For my clients, they understand that real estate is a powerful investment.
Why? Well, too many reasons to list, but if you must know…check out my reasons here.
Real Estate can potentially provide long-term wealth, tax flexibility and passive income streams. Although, let this be known, if you are a real estate investor, you know it’s not exactly “passive”.
And, while this is great for every investor, it’s even better for those who qualify as a real estate professional. There are strict IRS guidelines for who is determined to receive favorable tax treatment as a real estate professional.
Let’s just say if you and your spouse have a W-2 job, not in the real estate industry, it’s difficult for you to qualify.
OR IS THERE A LOOP HOLE?
Let’s, generally, talk about what is takes for the IRS to deem you a real estate professional. If you want to go into more specifics, I wrote about it at length in a previous blog.
750 Hour Requirement
The IRS sets a requirement that you must be involved in real property trade for at least 750 hours during the course of that calendar year.
More Hours Than W-2
You must have worked these duties more than any other job you are working.
If you are using rental properties to qualify for the 750 hour requirement, you must show the IRS that you materially participate in those same rental properties. Material participation really just means you would have to been involved in the operations of that property substantially- or specifically at least 500 hours of the 750 hour requirement.
You might be thinking, “remind me why we are taking about being a real estate professional?”.
Because being a real estate professional in the eyes of the IRS allows you to take any losses on your real estate against all of your income. All of it!
Let’s say you purchased a new investment property and had closing costs of $12,000. In the first year it needed a new roof at $20,000. You also paid $2,500 as a fee for the placement of your tenants. In year one, you have $34,500 in real estate losses.
Guess what?? You now have $34,500 to offset all of your household income when you qualify as a real estate professional.
If you are not a real estate professional, that $34,500 can only go to offset income from your real estate investments. If you don’t use it all up, it can only go to offset future rental income.
THE SHORT-TERM RENTAL ADVANTAGE
Short-Term rentals, like Airbnb, are all the rage right now. Especially in a post-pandemic world. We all have the ability and want to travel more freely these days and often that means traveling to more remote open spaces. Urban metro environments just don’t get the attention as they once did. So, making short-term rental investments in your own neighborhood, or on your own property for that matter, might make sense.
Dependent upon location and the type of property, short-term rentals have the potential to have significantly more cash flow than their long-term rental counterparts. Think about what you would typically spend on a hotel per night. Now compare that to the average nightly rate of a long-term rental in the same area. But remember, location is really the key here.
I would suggest looking at Airdna.com to help you determine that amount of cash flow for a particular property and region. It has a large amount of data that you can use for free and even more with their paid subscription.
Once you have the grasp on a property and region, then download my spreadsheet to give you an even more realistic idea of annual income, cash-on-cash return and your overall return-on-investment (ROI).
Remember all of those rules I mentioned above? That is going to come into play right here. Think about how much more time it takes to manage a short-term rental versus a long-term rental. With a long-term rental, you place the tenants and then wait for them to complain about something or move out.
With a short-term rental you have many more duties involved. You have get the property ready by making it Instagram-worthy. Then you have to manage the rental website, like an Airbnb page. Then you have to watch the market for seasonality pricing and make adjustments. You might need to spend time studying the local market trends. Of course, there is managing the cleaning companies and maintenance to get the property turned over in time for the next guests. And there is always marketing efforts that need to be made to make sure your property stands out above the rest.
It sounds like a lot of work, and it is, kind-of! Yes, there is a lot of work to a short-term rental, but there are some cheat codes and automations that make this all much easier.
However, you can see how it might be plausible, with documentation, that you could easily meet the 750 hour rule, 500 hours of material participation, and how you might technically spend more time on your short-term rental business than your W-2 job….
This all means that you would then meet the real estate professional status and have all real estate losses go to offset your total income, especially in a high-income year!
Everybody would like to save on their taxes. Real estate can provide significant diversification, potential returns, and good cash flow, but it can also help you pursue reduced taxes. By looking into short-term rentals, you could be well on your way to turning your tax situation into a big advantage.
If you have questions specific to your situation, talk with your accountant or feel free to reach out.
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