessment of that 15.3% / 2.9% / 3.8% level of tax.

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  • Greg ScottPro Member
    Rental Property Investor · SE Michigan · Member since 2014 · 4k+ posts · 6k+ votes
    1y

    You can do a cost segregation study on pretty much any property you own as an investment.  You can do it on a SF rental, an apartment, a car wash, a golf course, a hotel, a warehouse, etc.  The only one you really can't is raw land, because there are no costs to segregate.

    The bigger question is whether or not you can utilize the increased deductions from the cost segregation.  That will depend on the taxpayer's personal situation.

    3Reply
  • Joshua ThompsonBusiness Member
    Accountant · Melissa, TX (Remote) · Member since 2017 · 210 posts · 135 votes
    1y

    If your client works full time they most likely won't qualify as a REP however maybe a spouse could. 

    As Greg mentioned you can do a cost segregation on a STR, LTR, or other real assets but your client may not be able to utilize the benefits of a cost segregation based on their full situation.

    Typically, a client that has a STR and materially participates should be able to take advantage of a cost segregation done on the property. Assuming they aren't using the property personally over the allowed number of days.

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  • Krishnan Iyer
    Investor · Member since 2023 · 46 posts · 34 votes
    1y
    Quote from @Noah Laker:

    "My understanding was that, if he obtains REP status through any one of his properties, that he can take advantage of depreciation on any investment property, even if that one is not an STR. Am I missing something?"

    Just obtaining REP status is not enough. He needs to materially participate in the workings of the STR. THAT is a very critical requirement - hence the "loop hall" is called "Material Participation". Lookup the podcast called Tax Smart REI by Thomas Castelli and Ryan Carriere (Hall CPA) - they have described it very clearly with IRS case examples. 
    1Reply
  • Sean GrahamBusiness Member
    Investor , CPA · Detroit, MI · Member since 2016 · 586 posts · 249 votes
    1y
    Quote from @Noah Laker:

    I'm a real estate broker and my client is a high W2 earner, taking advantage of the "STR Loophole"

    His CPA told him that he can only do cost segregation on properties which are active STR's.

    My understanding was that, if he obtains REP status through any one of his properties, that he can take advantage of depreciation on any investment property, even if that one is not an STR. Am I missing something?

    He cannot be full time W2 and be REPS. 

    He has to meet material participation requirements. The grouping election would help with this so it looks at his portfolio as a whole 
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  • Natalie KolodijBusiness Member
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    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    1y

    If I give a client tax advice and they go to their real estate agent, who then goes to a forum to confirm what I said....I hope they get a cramp in their in their foot. 

    As others have mentioned you can do a cost segregation on whatever you'd like. 

    However; the STR loophole and REPS are completely different things.

    Qualifying for a short-term rental to be non-passive doesn't give you REPS. It gives you a non-passive short-term rental. So losses from that specific rental may be utilized. 

    REPS is for someone who meets specific requirements- at least 750 hours in real estate and more time on real estate than anything else; so having a fulltime job disqualifies someone. 

    If someone has REPS then potentially they can use all of their rental losses, from all properties, (there is more nuance especially with both LTR/STR) if they are materially participating. 

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  • Johnny McKeonPro Member
    Rental Property Investor · Mesa, AZ · Member since 2016 · 103 posts · 72 votes
    1y

    Sorry to hijack,  I own 12 apartment buildings with 53 apartment units in the Phoenix Arizona Metro, I self-manage everything. I don't have a W-2 job. I'm also a realtor.

    with the real estate professional tax status. Can I use cost segregation studies I've done on my apartment buildings to not pay any self-employment taxes on my real estate commissions?

    I keep getting mixed answers I don't know why this real estate professional tax status is confusing to me along with cost segregation and bonus depreciation no matter how much I read about them

    0Reply
    • Mohamed YoussefBusiness Member
      Accountant · Brea, CA · Member since 2018 · 122 posts · 64 votes
      1y
      Quote from @Johnny McKeon:

      Sorry to hijack,  I own 12 apartment buildings with 53 apartment units in the Phoenix Arizona Metro, I self-manage everything. I don't have a W-2 job. I'm also a realtor.

      with the real estate professional tax status. Can I use cost segregation studies I've done on my apartment buildings to not pay any self-employment taxes on my real estate commissions?

      I keep getting mixed answers I don't know why this real estate professional tax status is confusing to me along with cost segregation and bonus depreciation no matter how much I read about them


       This sounds like you can qualify if you document how you spend your hours and group all of your properties for the purpose of meeting the requirements. Documentation is very important tho.

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  • Greg ScottPro Member
    Rental Property Investor · SE Michigan · Member since 2014 · 4k+ posts · 6k+ votes
    1y

    @Johnny McKeon

    I'm not a CPA but my experience says, yes, you probably can.

    To avoid confusion it is helpful to separate out the concepts.

    REPS - Roughly, the requirements are minimum 750 hours active in real estate and those hours must exceed any hours in a non-real estate job.  You can get REPS status regardless of how you handle depreciation.

    Straight Line Depreciation - This is taken 27.5 years on residential and 39 for commercial.

    Accelerated Depreciation - This requires a cost segregation analysis so you can divide the total value of the building into 5, 7, 15, and 27.5 (or 39) year depreciation buckets.   The attached chart shows a good example of why this is helpful.

    Bonus Depreciation - This allows you to accelerate the depreciation even further, deducting anything with a 15 year depreciation life or less in the first year.  This rule has been phasing out and for 2025 has 40% of the benefit unless the new administration renews it.

    1Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    1y
    Quote from @Johnny McKeon:

    Sorry to hijack,  I own 12 apartment buildings with 53 apartment units in the Phoenix Arizona Metro, I self-manage everything. I don't have a W-2 job. I'm also a realtor.

    with the real estate professional tax status. Can I use cost segregation studies I've done on my apartment buildings to not pay any self-employment taxes on my real estate commissions?

    I keep getting mixed answers I don't know why this real estate professional tax status is confusing to me along with cost segregation and bonus depreciation no matter how much I read about them


     Do you pay a good tax professional to give you an answer? That's the one I'd listen to. 

    REPS = Your rentals are non-passive if you materially participate in them. (check page 7 of this IRS Pub)

    Something that's non-passive and you materially participate means you can deduct those losses up to the excess business loss limit. 


    So as a whole your rental losses can offset your agent income. 


    Cost segregations, bonus depreciation, etc.....are just ways and methods of writing off more or less at certain times. Normally done to create more losses. So there's no connect on if you can "use" a cost segregation or "use" bonus depreciation. 

    You get to use any methods legally allowed to create losses. 

    Whether you can use those ending losses is what changes due to REPS. 

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  • Kory Reynolds
    Accountant · NH · Member since 2019 · 269 posts · 288 votes
    1y
    Quote from @Johnny McKeon:

    Sorry to hijack,  I own 12 apartment buildings with 53 apartment units in the Phoenix Arizona Metro, I self-manage everything. I don't have a W-2 job. I'm also a realtor.

    with the real estate professional tax status. Can I use cost segregation studies I've done on my apartment buildings to not pay any self-employment taxes on my real estate commissions?

    I keep getting mixed answers I don't know why this real estate professional tax status is confusing to me along with cost segregation and bonus depreciation no matter how much I read about them


     If you qualify as a REP you can utilize those losses to offset your Income subject to Federal Income Taxes.  However, you can actually end up in a spot where you have no Federal Income Tax, but you still owe Self Employment Tax.  Rental losses are not self-employment income losses - so they don't offset the assessment of that 15.3% / 2.9% / 3.8% level of tax.

    3Reply
  • Patrick DruryBusiness Member
    Real Estate Agent · Columbus, OH & Cleveland OH · Member since 2021 · 1k+ posts · 2k+ votes
    1y

    @Johnny McKeon
    To reduce your self-employment tax you could make an LLC for your real estate agent business and then make an S election to file as an S corp. As an S corp, you would pay yourself a salary. I would check with your account to make sure doing this will be profitable for you and your situation. I am by no means a tax expert so keep that in mind I just speak from personal experience. In terms of doing cost segregations and taking bonus depreciation (assuming you have real estate professional status), they create losses that offset your income by rapidly depreciating the property. The best combination in my opinion to have your real estate agent income in an S corp to reduce personal income tax (as long as it financially makes sense) and then buy real estate and cos segregate it and take bonus depreciation to offset against your income.

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  • Sean GrahamBusiness Member
    Investor , CPA · Detroit, MI · Member since 2016 · 586 posts · 249 votes
    1y
    Quote from @Kory Reynolds:
    Quote from @Johnny McKeon:

    Sorry to hijack,  I own 12 apartment buildings with 53 apartment units in the Phoenix Arizona Metro, I self-manage everything. I don't have a W-2 job. I'm also a realtor.

    with the real estate professional tax status. Can I use cost segregation studies I've done on my apartment buildings to not pay any self-employment taxes on my real estate commissions?

    I keep getting mixed answers I don't know why this real estate professional tax status is confusing to me along with cost segregation and bonus depreciation no matter how much I read about them


     If you qualify as a REP you can utilize those losses to offset your Income subject to Federal Income Taxes.  However, you can actually end up in a spot where you have no Federal Income Tax, but you still owe Self Employment Tax.  Rental losses are not self-employment income losses - so they don't offset the assessment of that 15.3% / 2.9% / 3.8% level of tax.

    Here is your answer! 
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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    1y
    Quote from @Noah Laker:

    I'm a real estate broker and my client is a high W2 earner, taking advantage of the "STR Loophole"

    His CPA told him that he can only do cost segregation on properties which are active STR's.

    My understanding was that, if he obtains REP status through any one of his properties, that he can take advantage of depreciation on any investment property, even if that one is not an STR. Am I missing something?


    The most important thing you're missing is that you are his broker and not his accountant. You should not give him any tax advice, no more than we accountants should give him real estate advice.

    There're two ways for high W2 earners to benefit from cost segregation:
    A. With STRs provided he passes "material participation" test and some other restrictions
    B. With LTRs if he is married and his wife can qualify for REPS. He himself will almost certainly not qualify.

    1Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    1y
    Quote from @Johnny McKeon:

    Sorry to hijack,  I own 12 apartment buildings with 53 apartment units in the Phoenix Arizona Metro, I self-manage everything. I don't have a W-2 job. I'm also a realtor. with the real estate professional tax status. Can I use cost segregation studies I've done on my apartment buildings to not pay any self-employment taxes on my real estate commissions?

    I keep getting mixed answers I don't know why this real estate professional tax status is confusing to me along with cost segregation and bonus depreciation no matter how much I read about them


    You keep getting mixed answers because you're asking a flawed question. There're TWO different taxes that you owe on your Realtor income:

    1. Income tax. This tax can be offset with cost segregation losses from your rentals. Maybe fully, maybe partially, depending on the numbers. Remember that cost segregation works for one year only.  https://www.biggerpockets.com/forums/51/topics/1075919-five-...

    2. Self-employment tax. It cannot be offset by rental losses, including cost segregation. It might be partially reduced via an S-corporation. However, contrary to a popular notion, an S-corp is not a no-brainer for realtors. Discuss with an accountant before implementing.
    2Reply
  • Julio GonzalezPro Member
    Specialist · West Palm Beach, FL · Member since 2008 · 4k+ posts · 1k+ votes
    1y

    Here is an article that explains REPS. However, if your client is a full-time W-2 employee, they may not qualify for REPS making it easier to benefit from the cost segregation study on the STRs.



    Real Estate Professional StatusReal Estate Professional Status


    561-253-6640
    0Reply
  • Stephen Nelson
    Accountant , CPA, MBA in Finance, MS in Taxation · Redmond, WA · Member since 2025 · 172 posts · 135 votes
    1y
    Quote from @Natalie Kolodij:

    Qualifying for a short-term rental to be non-passive doesn't give you REPS. It gives you a non-passive short-term rental. So losses from that specific rental may be utilized. 
     

    I think a better way to say this is, if a rental property is a short term rental (meaning the average rental interval is seven days or less) it's not a rental. That matters because rentals are often automatically passive.

    That also means the taxpayer uses the material participation rules from 1.469-5T to determine whether the STR is passive or not.

    0Reply
    • Natalie KolodijBusiness Member
      Moderator
      Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
      1y
      Quote from @Stephen Nelson:
      Quote from @Natalie Kolodij:

      Qualifying for a short-term rental to be non-passive doesn't give you REPS. It gives you a non-passive short-term rental. So losses from that specific rental may be utilized. 
       

      I think a better way to say this is, if a rental property is a short term rental (meaning the average rental interval is seven days or less) it's not a rental. That matters because rentals are often automatically passive.

      That also means the taxpayer uses the material participation rules from 1.469-5T to determine whether the STR is passive or not.


      Having an average guest stay of 7 days or less breaks it out of the definition of being a passive rental under 469. This is what makes it non-passive. 

      The material participation has nothing to do with it being non-passive; it's the requirement allowing losses if an activity is non-passive. They are independent. 

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    • Stephen Nelson
      Accountant , CPA, MBA in Finance, MS in Taxation · Redmond, WA · Member since 2025 · 172 posts · 135 votes
      1y
      Quote from @Natalie Kolodij:
      Quote from @Stephen Nelson:
      Quote from @Natalie Kolodij:

      Qualifying for a short-term rental to be non-passive doesn't give you REPS. It gives you a non-passive short-term rental. So losses from that specific rental may be utilized. 
       

      I think a better way to say this is, if a rental property is a short term rental (meaning the average rental interval is seven days or less) it's not a rental. That matters because rentals are often automatically passive.

      That also means the taxpayer uses the material participation rules from 1.469-5T to determine whether the STR is passive or not.


      Having an average guest stay of 7 days or less breaks it out of the definition of being a passive rental under 469. This is what makes it non-passive. 

      The material participation has nothing to do with it being non-passive; it's the requirement allowing losses if an activity is non-passive. They are independent.

      I think that's incorrect or incomplete or perhaps most likely that we're miscommunicating here.

      Here's the logic I'm trying to convey...

      Section 469(c)(2) says rental activity is passive, quoting that, "

      (2)Passive activity includes any rental activity

      Except as provided in paragraph (7), the term “passive activity” includes any rental activity."

      Reg. Sec. 1.469-1T says short-term rentals aren't actually rentals, quoting, " 

      (ii) Exceptions. For purposes of this paragraph (e)(3), an activity involving the use of tangible property is not a rental activity for a taxable year if for such taxable year—

      (A) The average period of customer use for such property is seven days or less;"

      That puts the activity on the same basis as any other activity. Which means you look back at Section 469(c)(1) which says this, "

      (c)Passive activity definedFor purposes of this section—(1)In generalThe term “passive activity” means any activity—(A)which involves the conduct of any trade or business, and(B)in which the taxpayer does not materially participate."

      Are we reading these chunks of the statute and the reg differently? Or just miscommunicating? I get the latter.

      0Reply
  • Stephen Nelson
    Accountant , CPA, MBA in Finance, MS in Taxation · Redmond, WA · Member since 2025 · 172 posts · 135 votes
    1y
    Quote from @Michael Plaks:
    Quote from @Noah Laker:

    I'm a real estate broker and my client is a high W2 earner, taking advantage of the "STR Loophole"

    His CPA told him that he can only do cost segregation on properties which are active STR's.

    My understanding was that, if he obtains REP status through any one of his properties, that he can take advantage of depreciation on any investment property, even if that one is not an STR. Am I missing something?


    The most important thing you're missing is that you are his broker and not his accountant. You should not give him any tax advice, no more than we accountants should give him real estate advice.

    There're two ways for high W2 earners to benefit from cost segregation:
    A. With STRs provided he passes "material participation" test and some other restrictions
    B. With LTRs if he is married and his wife can qualify for REPS. He himself will almost certainly not qualify.


    I think there's another way to benefit from cost segregation, and that is to make a grouping election that combines the "unprofitable" cost-segregated rental with some other highly profitable business. The best example of that--and one every small business owner should consider--is a self-rental grouping from Reg. Sec. 1.469-4(d)(1)(C).

    1Reply
  • Bonnie Griffin KaakePro Member
    Real Estate Consultant · Denver, CO · Member since 2021 · 666 posts · 389 votes
    1y

    Clarifications that may be of help and less confusing:

    Q: Can I use the cost segregation benefits from my STR on my W2 income?

    A: Maybe. If you or your spouse materially participate in the property by spending at least 100 hours per year actively managing your STR and more than any other person or business entity, and the average customer stay is 7 days or less, the answer is yes. That property becomes an active investment, and the benefits can be used against your W2 income. If you or your spouse are not providing enough hours to be considered actively participating in the property, it becomes a passive investment, and the benefits can only be used against the income from that STR. See Treas. Reg. 1.469-5T(c)(2)

    If you have more than one passive property, you can use the passive losses from one against the passive gains on another if you group the passive properties. A knowledgeable CPA can easily do this for you when filing your taxes. 

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  • Stephen Nelson
    Accountant , CPA, MBA in Finance, MS in Taxation · Redmond, WA · Member since 2025 · 172 posts · 135 votes
    1y

    I think a handful of minor clarifications or emphases help fine-tune @Bonnie Griffin Kaake's comment.

    1. The 100 hour rule is not 100 hours, it's more than 100 hours.

    2. The material participation hours combines spouse hours. So for more than 100 hours rule, if spouse #1 spends 50 hours and spouse #2 spends 51 hours, the couple may qualify. (They do if no one spends more than they do.) BTW this is actually the cite probably you @Bonnie Griffin Kaake wanted to use above: Treas. Reg. 1.469-5T(a)(3).

    3. You don't need to group to use passive losses from one activity to shelter income from another activity. That happens automatically per Section 469(d).

    4. Crazy idea: Actually the easiest way to achieve material participation in some cases? Buy late in the year and be the only person who participates. E.g., Buy early December, on your own or with your spouse be the only housekeeping staff and maintenance people, rent one or two weekends, voila... STR with material participation based on 6 hours of work. (This is actually Treas. Reg. 1.469-5T(a)(2).)

    1Reply
  • Mohamed YoussefBusiness Member
    Accountant · Brea, CA · Member since 2018 · 122 posts · 64 votes
    1y
    Quote from @Noah Laker:

    I'm a real estate broker and my client is a high W2 earner, taking advantage of the "STR Loophole"

    His CPA told him that he can only do cost segregation on properties which are active STR's.

    My understanding was that, if he obtains REP status through any one of his properties, that he can take advantage of depreciation on any investment property, even if that one is not an STR. Am I missing something?


     If your client W-2 job is in the real estate industry then cost seg. may benefit him even if he owns mid or long term rental properties.

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    • Stephen Nelson
      Accountant , CPA, MBA in Finance, MS in Taxation · Redmond, WA · Member since 2025 · 172 posts · 135 votes
      1y
      Quote from @Mohamed Youssef:
      Quote from @Noah Laker:

      I'm a real estate broker and my client is a high W2 earner, taking advantage of the "STR Loophole"

      His CPA told him that he can only do cost segregation on properties which are active STR's.

      My understanding was that, if he obtains REP status through any one of his properties, that he can take advantage of depreciation on any investment property, even if that one is not an STR. Am I missing something?


       If your client W-2 job is in the real estate industry then cost seg. may benefit him even if he owns mid or long term rental properties.

      @Mohamed Youssef Being a W-2 employee in a real property trade or business doesn't give "real estate professional status" unless W-2 employee owns at least 5% of the business. (See Reg Sec. 1.469-9(c)(5).)

      Also just an FYI for @Noah Laker but REPS doesn't do anything for STRs because STRs aren't considered rental activity...

      2Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    1y

    @Natalie Kolodij, "a cramp in their foot" - really????? You're sounding more like @Michael Plaks every day.  Love it!!!

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  • Krishnan Iyer
    Investor · Member since 2023 · 46 posts · 34 votes
    1y

    One of the best in the business is Hall, CPA - 100% of their clients are in real estate, and they have in depth knowledge of all things related to real estate - STR and LTR rules (REPS, MP etc.). Check out Brandon Hall and Nathan Sosa on LinkedIn and their podcasts (TaxSmart REI) are VERY informative. Highly recommended for this audience.

    1Reply
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