STR tax loophole with a 2nd home loan
Investor · Austin, TX · Member since 2021 · 83 posts · 80 votes
STR tax loophole with a 2nd home loan
Most Popular Reply
Greg O'BrienBusiness Member
Accountant · Boston, MA · Member since 2019 · 386 posts · 336 votes@Pretty Khare this is a nuanced issue. First, unfortunately many CPAs are not interpreting the Regs to IRC 469 properly and some are even defaulting STR to Sch C and SE tax without regard. We see new clients with 2-3 yrs of improper treatment all the time. Its seems many pros are burying their heads to the regulations or not thoroughly understanding how to interpret STRs in the tax code (the transient rental rules etc).
The IRS CCA clarified the above issue (SE tax) in January. I’d encourage anyone who has a CPA that does not understand how different types of STRs interplay with IRC469 and IRC 1402 to start with the IRS legal memo.
Next, regarding W2 offset, the answer like everything in tax is it depends. It 100% is possible to limits but you need to plan around the Excess Biz Loss rules from TCJA.
22 Replies
- Realtor · Gatlinburg · Member since 2020 · 1k+ posts · 957 votes4y
I think the Brandon Hall proposal is very interesting. The issue is most accountants think what he says on this topic is not accurate. Not the 10 percent down aspect, just the whole idea that you can deduct against w-2 income without being a RE professional. It’s true that you can have a 10 percent down and have it classify as investment property for tax purposes as long as you can meet the irs definition of investment property while also meeting your lenders occupancy requirement.
Irs determination “You're considered to use a dwelling unit as a residence if you use it for personal purposes during the tax year for a number of days that's more than the greater of: 14 days, or. 10% of the total days you rent it to others at a fair rental price.”
- Short Term Rental: Realtor, Investor, Manager · Atlanta, GA · Member since 2017 · 138 posts · 85 votes4y
I am no CPA, but you should work with one that understands your goal..."can't" usually means there's something they don't know or is not being creative enough, I'll plant a seed that I received from my CPA that I won't butcher because I'm not a CPA. But get an LLC and rent from it personally...any cleaning expenses, paying your mortgage etc. come from the LLC's bank account, any outside money that you need to fund the account will be a capital contribution and then you will be able to do cost seg on that property. If you speak to a CPA who understands remotely what I mentioned then you're in good hands.
- 4yJulio GonzalezPro MemberSpecialist · West Palm Beach, FL · Member since 2008 · 4k+ posts · 1k+ votes
@Pretty Khare As Ruben and John mentioned above, you can utilize a cost segregation study on your STR property to reduce taxable income (or create a taxable loss) to offset against your W2 income, but you need to ensure you are following the IRS guidelines very carefully. Here's the link to the IRS topic that John was referring to. I think its important to note that "personal use" also includes your family members or anyone else that uses the property at less than a fair rental price. If you are starting to build up your real estate portfolio, you may want to switch to a CPA that specializes in real estate taxation.
- Investor · Austin, TX · Member since 2021 · 83 posts · 80 votes4yThanks for the tip, Ruben. Because I am taking a 2nd home loan, I can’t take in an LLC. I don’t think having an LLC is a requirement for doing a costseg study. That said I am no CPA either. You are right my CPA is not being creative enough and it maybe time to look for a real estate focused one with experience in STR.
Quote from @Ruben Kanya:
I am no CPA, but you should work with one that understands your goal..."can't" usually means there's something they don't know or is not being creative enough, I'll plant a seed that I received from my CPA that I won't butcher because I'm not a CPA. But get an LLC and rent from it personally...any cleaning expenses, paying your mortgage etc. come from the LLC's bank account, any outside money that you need to fund the account will be a capital contribution and then you will be able to do cost seg on that property. If you speak to a CPA who understands remotely what I mentioned then you're in good hands.
Any recommendations? - Financial Advisor · Saint Paul, MN · Member since 2016 · 190 posts · 143 votes4y
I've actually been digging into this a ton recently. I'm a financial planner by profession so I want to fully understand the process.
I've found that most CPA's have different understandings of the rules. The STR Loophole (materially participate & less than 7 day rental) vs. providing substantial services.
I ended up spending HOURS building a tax estimate spreadsheet. Most of the tax schedules follow pretty easy to follow math, (IE- multiply line 7 by 50% & enter on 1040 line 11).However, when you get to forms 8582 (passive activity loss limitations) and form 4562 (depreciation & amortization), it's less math & more theory. IE- it requires interpretation and I could see how a CPA's interpretation could differ from one to the other.
Here's my understanding. Materially participate & rent for less than 7 days, you should be able to write it off against active income. The 14 days or less than 10% of rented days refers to the exclusion ratio. IE- if you stay more than 14 days or 10% of rented days, you won't be able to 100% deduct the loss, only partially. BUT, you can keep track of this also. I've stayed at my property a total of probably 20 or so days this year so far, but will probably only log 3-4 personal days because I was doing more than 4 hours of work on the property most of the days.I don't think your mortgage factors in at all. Tax forms don't ask about your mortgage & how much you put down. They only ask for interest paid etc.
You may need to shop for a CPA who understands the rule the way you & Brandon Hall do.
- 4yYonah WeissPro MemberCost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
Quote from @John Carbone:
I think the Brandon Hall proposal is very interesting. The issue is most accountants think what he says on this topic is not accurate. Not the 10 percent down aspect, just the whole idea that you can deduct against w-2 income without being a RE professional. It’s true that you can have a 10 percent down and have it classify as investment property for tax purposes as long as you can meet the irs definition of investment property while also meeting your lenders occupancy requirement.
Irs determination “You're considered to use a dwelling unit as a residence if you use it for personal purposes during the tax year for a number of days that's more than the greater of: 14 days, or. 10% of the total days you rent it to others at a fair rental price.”
I'm wondering what data you are using to determine your statement: "The issue is most accountants think what he says on this topic is not accurate." The "STR Loophole" as @Daniel Murphy explained below, is pretty clear "Materially participate & rent for less than 7 days, you should be able to write it off against active income."
I have spoken with dozens of CPAs that understand the ruling in the passive loss limitations as @Brandon Hall explains it (tagging him in case he wants to defend his position), and very few that don't view it that way. Of those who have not viewed it that way, they all had little experience with real estate. My experiences are anecdotal.
- 4yRyan MoyerBusiness MemberProperty Manager · Orlando Kissimmee Davenport Salt Lake City, Park City · Member since 2019 · 996 posts · 1k+ votes
I am no CPA but my understanding is the same as yours, that the type of mortgage is completely irrelevant to how the IRS classifies the property.
Cosmic Vacations4.9174 Reviews - Realtor · Gatlinburg · Member since 2020 · 1k+ posts · 957 votes4yI’ve spoken with a few accountants about this and the consensus has been from them that you can’t have the best of both worlds with schedule E and all the write offs. I’m not saying he isn’t right with the loophole (I agree and interpret it that way as well), it’s just so new that possible audit flag and a lengthy court case? Is there actual precedent where this has been successfully applied?
Quote from @Yonah Weiss:
Quote from @John Carbone:
I think the Brandon Hall proposal is very interesting. The issue is most accountants think what he says on this topic is not accurate. Not the 10 percent down aspect, just the whole idea that you can deduct against w-2 income without being a RE professional. It’s true that you can have a 10 percent down and have it classify as investment property for tax purposes as long as you can meet the irs definition of investment property while also meeting your lenders occupancy requirement.
Irs determination “You're considered to use a dwelling unit as a residence if you use it for personal purposes during the tax year for a number of days that's more than the greater of: 14 days, or. 10% of the total days you rent it to others at a fair rental price.”
I'm wondering what data you are using to determine your statement: "The issue is most accountants think what he says on this topic is not accurate." The "STR Loophole" as @Daniel Murphy explained below, is pretty clear "Materially participate & rent for less than 7 days, you should be able to write it off against active income."
I have spoken with dozens of CPAs that understand the ruling in the passive loss limitations as @Brandon Hall explains it (tagging him in case he wants to defend his position), and very few that don't view it that way. Of those who have not viewed it that way, they all had little experience with real estate. My experiences are anecdotal.
- 4yYonah WeissPro MemberCost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
Quote from @John Carbone:
I’ve spoken with a few accountants about this and the consensus has been from them that you can’t have the best of both worlds with schedule E and all the write offs. I’m not saying he isn’t right with the loophole (I agree and interpret it that way as well), it’s just so new that possible audit flag and a lengthy court case? Is there actual precedent where this has been successfully applied?Quote from @Yonah Weiss:
Quote from @John Carbone:
I think the Brandon Hall proposal is very interesting. The issue is most accountants think what he says on this topic is not accurate. Not the 10 percent down aspect, just the whole idea that you can deduct against w-2 income without being a RE professional. It’s true that you can have a 10 percent down and have it classify as investment property for tax purposes as long as you can meet the irs definition of investment property while also meeting your lenders occupancy requirement.
Irs determination “You're considered to use a dwelling unit as a residence if you use it for personal purposes during the tax year for a number of days that's more than the greater of: 14 days, or. 10% of the total days you rent it to others at a fair rental price.”
I'm wondering what data you are using to determine your statement: "The issue is most accountants think what he says on this topic is not accurate." The "STR Loophole" as @Daniel Murphy explained below, is pretty clear "Materially participate & rent for less than 7 days, you should be able to write it off against active income."
I have spoken with dozens of CPAs that understand the ruling in the passive loss limitations as @Brandon Hall explains it (tagging him in case he wants to defend his position), and very few that don't view it that way. Of those who have not viewed it that way, they all had little experience with real estate. My experiences are anecdotal.
Okay, now you're saying something else, from your original statement that I questioned.
You're right that it is new, and there is not precedent (to my limited knowledge) that this has ever been challenged and succeeded in an audit. Since STRs have really taken off over the past few years, this has only recently become popular. Will this become an issue in 3-5 years from now, when the IRS finally notices? I don't know, but I trust the CPAs I have spoken with to interpret the code, and apply it how the feel would stand up in an audit.
- Financial Advisor · Saint Paul, MN · Member since 2016 · 190 posts · 143 votes4y
IRS pub 425 says, "Passive activities include trade or business activities in which you don't materially participate. You materially participate in an activity if you're involved in the operation of the activity on a regular, continuous, and substantial basis. In general, rental activities, including rental real estate activities, are also passive activities even if you do materially participate. However, rental real estate activities in which you materially participate aren't passive activities if you qualify as a real estate professional. Additionally, there's a limited exception for rental real estate activities in which you actively participate. The rules for active participation are different from those for material participation. You can find guidelines for determining material participation, the rules for determining who's a real estate professional and what's active participation, and the special rules that apply to the income and losses from a passive activity held through a publicly traded partnership (PTP) in Publication 925,"
Basically, rental is generally passive unless you are a real estate professional, HOWEVER, refer to pub 925 for special rules.
Pub 925 says, "Rental Activities
A rental activity is a passive activity even if you materially participated in that activity, unless you materially participated as a real estate professional. See under Activities That Aren’t Passive Activities, later. An activity is a rental activity if tangible property (real or personal) is used by customers or held for use by customers, and the gross income (or expected gross income) from the activity represents amounts paid (or to be paid) mainly for the use of the property. It doesn’t matter whether the use is under a lease, a service contract, or some other arrangement.
Exceptions.
Your activity isn’t a rental activity if any of the following apply.
- The average period of customer use of the property is 7 days or less.
In my brain, the IRS says that rental is generally a passive activity. Unless, you are a real estate professional, or average rental of 7 days or less.
- The average period of customer use of the property is 7 days or less.
- 4yBonnie Griffin KaakePro MemberReal Estate Consultant · Denver, CO · Member since 2021 · 666 posts · 389 votes
As others have mentioned, you do need a savvy CPA to help you with this so you are on the right side of the IRS. One thing that is not clearly mentioned above is that if you are materially participating in the short-term (Airbnb or VBRO type property), it is a business, like a hotel and qualifies as an active investment, not passive. And, you don't have to be a real estate professional to take advantage of this benefit. Just be sure you are not staying in the property for personal use for more than 14 days or more than 10% of the time it is rented to others. For accelerated depreciation purposes, a short-term rental is less than 30 days and the property must be depreciated over 39 years, not 27.5. Cost segregation is excellent for STRs because you can take it to offset the terrific gains on this type of property as well as off-setting it against W2 income if you are materially participating in its management.
- Realtor · Gatlinburg · Member since 2020 · 1k+ posts · 957 votes4yMy understanding is that to be classified as a hotel and active you need to be providing substantial services.
Quote from @Bonnie Griffin Kaake:
As others have mentioned, you do need a savvy CPA to help you with this so you are on the right side of the IRS. One thing that is not clearly mentioned above is that if you are materially participating in the short-term (Airbnb or VBRO type property), it is a business, like a hotel and qualifies as an active investment, not passive. And, you don't have to be a real estate professional to take advantage of this benefit. Just be sure you are not staying in the property for personal use for more than 14 days or more than 10% of the time it is rented to others. For accelerated depreciation purposes, a short-term rental is less than 30 days and the property must be depreciated over 39 years, not 27.5. Cost segregation is excellent for STRs because you can take it to offset the terrific gains on this type of property as well as off-setting it against W2 income if you are materially participating in its management.
- 4yGreg O'BrienBusiness MemberAccountant · Boston, MA · Member since 2019 · 386 posts · 336 votes
@Pretty Khare this is a nuanced issue. First, unfortunately many CPAs are not interpreting the Regs to IRC 469 properly and some are even defaulting STR to Sch C and SE tax without regard. We see new clients with 2-3 yrs of improper treatment all the time. Its seems many pros are burying their heads to the regulations or not thoroughly understanding how to interpret STRs in the tax code (the transient rental rules etc).
The IRS CCA clarified the above issue (SE tax) in January. I’d encourage anyone who has a CPA that does not understand how different types of STRs interplay with IRC469 and IRC 1402 to start with the IRS legal memo.
Next, regarding W2 offset, the answer like everything in tax is it depends. It 100% is possible to limits but you need to plan around the Excess Biz Loss rules from TCJA.
- Investor · Austin, TX · Member since 2021 · 83 posts · 80 votes4y
Quote from @John Carbone:
My understanding is that to be classified as a hotel and active you need to be providing substantial services.Quote from @Bonnie Griffin Kaake:
As others have mentioned, you do need a savvy CPA to help you with this so you are on the right side of the IRS. One thing that is not clearly mentioned above is that if you are materially participating in the short-term (Airbnb or VBRO type property), it is a business, like a hotel and qualifies as an active investment, not passive. And, you don't have to be a real estate professional to take advantage of this benefit. Just be sure you are not staying in the property for personal use for more than 14 days or more than 10% of the time it is rented to others. For accelerated depreciation purposes, a short-term rental is less than 30 days and the property must be depreciated over 39 years, not 27.5. Cost segregation is excellent for STRs because you can take it to offset the terrific gains on this type of property as well as off-setting it against W2 income if you are materially participating in its management.
Going off of Brandon Halls podcast, you need to provide substantial service only when average stay is greater than 7 days but less than 30 days. He specifically mentions "make sure you do not provide substantial services so that you report the STR rental income on schedule E not C and so you are not subject to 15% self employment tax"
- Investor · Austin, TX · Member since 2021 · 83 posts · 80 votes4y
Quote from @Greg O'Brien:
@Pretty Khare this is a nuanced issue. First, unfortunately many CPAs are not interpreting the Regs to IRC 469 properly and some are even defaulting STR to Sch C and SE tax without regard. We see new clients with 2-3 yrs of improper treatment all the time. Its seems many pros are burying their heads to the regulations or not thoroughly understanding how to interpret STRs in the tax code (the transient rental rules etc).
The IRS CCA clarified the above issue (SE tax) in January. I’d encourage anyone who has a CPA that does not understand how different types of STRs interplay with IRC469 and IRC 1402 to start with the IRS legal memo.
Next, regarding W2 offset, the answer like everything in tax is it depends. It 100% is possible to limits but you need to plan around the Excess Biz Loss rules from TCJA.
That makes a lot of sense. My understanding is that excess business loss limits in 2022 are $270k for single filers and $540k for married filing jointly. So as long as your losses from STR are less than those limits and you meet other requirements (Materially participate in management, spend more than 100 hours and more than any other person/entity, rent on average for 7 days or less, do not live in the house for 14 days or more than 10% of the days it is rented out) you should be able to deduct losses against w2 income. Does that sound good?
- 4yGreg O'BrienBusiness MemberAccountant · Boston, MA · Member since 2019 · 386 posts · 336 votes
@Pretty Khare yes. Of course there could be other circumstances specific to you that change your analysis, but what you laid out is correct. A lot of CPAs get hung up on "substantial services" piece which is a semi grey area but if you understand STR the judgement calls are a lot easier.
- 4yBonnie Griffin KaakePro MemberReal Estate Consultant · Denver, CO · Member since 2021 · 666 posts · 389 votesYes, John, that is correct. The owner must meet the "material participation" requirement. If they are managing the STR themselves and providing more time than anyone else, 100 hours at least, it is a business like a hotel. Thanks for pointing this out.
Quote from @John Carbone:
My understanding is that to be classified as a hotel and active you need to be providing substantial services.Quote from @Bonnie Griffin Kaake:
As others have mentioned, you do need a savvy CPA to help you with this so you are on the right side of the IRS. One thing that is not clearly mentioned above is that if you are materially participating in the short-term (Airbnb or VBRO type property), it is a business, like a hotel and qualifies as an active investment, not passive. And, you don't have to be a real estate professional to take advantage of this benefit. Just be sure you are not staying in the property for personal use for more than 14 days or more than 10% of the time it is rented to others. For accelerated depreciation purposes, a short-term rental is less than 30 days and the property must be depreciated over 39 years, not 27.5. Cost segregation is excellent for STRs because you can take it to offset the terrific gains on this type of property as well as off-setting it against W2 income if you are materially participating in its management.
- Member since 2019 · 8 posts · 3 votes2y
Quote from @Ruben Kanya:
I am no CPA, but you should work with one that understands your goal..."can't" usually means there's something they don't know or is not being creative enough, I'll plant a seed that I received from my CPA that I won't butcher because I'm not a CPA. But get an LLC and rent from it personally...any cleaning expenses, paying your mortgage etc. come from the LLC's bank account, any outside money that you need to fund the account will be a capital contribution and then you will be able to do cost seg on that property. If you speak to a CPA who understands remotely what I mentioned then you're in good hands.
@Ruben Kanya : do you have recommendations for a CPA to execute this, anyone you work with ?
- 2yBill HamptonBusiness MemberAccredited Investment Fiduciary, AIF®, Financial Planner, Tax Strategist, Real Estate Investor · Atlanta, GA · Member since 2012 · 2k+ posts · 979 votes
Quote from @Teejay Lobos:
Quote from @Ruben Kanya:
I am no CPA, but you should work with one that understands your goal..."can't" usually means there's something they don't know or is not being creative enough, I'll plant a seed that I received from my CPA that I won't butcher because I'm not a CPA. But get an LLC and rent from it personally...any cleaning expenses, paying your mortgage etc. come from the LLC's bank account, any outside money that you need to fund the account will be a capital contribution and then you will be able to do cost seg on that property. If you speak to a CPA who understands remotely what I mentioned then you're in good hands.
@Ruben Kanya : do you have recommendations for a CPA to execute this, anyone you work with ?
You came to the right place. I recommend finding an accountant who specializes in real estate taxation and tax planning.
You may want to consider working with your accountant remotely to expand your options.
I would also recommend looking for a accountant willing to work with you throughout the year. You want an accountant who can help you strategize and who is responsive when you want to know the consequences of the financial decisions you are making throughout the year.
There are over 20 real estate accountants on this site. Reach out to a few and see who you like.
You can also ask members of your local real estate investors association for real estate accountant recommendations.
Good luck.
Hampton Tax and Financial Services LLC4.7106 Reviews - 2yBasit SiddiqiBusiness MemberAccountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
The second home loan is a loan where you agree to live in the home for a minimum of 14 days.
Living in a rental property for more than 14 days as personal use can potentially disquality you from taking losses against other forms of income.
It is true that you can at the time of applying for the mortgage attend to stay in the property for 14+ days but actually only stay a few amount of days.
Best of luck.
Basit Siddiqi CPA4.880 Reviews - Accountant · San Diego, CA · Member since 2019 · 1k+ posts · 552 votes2y
Quote from @Pretty Khare:
If I buy a vacation home using a 2nd home loan and rent it as an AirBNB when I am not using it, can I still do a cost segregation study to accelerate depreciation and offset losses against my W2 income if I follow the rules of STR tax loophole (I.e., the average stay in the house is less than 7 days, I manage the AirBnB myself, and spend 100 hours or more a year and more time than any other person/entity on managing my AirBnB business)?
My CPA is saying I cannot offset accelerated depreciation losses against my w2 income as I have a 2nd home loan, but I heard in Brandon Hall’s podcast that IRS has a different definition of a 2nd home than what is used for mortgage.
PS: I think I need a better CPA. Any recommendations?Brandon Hall is a great CPA! I would recommend for your situation finding someone who is not to expensive but will still help you with your tax advice. Your situation isn't to complex for the right tax professional to save you money.
- 1yBonnie Griffin KaakePro MemberReal Estate Consultant · Denver, CO · Member since 2021 · 666 posts · 389 votes1. You may be confusing the use of Schedule E versus Schedule C for tax filing. STRs rented and NOT providing substantial services (regular cleaning, meal prep, trips/excursions, etc) goes on schedule E, not schedule C.
Quote from @John Carbone:
My understanding is that to be classified as a hotel and active you need to be providing substantial services.Quote from @Bonnie Griffin Kaake:
As others have mentioned, you do need a savvy CPA to help you with this so you are on the right side of the IRS. One thing that is not clearly mentioned above is that if you are materially participating in the short-term (Airbnb or VBRO type property), it is a business, like a hotel and qualifies as an active investment, not passive. And, you don't have to be a real estate professional to take advantage of this benefit. Just be sure you are not staying in the property for personal use for more than 14 days or more than 10% of the time it is rented to others. For accelerated depreciation purposes, a short-term rental is less than 30 days and the property must be depreciated over 39 years, not 27.5. Cost segregation is excellent for STRs because you can take it to offset the terrific gains on this type of property as well as off-setting it against W2 income if you are materially participating in its management.
2. On the other hand, if you are renting the property for less than 30-days on average, it is a STR depreciated over 39 years.
3. If you are renting it for 30 days or more, it is a long-term rental and must be depreciated over 27.5 years like any other long-term rental property.
4. If you are a RE Professional, you can claim STRs and LTRs as an active investment.
5. If you have a W2 and materially participate in a short-term rental for at lease 100 hours and more than anyone else, it is also an active investment and can be used against your W2 income. Accurate and meticulous record keeping will keep you safe from IRS audits.
6. Be sure to get an engineering-based cost segregation study done by a reputable company if you paid at least $250K for the property including land. CSSI provides audit defense at no cost to you for as long as you own the property plus 3 years...that is how long the IRS can audit your depreciation schedule.
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