How to Claim Passive Losses without getting Audited

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How to Claim Passive Losses without getting Audited

Kyler J Sloan
Investor · Maggie Valley, NC · Member since 2020 · 284 posts · 85 votes

I have poured my cash into STR construction projects, and so actually have a loss which nearly equals my income.

Using the "STR Loophole", this should enable me to deduct these expenses from my W2 income.

However, this also puts me at risk of an audit. 

Are there any other STR investors who have struggled with this?

Is there a "rule of thumb" for avoiding an audit? -- i.e. "Do not allow your losses to reach X percent of your income". 

I just wondered if there was a threshold that I should be wary of. 

Thanks in advance. 

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Nathan GesnerBusiness Member
Moderator
Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes
3y
Quote from @Kyler J Sloan:

My rentals made over $150,000 net cashflow last year, but my tax returns showed around $10,000 income because I wrote off all the LEGAL deductions. It's not going to generate an audit because it is completely normal.

Talk to your CPA and wrap your head around this. Writing off deductions is one of the many benefits of real estate investing.

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  • Kyler J Sloan
    OP
    Investor · Maggie Valley, NC · Member since 2020 · 284 posts · 85 votes
    3y
    Quote from @Natalie Kolodij:
    Quote from @Kyler J Sloan:

    @Natalie Kolodij I may not be a tax expert, but I can understand plain English:

    Readiness generally means that the rental property is habitable and legally able to be rented. A taxpayer can generally claim that a rental property is ready if the property either receives, or is ready to receive, a Certificate of Occupancy (CO) by a state or local authority. The rules regarding a CO can vary between different localities; however, if the property is legally allowed to be occupied it should meet the readiness requirement.

    Availability generally means that the rental property is advertised to be rented. The property does not need to have a signed lease, as long as it is available to be rented and there is some attempt to make it known to the market. (Note: Advertising can be word-of-mouth advertising or something as simple as a “FOR RENT” sign with a contact number posted on the property. Documentation of attempts to advertise the property to the marketplace are helpful to demonstrate the position that the property was available.)

    So, yes, a property can never be placed into service and yet be ready and available for rent. That would mark its service date by the definition above. If all further work must be classified as either a "repair" or "improvement", then that would imply that there can indeed be "repairs" to a property that has not yet been rented in the eyes of the IRS. 


     

    You are right...you are not a tax professional, and your understanding of plain english lacks becuase I didn't say beforeit was RENTED. I specifically said before a property is in service. 

    What you posted literally defines what I told you. In service is by definiiton "ready and available for rent". 


    In service date is when the property is both ready and available for rent. So all of your costs to get it ready for it's intended use are capitalized. 


    There are IRC sections that pertain to asset basis, there is Pub guidance, there was even a recent court case related to rediness of an asset and an airplane with renovations where the tax court ruled on this. 
    Three licensed tax professionals how now 


    You said "in service", not "Placed-in-service".

    I guess the issue is that you were meaning to use the term "in-service", and I was reading "simple English"

    If we go by Oxford, service is always active -- i.e. the action of helping or doing work for someone.

    So, without the use of terms, it would mean what I thought. 

    But, also according to Oxford, "in-service" means "in OR available for use". 

    Honestly, if they are going to make a term for this, we ought to stick to adjectives like "Service-Ready". 
     

    0Reply
  • Kyler J Sloan
    OP
    Investor · Maggie Valley, NC · Member since 2020 · 284 posts · 85 votes
    3y
    Quote from @Steven Hamilton II:

    Linda and Natalie are correct. End of story. They understand this backwards and forwards. You should strongly consider paying for competent guidance like theirs. 

    Tax is not plain English. It is definition built upon definition... etc. An audit can happen even if everything is correct. I carry a caseload of 25-50 open IRS audits. Everything here is discussed regularly in these cases.  And it can mean some huge adjustments in the case of those who interpreted incorrectly.

    You claim what is true and accurate, not what you think will avoid audit. Failing to claim expenses can lead to mortgage fraud or even major tax issues if you get certain refundable credits.

    Not worth my time to comment further. Natalie and Linda nailed the replies perfectly. Your understanding is not that of an expert who has studied tax law. They took their time to give you guidance at no charge. That was kind of them. 

    @Natalie Kolodij

    You said "in service", not "Placed-in-service".

    I guess the issue is that you were meaning to use the term "in-service", and I was reading "simple English"

    If we go by Oxford, service is always active -- i.e. the action of helping or doing work for someone.

    So, without the use of terms, it would mean what I thought.

    But, also according to Oxford, "in-service" means "in OR available for use".

    Honestly, if they are going to make a term for this, we ought to stick to adjectives like "Service-Ready".

    0Reply
  • Kyler J Sloan
    OP
    Investor · Maggie Valley, NC · Member since 2020 · 284 posts · 85 votes
    3y

    I don't know why I posted that twice. 

    0Reply
  • Michael BaumPro Member
    Olympia, WA · Member since 2016 · 8k+ posts · 7k+ votes
    3y

    And BOOM! Account closed...Hmmm.

    1Reply
  • James Sloan
    Member since 2022 · 40 posts · 13 votes
    3y

    Just so you all know, my brother was blocked by a moderator (I wonder who), but wanted to convey his response here (see below). 

    You said "in service", not "Placed-in-service".

    I guess the issue is that you were meaning to use the term "in-service", and I was reading "simple English"

    If we go by Oxford, service is always active -- i.e. the action of helping or doing work for someone.

    So, without the use of terms, it would mean what I thought.

    But, also according to Oxford, "in-service" means "in OR available for use".

    Honestly, if they are going to make a term for this, we ought to stick to adjectives like "Service-Ready".

    0Reply
  • Michael BaumPro Member
    Olympia, WA · Member since 2016 · 8k+ posts · 7k+ votes
    3y

    Actually @James Sloan, the post got through. 

    0Reply
  • James Sloan
    Member since 2022 · 40 posts · 13 votes
    3y

    @Michael Baum Weird. It was not showing up for us before.

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

    I got a nasty Dm as well 

    "Oh , so as a moderator you can block other people's view of my post so you cannot be contested..."

    I didn't block or remove any thing. Post is still here. Not sure why his account is closed - Moderators can't close an entire account, only edit posts and leave notes regarding rules being broken. 

    Multiple tax professionals tried to explain the original CPA's concern further  but no dice. 

    So I wish you the best and hope you find the input/answers you're in search of. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
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    1Reply
  • James Sloan
    Member since 2022 · 40 posts · 13 votes
    3y

    He is going to post through here: 

    It is possible that you didn't do it. It is also possible that I am a bit wired with caffein right now and it is affecting my choice of words. 

    However, this has gotten a bit over-dramatized. All I did was provide a little push-back to get to get clarification, and Steven swept in pretending to be a knight in shining honor. Clearly, she did not need his help. 

    I already listed the reason for the misunderstanding. She was using a tax definition for "in service" which differed from "Placed-in-Service" and I thought she was using straight English, when she was actually using another definition.

    Regardless, the last couple forum posts helped me to fill out my first P&L Statement, so I do greatly appreciate the feedback on these terms. I am now only taking deductions for genuine repairs. 

    Some of us are just more comfortable than others with confrontational language. 

    I will probably open a new account using a pseudonym

    Adios 

    0Reply
  • Shadonna N.
    Developer · . · Member since 2014 · 520 posts · 162 votes
    3y

    What is the STR loophole? How do you handle a situation where you have repairs where the tenant cannot live in the property until the repairs are made. When the tenant leaves is the property considered out of service and those expenses are depreciated?

    1Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    3y
    Quote from @Shadonna N.:

    What is the STR loophole? How do you handle a situation where you have repairs where the tenant cannot live in the property until the repairs are made. When the tenant leaves is the property considered out of service and those expenses are depreciated?


    STR properties that have an average length of tenancy of 7 nights or less qualify as non-passive rentals. Therefore if the required hours are put in, then you may be able to use the losses to offset your non passive income such as W-2 wages. That is still in service, those will have to be determined if they are repairs or improvements depending upon the project and its effect on habitability as well as material that was existing in the property prior.

    [email protected]224-381-2660
    1Reply
  • Todd Goedeke
    Contractor · Sheboygan, WI · Member since 2016 · 917 posts · 266 votes
    3y

    @Steven Hamilton II don t service participation rules also include time spent in building construction and or construction management? 
     participation also includes ongoing management of STVR once it’s in service?

    0Reply
  • John Carbone
    Realtor · Gatlinburg · Member since 2020 · 1k+ posts · 957 votes
    3y
    Quote from @Nancy Bachety:

    Trust but verify. What @Michael Baum said first, to ask your CPA was good but actually, we do know a lot and can help answer your question.
    You’re wondering if you increase your chances of getting audited because you’re qualifying for the short term rental loophole. It’s a fairly knew concept to the irs and they all don’t know everything about it, and sometimes a good CPA doesn’t either.

    We got called out on it but I armed myself with tax code law and cited them in my rebuttal. The agent actually told me he read my answer, looked it up, and, as long as I send him my guest lists indicating less than 7 night stays, I win. He was thinking I needed to meet the rep status but no way was I because I had a w2 that year.

    So, track your hours for material participation and work your w2 without fear.

    Hi Nancy, did you speak to them in the office or did you do my mail or phone?  Was it a long process or was it resolved once you showed the guest list? I think you may be the first person on here who has been audited. 
    0Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    3y

    Typically that would be an office or field examination. I do a ton of audit representation. I handle 25-50 open cases at any given time. The average exam is 3-9 months from open to close. 

    [email protected]224-381-2660
    0Reply
  • Nancy Bachety
    Rental Property Investor · North Fork, NY · Member since 2016 · 1k+ posts · 631 votes
    3y

    Hi Nancy, did you speak to them in the office or did you do my mail or phone?  Was it a long process or was it resolved once you showed the guest list? I think you may be the first person on here who has been audited. 

    @John Carbone

    I finally got an agent assigned and called him. I told him why I was right, it's non passive. He finally understood how the regulations on STR work and asked if I "do Airbnb". Once I told him yes, he asked if I had a guest list showing 7 night or under stays. I faxed him 8 pages worth of our guest lists. This was months after I had submitted to no one in particular my log of 200+ hours of material participation, along with citations from the irs tax code.
    It wasn’t an audit per se, it was more like a request for clarification. Maybe it’d be called an audit but it was only about that one issue, they saw this as passive investing, like traditional LTR. 

    Noteworthy, every CPA that markets their STR loophole courses, and they are here on BP and on FB and have been mentioned here, they all act as if they have the secret to saving hosts thousands of dollars. It’s no secret, and you don’t need a course. You don’t even need a real estate savvy CPA. You just need to know the so-called STR loophole, ie, the regulations, the law- and tell your CPA. It’s a fairly new regulation and as Airbnb and STR have exploded in recent years, the irs agents simply don’t have enough experience with hosts returns, like they do real estate investor LTR returns. 

    No one cares about your money more than you. 

    1Reply
  • John Carbone
    Realtor · Gatlinburg · Member since 2020 · 1k+ posts · 957 votes
    3y
    Quote from @Nancy Bachety:

    Hi Nancy, did you speak to them in the office or did you do my mail or phone?  Was it a long process or was it resolved once you showed the guest list? I think you may be the first person on here who has been audited. 

    @John Carbone

    I finally got an agent assigned and called him. I told him why I was right, it's non passive. He finally understood how the regulations on STR work and asked if I "do Airbnb". Once I told him yes, he asked if I had a guest list showing 7 night or under stays. I faxed him 8 pages worth of our guest lists. This was months after I had submitted to no one in particular my log of 200+ hours of material participation, along with citations from the irs tax code.
    It wasn’t an audit per se, it was more like a request for clarification. Maybe it’d be called an audit but it was only about that one issue, they saw this as passive investing, like traditional LTR. 

    Noteworthy, every CPA that markets their STR loophole courses, and they are here on BP and on FB and have been mentioned here, they all act as if they have the secret to saving hosts thousands of dollars. It’s no secret, and you don’t need a course. You don’t even need a real estate savvy CPA. You just need to know the so-called STR loophole, ie, the regulations, the law- and tell your CPA. It’s a fairly new regulation and as Airbnb and STR have exploded in recent years, the irs agents simply don’t have enough experience with hosts returns, like they do real estate investor LTR returns. 

    No one cares about your money more than you. 

    So was this filed on schedule E and did you deduct paper loses against a W-2 income? 
    0Reply
  • Nancy Bachety
    Rental Property Investor · North Fork, NY · Member since 2016 · 1k+ posts · 631 votes
    3y

    Yes and yes @John Carbone

    1Reply
  • Todd Goedeke
    Contractor · Sheboygan, WI · Member since 2016 · 917 posts · 266 votes
    3y

    @Nancy Bachety it should be filed on schedule C. (Business income or loss)

    0Reply
  • John Carbone
    Realtor · Gatlinburg · Member since 2020 · 1k+ posts · 957 votes
    3y
    Quote from @Todd Goedeke:

    @Nancy Bachety it should be filed on schedule C. (Business income or loss)


     Not if substantial services were not provided 

    0Reply
  • Troy P.
    Investor · Baton Rouge, LA · Member since 2019 · 184 posts · 167 votes
    3y
    Quote from @Todd Goedeke:

    @Nancy Bachety it should be filed on schedule C. (Business income or loss)


    https://www.hrblock.com/tax-ce...
    0Reply
  • Nancy Bachety
    Rental Property Investor · North Fork, NY · Member since 2016 · 1k+ posts · 631 votes
    3y

    @Troy P.. @Todd Goedeke good graphic but if you follow it accurately it’ll lead right to schedule e. No substantial services are provided. That’s why you shouldn’t believe everything you read on a forum. Learn to read the irs codes, then evaluate your own specific circumstances. 

    1Reply
  • Troy P.
    Investor · Baton Rouge, LA · Member since 2019 · 184 posts · 167 votes
    3y
    Quote from @Nancy Bachety:

    @Troy P.. @Todd Goedeke good graphic but if you follow it accurately it’ll lead right to schedule e. No substantial services are provided. That’s why you shouldn’t believe everything you read on a forum. Learn to read the irs codes, then evaluate your own specific circumstances. 


    Yes, that was the point of my reply, to correct the original quote and provide everyone a reference for a more accurate return.  You must have misunderstood my intent, but thank you for the advice.
    1Reply
  • Nancy Bachety
    Rental Property Investor · North Fork, NY · Member since 2016 · 1k+ posts · 631 votes
    3y
    Quote from @Troy P.:
    Quote from @Nancy Bachety:

    @Troy P.. @Todd Goedeke good graphic but if you follow it accurately it’ll lead right to schedule e. No substantial services are provided. That’s why you shouldn’t believe everything you read on a forum. Learn to read the irs codes, then evaluate your own specific circumstances. 


    Yes, that was the point of my reply, to correct the original quote and provide everyone a reference for a more accurate return.  You must have misunderstood my intent, but thank you for the advice.

     You got it right, the other poster is either wrong or misunderstands this topic.

    1Reply
  • Mike S.
    Member since 2024 · 4 posts · 1 vote
    2y

    hi guys, this thread is very informative. As a follow up question to the topic discussed, Is the guest list a required item for audit puposes? I have all of my documentation but I'm wondering what data I should provide if asked. i.e. Do I need the client's full info, payment method, how I obtained the bookings etc etc? or just their name and dates would suffice?

    0Reply
  • John Malone
    Attorney · Boston, MA · Member since 2023 · 139 posts · 75 votes
    2y

    @Mike S. Depends on the auditor. Some will want full tracing proof.

    0Reply
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