Madeleine Raiford-Holland: Hey there, I'm Madeleine and welcome to The Luxe and The Short of It podcast. I'm a military wife, mom, and entrepreneur that went from a stressed out nine-to-fiver to now a present-minded seven-figure business owner and investor, all through the power of short-term rentals. Here we believe the Luxe life means having the time and financial freedom to be present for the moments that matter most. And I'm here to teach you the exact mindset shifts, insider expertise, and business strategy to make that a reality for you today. So are you ready to actively create the life you want? I'm Madeleine and this is The Luxe and The Short of It podcast.

[00:01:22] Welcome back to this episode of the Luxe and The Short of It. I am diving into something that most people I know care about, and that is paying less taxes. The short-term rental tax loophole is one of the most powerful vehicles for high income nine to fivers, W-2 folks, to leverage to invest in real estate and pay less taxes, but the majority of the time people don't understand it. And because it's called a loophole, people are afraid that it's going to trigger an automatic audit, or it's some shady backdoor nonsense that is just not really good. Like they must be cheating the system. When in reality, folks, this is written into the tax code, perfectly legal, as long as you play by the rules. This episode is all about making you more knowledgeable, helping you understand, so that you can leverage it to pay less in taxes. All right, let's dive in. So the very first thing is why does this matter? Most people see their tax bill as an unavoidable loss. High earners often send tens of thousands, sometimes hundreds of thousands to the IRS every year, believing that there is nothing that they can do about it.

[00:02:54] The truth is that the U.S. Tax code rewards certain types of investments and short-term rentals are one of the most powerful opportunities for individuals who want to reduce those taxes, build wealth while still maintaining control over their assets. That is a key part here. My goal for you when you are investing in short-term rentals is I want you to win on equity, meaning somebody else is paying your mortgage and your property is building that equity without you having to invest in it. Appreciation, meaning it's gaining in value. Cash flow, where we are at a minimum underwriting for $2,000 a month in cash flow. A minimum of $2,000 a month in cashflow, and then the tax savings. So when you are focused on my four pillar profit strategy, your portfolio grows in every direction at once. I'm going to give this a disclaimer because my producer is going to get me if I don't, but I am not an attorney or a CPA, and I don t know your specific legal or financial situation. Always consult a qualified professional to make sure these strategies apply to you. This podcast is a general guide based on what works for most short-term rental investors. And the examples that I give are going to be anecdotal only and they're not meant to be construed as advice. We clear?

[00:04:31] So most rental property owners can only use depreciation losses to offset passive income. So that is the majority of asset classes in real estate can only be used to depreciate losses and offset passive income. That means if you have a W-2 job, those losses don't reduce your active income taxes. But short-term rentals, where the average day is less than seven days, fall under a different part of the tax code. And if you meet certain material or participation requirements, you can use those losses to offset your active income. So that means when you buy a property and you furnish it, a cost segregation study can accelerate the depreciation to one year on many components that typically have to be depreciated over five and 15 years. Furniture, appliances, flooring, decks, landscaping, that can create huge paper loss, which if you qualify can be applied against your active income. That's massive, guys. It's not about avoiding taxes through a loophole that might close. It's about using the law as it's written to redirect money you'd owe in taxes into an asset that produces income and builds equity. Everyone tracking here? Good.

[00:05:55] So with that there are certain requirements that you need to be aware of when it comes to the material participation piece. And there are three core requirements to be able to materially participate and qualify for the short-term rental tax loophole. The first is you must meet all three, and again your average guest stay is less than seven days, you materially participate, which I'm going to cover in a second, and the property is actually rented. That first piece of the stay must be less than 7 days. STR is considered a business, not a rental, if the average day is less that seven nights. So you need to check your booking platform data. And our mentorship clients understand we typically say Hostfully because you can aggregate all of that information. And the way that you calculate this is the total number of nights rented divided by the number of bookings equals your average day. Total number of nights divided by number of bookings, that equals your average stay length. Sorry for the third grade math lesson guys, but sometimes you just got to put it out there.

[00:07:17] So the next part is that material participation piece. So, one, you must be actively involved. This means if you have hired a property manager, it doesn't work for you. This is why I preach all day every day to self-manage it with the appropriate systems, processes, automations in place. And I want you to keep that revenue in-house. When done correctly, I have 20 properties under management and I spend less than an hour a week, guys. But I'm also not paying the industry average of 20 to 40% in property management fees. So I don't understand why people feel the need to do that. Regardless, in order to materially participate, you need to be the one managing it or your company needs to be in the one managing it, which is another key differentiator here. And the litmus test for that is the 100 hour rule. And that is you worked at least 100 hours and no one else did more than you. This is really easy in your first year because especially if you set it up yourself or you worked 500 plus hours on the property that year. So what this does is it essentially circumnavigates the real estate professional status that you would need to be able to claim this stuff.

[00:08:49] So what counts as material participation? Examples of qualifying work, guest messaging and check-in help. Most of that is automated. Cleaning and turnovers, repairs and restocking, managing listings or pricing, buying and set up a furniture you can easily hit a hundred hours with that, and then bookkeeping. It does not include time spent thinking or reviewing reports. Also, the property must be rented. You must actually have booking. Setup time doesn't count alone. You must rent the property during the year to qualify. Even a partial year can work. We have plenty of clients right now (I'm recording this in the middle of November) who are closing on a property this week, next week, the first week of December, getting it set up and then they will host their guest the last week of the year, and you can bet your bottom dollar that they are going to use a cost segregation study and bonus depreciate this property in 2025 to offset their income. My friend's joke that I would do just about anything for a tax break, including my oldest son was born at 6 p.m. on December 31st. I mean, my father-in-law is a CPA and he texted us at 6 a.m., the morning that my oldest was born and said, "Hey, you guys. You have about 18 hours to get this baby out." And we were already on the way to the hospital.

[00:10:22] I didn't plan it that way. I would have loved to have a pre-Christmas baby. I was ready to get that baby out, but just so happened to work out that way. But the same thing applies. Even if you open that property the last week of the year and host guests the last week of the years as your first guest, you can use that for the entire year's depreciation guys. And it is not too late. I get all kinds of riled up about this. The other aspect that I want to make sure that you guys are clear on is what a cost segregation study. The cost segregation study is a report done by an engineer and it aids with spreading things out, understanding the specifics of your property that can have accelerated depreciation. So it breaks down the property components for faster depreciation. The thing is you can't depreciate the land itself. So that cost segregation study is the engineering report that breaks down all of the different aspects in your property that can have accelerated depreciation. I have somebody within my mentorship that we refer all of our clients to. He does an amazing white glove service. And my process with that is I'm working with my tax strategist year round tracking my income. And he tells me how much revenue we are looking to show, how much profit we're looking to show in our business, and gives me an estimate of how much of a loss I need for a property.

[00:12:04] I take that information, and I start looking at properties. And any time before I purchase a property, I have sent that information over to my cost segregation specialist who has given me an estimated analysis of benefits so that I know exactly how much that property will allow me to bonus depreciate and use to offset that active income. So the cost segregation study is the piece of it, but the short-term rental tax loophole allows you to offset your active income by bonus depreciating the information from that cost segregation study, as well as a few other things. But that is the crux of the matter and how it becomes super powerful. A lot of people ask me like what is the difference between real estate professional status and the short-term rental tax loophole? The core requirement of real estate professional status is you have to spend 750 hours a year in real estate activities and more than half of your working time in real estates. That is really difficult for people who have nine to five, W-2s, our doctors, our engineers, our people who have high paying nine to five. That's really difficult to spend more than half of your working time in real estate.

[00:13:25] So the core requirement of the short-term rental tax loophole is average rental period of less than seven days or less and material participation in the operations. So who qualifies for the real estate professional status? Full-time investors or agents with flexible schedules. And the people who qualify for the short term rental tax loopholes are busy professionals, business owners, or household where the spouse has a lot of flexibility. The time commitment of real estate professional status is often very high and typically needs to replace full-time work. And the time commitment of the short-term rental tax loophole is moderate, typically 100 to 500 hours a year, depending on the participation method. You have those two options there. The loss offset potential for the real estate professional status can offset the active income if real estate professional status is qualified for. And for the short-term rental tax loophole, it can offset active income if material participation is met. You don't need real estate professional status. That's huge, guys.

[00:14:37] It is really difficult to qualify for real estate professional status for anybody with a full-time non-real estate job, where the short-term rental tax loophole is much more attainable for W-2 earners and people who are self-employed with other businesses. Also, the real estate professional’s status requires hour logs, activity breakdowns, proof of majority of time spent in real estate; where the short-term rental tax loophole, you can provide hour logs, proof of direct operational involvement, booking records, guest communication logs, but the hours spent can be provided in a narrative form. You don't have to keep contemporaneous logs as long as you can a narrative that supports the hours spend. So the scalability aspect, once your real estate professional status is achieved, it applies to all rentals owned that year. The short-term rental tax loophole, you must qualify participation for each short- term rental individually. So that's one of the nuances there. But a lot of times our folks are able to achieve that if they have multiple or they're only acquiring one a year. So it's easier to materially participate for that.

[00:15:50] The common pitfalls of the real estate professional status is underestimating hours, weak documentation, and failing to meet the more than half-time rule. And then the short-term rental tax loophole pitfalls are hiring out too much, failing to meet the participation threshold and poor record keeping. Real estate professional status is definitely best for people who are ready to commit their career to real estate. And short-term rental is best for people wanting to keep their career, but still use real estate to offset their taxes. So we covered a lot right there for sure. But I want you to know that even this late into Q4, we still have people who are going through that acquisition process, who are going to be able to offset their active income this year with the short-term rental tax loophole. Regardless of if you start this year or if you start next year, the key is to be informed and understand how to make this work for you. Some of the things that I see people struggle with when they are wanting to offset their taxes is that piece that you cannot depreciate the land. And so they go into these really high value vacation markets where the land itself is valued extremely high. And the property itself doesn't have a high depreciable value because the value is mainly sitting in the land itself. So if you're wanting to leverage this, the beautiful thing to do is to find a market that has high revenue potential but the cost of the land itself is lower, and then an amazing property, the property itself has a high value, that is going to benefit you more on the tax piece.

[00:17:47] At the end of the day, you need somebody in your corner who understands what your goals are for this particular investment. And it varies from deal to deal. My goals for my first property were different than my goals for my sixth property. And being able to look at each individual investment with a set of eyes that understands what the goals are, what the nuances are of the strategy is important. That's what we help our clients do. We come in, we figure out where you are. Do you need to offset a certain amount of income for this year? What is your tax liability piece? Guys got access to my specific tax strategist in my program, as well as my cost segregation study. But we come in and say, hey, this is what you have going on. This is the type of property that we need. Then we're going out and we are underwriting, running the numbers with you on all of these deals so you understand if it works. Then putting the strategy in place for setting it up for success. What do you need to be competitive in that market? And then the digital setup piece. So even though you are the one managing the property like you need do to materially participate, you have the systems, processes, automations in place so you are relatively hands-off and not spending a ton of time managing this property.

[00:19:10] It's the golden trifecta that leads to the profit pillars, the for-profit pillars, because we want you to win equity, appreciation, cash flow, please. And then, of course, maximizing that tax strategy. I hope that this episode really helps you get into the nitty gritty of what the short-term rental tax loophole is, how you can leverage it. And if you want my team's help, click down in the show notes, book a call with my team. We will be the first ones to help you figure out if it makes sense for what you have going on. See you next week.

[00:19:53] Hey y'all, if you're loving the show, be sure to hit the follow button or the plus sign on your podcast app to subscribe. This will ensure you don't miss a single episode and I'll see you next week.

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