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Leveraging Cost Segregation and Bonus Depreciation to Save Thousands on Your Tax Bill transcript
Hey everyone, it’s John from Vacation Rentals with John. Today I wanna help you save thousands of dollars on your tax bill through cost segregation. We talked briefly about this on a previous podcast episode, but what I want to do is break it down for you. I know taxes can be boring, but you know, saving money, it’s delicious. Definitely not boring. So I’m going to break it down in the simplest way possible so you can at least understand what cost segregation is, what bonus depreciation is, and how you can potentially use it to write off hundreds of thousands of dollars. Alright, so let’s get into it. Now, first I want to start by saying I’m not a C P A and you should really consult your C P A for your unique situation. I’m just giving you this information to make you aware of some of the opportunities that are available to you, especially opportunities that not too many short-term rental investors know about, but should be taking advantage of.
Okay, so what is this short-term rental vacation rental loophole and how can I use it? So this is a depreciation loophole. What is depreciation? Well, this is a concept of when you buy a building, you’re allowed to capitalize and depreciate it over time. The I r s I r Ss, right? But the i r s thinks you are going to have this building for a while. Vacation rental life is usually 27 and a half years. This is residential, and if you have a commercial property, it’s 39 years. Now, if you’re renting for average length of stay less than 30 days, and you’re technically qualified as a transient property similar to hotel, then you can classify as a short term rental, a commercial property, and depreciate over 39 years. So they want you to depreciate 2.5% a year over the next 39, 40 years, right? So the government wants you to do this.
They want you to use straight line depreciation, but to do this, you need to do what’s called a cost segregation report. So what is, what is this cost segregation? Well, you need a cost segregation report from a professional. A professional engineer would provide this. Sometimes these firms will charge $4,000, $6,000, sometimes even more, depending on the type of property you have. But for a short-term rental, it shouldn’t really be that expensive. Lots of these properties were built the same. They’re not very big. You might have a three two cabin or cottage. It shouldn’t take that long to do it. So the service should actually cost around $750. How do I recommend finding them? I have people I refer, but you can also just Google the actual key word cost segregation, and you can find professionals that do that in your area. So you just want to find a good price.
You definitely want to, don’t want to pay over $4,000 for a cost segregation report when it doesn’t really take that long. It’s just something you need to actually do this tax savings. Now, cost segregation, it’s exactly how it sounds. You’re breaking something up into parts segregation, breaking up into parts, okay? So you’re taking your vacation rent and you’re breaking it into, for the purposes of depreciation, you’re taking your land, separating it, taking your improvements, separating it, taking your appliances like your refrigerator, your washing machine, your dishwasher, all that stuff, separating it. Think of your appliances of having a five-year life, right? They’re separating all the parts of your building so that they can depreciate them individually, right? And that’s gonna give you the biggest bonus depreciation you can possibly take and write off thousands of thousands of dollars on your tax bill, which is nice.
Really nice. Now, accelerated depreciation has always been around, but since 2017, the Tax Cuts and Jobs Act hit it, took bonus depreciation and allowed you to depreciate it, took it to a whole new level. You were able to get a hundred percent in year one and just write it off or create a loss. It opened up a whole new world, a whole new world for people. You can also take bonus depreciation on a used property. You can take five year, seven year, and 15 year property, depreciate it all in year one. Now usually cool tricks like this were only available for people who were in a real estate business. Think developers, real estate investors who are full-time what the I r s likes to call real estate professionals. Now, if you have a day job, you’re a professional. Like in a C P A, if you’re a dentist, if you’re a doctor, if you’re a chiropractor, you have a corporate job.
So if you’re a professional, you’re a chiropractor or a C P A A bat you have a corporate job, you can still take advantage of this bonus appreciation, but you need to be a material participant in your short-term rental business. I’m gonna explain a couple ways that the i r s classifies you as materially participating. So you can see how you can actually qualify for this, but overall, you need to be doing an active role in the business. This means if you’re hiring a property manager to do the majority of the work for your short-term rental, you are not going to be able to qualify for this. You need to be a self-managing owner who’s actively participating in the management of your rental. And there are time requirements, which I’m going to get into right now. So to be considered a material participant in the business, this is how you can meet that requirement.
One, you spend all the time doing it, so you’re a full-time host. Two, you’re spending a hundred hours of your time and more than half the time in the activity, you need to spend more time on your short-term rental than any other people or contractors that you’re hiring. So this is about two hours a week, and that’s actually really realistic as a short-term rental owner or Airbnb host or third, you have to spend 500 hours in the activity, but you can aggregate all of your Airbnb or short-term rental activities into one for time purposes. So if you have three or four short-term rentals, you can add up all the time you spent on the total business to meet that 500 hour requirement or a hundred hour and a half requirement. Okay? This is time spent communicating with guests, managing, traveling to the property, furnishing, doing maintenance, buying the property.
All of this can count towards your hours for material participation. So if you have ordinary income from your regular job, the i r s does allow you to run a short-term rental business on the side. So when your average length of stay is seven days or less, you’re treating this like you own a salon and it’s ordinary income, but you’re also running a short-term rental business. So you can depreciate your short-term rental business and it will actually offset your ordinary income. Now it’s important to talk about these buckets. Again, you have ordinary income and passive income. Passive losses can be used to offset passive income, but you can’t take passive losses and offset your W two job income. You just can’t do it. They don’t allow you to do it doesn’t work that Now you can take depreciation and losses from your short-term rental business to offset your ordinary income.
If you are a material participant in the short term rental business, which is amazing, it’s a total game changer. Now, I’m going to give you a real life simplistic example so you can see how this actually works. Okay? You buy a home for $500,000. This is your short term rental. After you bought that home, you’re able to take depreciation of 30%. You’re gonna get $150,000 a bonus depreciation on day one. You’re almost writing off your entire down payment. This is if the land isn’t super expensive, like in New York City, if the land is a majority of your property, it’s not going to be this dramatic of an effect. But if it’s not, you can almost write off your whole down payment. This makes this a great retirement type asset. It’s way better than putting your money in Ameritrade or think or swim or something like.
Now it’s important to know every year this bonus depreciation i r s changes the rules. So right now, right now, you’re going to get in 2023 80% bonus depreciation, 2024, it’s going to be 60%, but you can look back. So if you bought the property in 2021, you can do a look back, amend your tax return, and you can take that bonus depreciation this year in 2023. You could take a hundred percent bonus depreciation in 2023 if you amend a tax return, do a look back if you bought the property, say in 2021, okay? And the higher your tax bracket, the higher your marginal rate, the lower your tax bill will be. The whole point of this podcast episode is to create that awareness that you can do this, that this is an option for you because you may know that you have to file taxes and keep good records, but you may not be aware of this, this strategy.
And if you’re aware of this, you can get that conversation going with your accountant, with your C P A, and they can point you in the right direction. So you can actually take full advantage of this bonus depreciation and it will save you a ton of money in the long run. Now, it’s important to talk about recapture, like when you do sell the property, you are going to recapture and you’re going to make money on the property sale, and they, they will want the i r s will want their money at that time. So you can do things like a 10 31 exchange to get in, invested in another property. So you could kick the can down the road a little bit. But there is recapture and it’s a concept you need to understand when you sell the property and you cash out, the windfall will eventually be taxed.
So you just want to keep an eye out for that. Now, every year things change. So just because I’m talking about this now doesn’t mean two, three years down the road if you’re listening, that this is going to hold constant. So definitely talk to your C P A, talk to your accountant and see the opportunities available for you. In regards to bonus appreciation when you’re investing in short-term rentals, you do want to ask your accountant about these opportunities. So you’re not missing out this week, I’m developing A P D F with all the high level notes. So you can have sort of a cheat sheet like cliff notes that you can actually just skimm through so you can get a greater understanding of how this works. You can even share it with your C P A or accountant so it can get that discussion started. A copy of this P D F will be available for you in the Facebook group. A link in the show notes will take you there so you can join. And if you like this content and you want to help me create more of it, all I would need is for you to take 20 seconds out of your day and leave a rating or review on Apple Podcast or on Spotify or on the podcast platform of your choosing. So if that being said, until next time, friends, stay booked. Take care.
Vacation Rentals With John is one of the fastest growing short term rental podcasts. The show has been growing in popularity because of its no BS, to the point lessons on how to grow and operate a vacation rental. Join the facebook group. To listen to any of the past episodes, check out this page.