Ep. 12 | Exploring Tax Strategies and Benefits of Short-Term Rentals
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John Tripolsky:Hey, everybody, and welcome back to the mister r show. As you heard in the intro, hopefully, you took the time to read it, listen to it, or you just skipped over it. And if you did that, we're gonna tell you about what we're talking anyways today. And as you hopefully read or listened, we are gonna talk about those STR loopholes. And if you don't know what an STR is, you are about to find out.
John Tripolsky:But as always, I must introduce my, partner in crime. I guess it's a PIC or maybe it's a pit. Partner in taxes.
John Tripolsky:Gosh. I'm upset.
John Tripolsky:Creative.
Chris Picciurro:I've been called a lot of stuff. Not that one, though, Johnny t.
Chris Picciurro:Hey. At least I didn't call you a PETA. So if anybody is interested in what the PETA acronym is, email us. So Or, John, anyways.
Chris Picciurro:This group, I can promise you a lot of them know what a PETA is, and you probably are one of them to some of somebody. Oh, wait. I'm your tax professional.
John Tripolsky:Yeah. Yeah. You you've been stuck with me. I've been I've been a PETA, so long time. So so, Chris, tell us really, why we're here, and and who's who do we bring to the party today to help us run through this?
John Tripolsky:Because this might be something a lot of tax pros maybe know a little bit about, but maybe they they won't say don't have the confidence, but just haven't dipped their toes in
Chris Picciurro:it yet. Well, first of all, I am so excited about today's guest. I say that all the time, but I truly, really am. I had to beg, borrow, and steal. No.
Chris Picciurro:Maybe I didn't have to do that. But we are here to talk about short term rental properties. And as as someone that works in the real estate realm of things on the tax side, this is something that is an issue quite a bit for tax professionals. There is a lot of bad information out there. There is a lot of tax professionals preparing tax returns with some misunderstandings, and especially with with the Tax Cuts and Jobs Act of 2017 and bonus depreciation going to a 100%, Now we know it's phasing down as we record this.
Chris Picciurro:The maybe it'll come back. We don't know yet. But you there was an influx of people, especially with the pandemic, moving to either staying in and then potentially purchasing short term rental properties. And there is a significant tax strategy, tax loophole, whatever you wanna call it, associated with that. So what do we do?
Chris Picciurro:Because on on the Mr. R Show, we go out and we get the best person to educate us on this, someone that has spent a ton of time educating her peers, someone in my opinion, this is my own personal opinion, is the number one STR, tax professional in the country. So, Natalie Collati, welcome to the mister r show. How are you doing today?
Natalie Kolodij:Awesome. Thanks so much, Chris. Thanks for having me, and I am doing fantastic.
Chris Picciurro:We are thrilled to have you, and we're gonna talk through, short term rental properties. We are going to potentially hopefully, by until the end, refrain from breaking down schedule c versus schedule e or any of those fun things that you have to battle on a weekly basis, I'm sure, with people. But we we don't wanna spoil anything. We're gonna start slow, And we're going to, first of all, ask you a little bit of about yourself. We met through our association in teaching with the National Association of Tax Professionals, and, I was I met you in person at tax posium in 2023, went to your both your sessions.
Chris Picciurro:I was extremely impressed. But tell me a little bit about yourself so and how you got into becoming a tax professional, becoming an EA, and then falling into the niche of real estate.
Natalie Kolodij:Yeah. Absolutely. So I got into tax the standard way or I think one of the most common ways, which is I went to school for 5 years, and I was on the CPA track. I ended up in accounting on accident. I had a professor write the average salary of a business major versus an accounting major on the board, and I said, oh, well, I can do that if that's the difference.
Natalie Kolodij:And then when I got out of school, I started working for CPA firms, and it was the same time I got into real estate investing. So the 2 just ended up heavily overlapped for me. So as I was learning about real estate, I was also helping investors answer some of their tax questions, and it just kind of grew into a really specialized area for me. And then I ended up getting my EA license because I started my own firm and I got buried in work, and I don't do anything on the audit side. So only tax, and so the EA credential made sense for me.
Natalie Kolodij:And so I've had my own firm now since 2017, working exclusively with investors. And then a few years ago, I started teaching as well. Like you said, we met both instructing at Taxposium. And so that's been my focus for the last few years is tax education.
Chris Picciurro:That is really neat. I mean, it's funny to to have you started investing in real estate? I don't answer this, but personally. And, could you tell us a little bit about your some of the good experiences, bad experiences, and if it helps you work with clients and other tax pros that, run into real estate.
Natalie Kolodij:Yeah. Absolutely. So I've had good and bad real estate. I think anyone who invests in it has. I got started in it in the worst way you should start or could start, which was I paid for one of those, like, weekend guru seminars.
Natalie Kolodij:So don't do that. But then the flip side was I was pretty driven to actually go and do something to make back the money I spent on this nonsense class. So I got started in real estate, by flipping mobile homes. I was renovating mobile homes in parks and then reselling them on owner finance. So I did that for several years in Seattle.
Natalie Kolodij:Now I have moved on to buy and hold, and I typically do mid term rentals. But there's been all kinds of unique road bumps in between, and I would say most of them involve contractors in my experience.
Chris Picciurro:Well, that's funny because John and John, my our cohost here, little known fact. Although marketing guru also has his general contractor license.
Natalie Kolodij:So is that most of the angry emails?
Chris Picciurro:See, I I he's been renovating in well, he's, like, old old property in Michigan, his primary residence, and I get to you know, even contractor to contractor, I get to hear some of the some of the headaches that you go through there, Johnny t.
John Tripolsky:Oh, yeah. Oh, yeah. That's I mean, not to to get in the weeds too much with that. Right? But I've heard it a lot, not being a tax pro.
John Tripolsky:You know? That's actually what keeps people out of dipping their toes into it or trying it is just the fear of, you know, who do I turn to if something goes wrong? Because you can't I mean, the the thought, right, I think, says we'll say society in general, AKA cable TV and YouTube, have made the, flipping properties seem like it's extremely easy and profitable. But in fact, it's actually the opposite of both of those if you if you don't do it right. Right?
John Tripolsky:And I think that, you know, obviously keeps a lot of people from it. So I I find it very interesting that both of you have found in your private practice have have found that niche with real estate investors. Obviously, a lot of them being more hands off and some, you know, being more hands on, but then, you know, obviously, incomes STRs. So the short term rentals and, you know, Airbnb has done a a fantastic job of marketing throughout the years. I got a story about that.
John Tripolsky:I won't shake her because I think we did on a previous podcast. But just how they have made it more normal to stay in somebody else's home instead of a standard hotel. So I'd love for you guys really just to maybe get into it and and start us off on that foot again for somebody who who's not too familiar with them. Maybe draw the lines and really define those. You know?
John Tripolsky:What what are short term rentals? What are they not? And just some experiences maybe you guys have had from the Tax Pro side.
Natalie Kolodij:So for me, a short term rental is anything under 30 days, but most typically, it's a week or under for the average guest stay, and it comes furnished. You're not having to bring in all your own furniture. You can typically just show up, make yourself at home, and it's an alternative to a hotel. On the tax side of things, it gets a little complicated because there's sort of this very gray area outside of some standard terms we have. So as Chris was mentioning, they absolutely blew up in popularity.
Natalie Kolodij:I think we had 200,000 new short term rental listings on Airbnb from 2019 through the end of the pandemic, and all of those people now had tax returns to file for their new listings. And that's kinda where we, where we had to dive into things.
Chris Picciurro:Absolutely. And one of the things Natalie mentioned is with, you know, with the IRS and, you know, what does the IRS consider a short term rental property? Because I know there's there's confusion out there. I there's, almost, fist fights at these see at these tax conferences because there you know, there's kinda 2 definitions. There's the 7 day rule.
Chris Picciurro:There's a 30 day rule, and there's that those substantial services. And I would agree with Natalie. The vast, vast majority of short term rental properties are the weak or less average stay. So what does you know, for as a tax professional, what what do we consider a short term rental, by definition? And I'll finally add in there that and, Natalie, I know you're on BiggerPockets and a lot of lot of people that are in the space and in some of these other forms, there's these midterm rentals.
Chris Picciurro:But midterm rental doesn't last time I checked, isn't in the tax code.
Natalie Kolodij:Yeah. Neither is short term rental. That's what made this such a fun few years. I was trying to pair up these non tax words with what it actually means for our world. So on the tax side for me, short term rentals typically, so like you said, there's short term, mid term, long term.
Natalie Kolodij:And the tax code doesn't define either of those, short or mid, But what it does say is what isn't kind of your standard long term passive rental. And so it goes on and on and on. The tax code's big on telling us a whole bunch about what something is, and then in, like, fine print almost at the very end, there's these except for blah blah blah blah blah. So after it goes on to tell us all about what a rental is, it says, oh, but it doesn't count if the average guest stay is 7 days or less. So that one little caveat is what we can use to kind of define a short term rental for tax purposes is just where the average guest stay is 7 days or less.
Natalie Kolodij:And then you mentioned mid term rentals. So those aren't specifically excluded in that same category, but like you said, when they're services. So if you start adding services in, substantial services, anything 30 days or under with substantial services can also technically fall out of that standard what is a rental definition. So there's kind of a lot of wiggle room and circumstance you can control to see where your property is gonna land.
Chris Picciurro:There is a lot of wiggle wiggle room. The IRS came out, I or not came out with it, but it's been there for a while and identified what they say are substantial services, which still is a lot of gray area in my opinion. And just my personal opinion, I'd love to hear yours, and it might be different. But I I find it very difficult for someone to provide substantial services if they don't live in a very, very close proximity to the properties that they're managing.
Natalie Kolodij:Yeah. And it's it's kind of interesting. So there's 2 different wordings we use in the tax code. So in what's a rental and what's passive, it says, personal services. I forget the first word, but, like, expansive personal services.
Natalie Kolodij:I'm blanking on the exact definition. And then when we look at what is a business that pays self employment tax, it says substantial services. And we tend to use the terms interchangeably because they tend to be 1 and the same. And where this gets mixed up, and this is, for me, the hill I will die on, and I agree with you, Chris. I think it is very rare for a rental to meet this level of substantial services, but it has to be a service occurring while the guest is there that has a substantial value.
Natalie Kolodij:So not just like a mint on the pillow that wasn't worth anything, but something of a pretty decent value and that occurred during their stay. A verb there has to be a verb. If the verb didn't happen while the guest was renting the property, we don't have a substantial service. So doing a service in between guests is just standard operations. If you're just cleaning in between people, you do that on long term rentals also, not a substantial service.
Natalie Kolodij:You have to be doing stuff during the stay, maid service, fresh towels, cleaning the room daily, meal delivery, room service, all of those kind of activities.
Chris Picciurro:Right. I always use the example, and now I'm a little older than you 2, but missus Garrett, she was the what was the name of that show? I had Tootsie on it. Oh, I, I'll think of it. But anyway, it was she had, like, a almost like you you have a your own Airbnb.
Chris Picciurro:You live there. You cook the meals. You turn over the sheets. You might pick someone up from the airport. You might take them to a wine tasting personally.
Chris Picciurro:So it is very rare that someone meets that that that level, and and I'm glad you pointed that out. So, you know, as far as substantial services, something has to meet substantial services or substantial personal services, and those are 2 separate terms to for some so there's 2 things we're talking about. Right? There's a schedule c versus schedule e. And what we're saying is it has you have to meet substantial services to get to schedule c.
Natalie Kolodij:Yeah. So where it comes into play is for 2 different things. 1 is whether it is passive or non passive, and the other is when a rental moves from schedule e to schedule c. And so from e to c is where we look at those substantial services. So even if a rental is 7 days or less, even if it's non passive, even if anything else has happened, unless they are providing those substantial services, it doesn't move to c.
Natalie Kolodij:The reason being is that the only time a I shouldn't say only, the the almost only time a rental property pays self employment tax is when it is providing those substantial services, and the only time activities really go on schedule c is if they're paying self employment tax. So unless you have both that short stay of 7 days or less and those services, your rental should almost never be on schedule c.
Chris Picciurro:Right. Correct. And, yeah, there's a there's a lot of there there yeah. We get a lot of and it's fine. There's it could be pushback, but but it's very, very rare.
Chris Picciurro:Now the so the 30 day rule, which is provide 30 days are so when we're talking about is a property a short term rental property, it's the average stay is 7 days or less. In average means, typically, like, more than one, if you have an average. But, again, sometimes things people squeeze in right at the end of the year. Or 30 days or less and you're providing substantial personal services. So is that and and that's the verb during your stay?
Chris Picciurro:Am I understanding that right?
Natalie Kolodij:Yeah. Correct. So I was trying to find the exact wording because it's not substantial personal services. That first word's slightly different.
Chris Picciurro:Okay.
Natalie Kolodij:And I can't think of it offhand. But, but, yeah, if you are 30 days or less and because they're almost 1 in the same is the thing. If you have substantial services, you almost always have the personal services definition. So if you're 30 days or less and providing services in line with, like, a hotel or a bed and breakfast where
Chris Picciurro:you're
Natalie Kolodij:cooking meals daily, you know, shuttling them to and from the hotel, all of that, then it might also be on schedule c. So either way, it has to be that level of service verb during their stay, and that's where we start looking at schedule c and also paying self employment tax.
Chris Picciurro:Right. And and I see this a lot of times. One of the strategies a client or a taxpayer can use, which I think is a pretty good strategy, is maybe that 1st year you own it, because there are some markets that you could have a snowbird in the winter. And, you know, if you accept a snowbird, obviously, financially, we say that we say don't let the tax tail wag the dog, but, you know, financially, it's nice to have that rent in there. But if you have someone that wants to rent, let's say, you know, all of December and January and February, you can really muck up your average rental days pretty quickly.
Chris Picciurro:So people should be aware that. Have you seen anyone run into that situation?
Natalie Kolodij:Oh, yeah. Absolutely. So that 7 day or less rule is an average of all the separate stays during the year. And so if you I've seen it where people will do exactly like you're saying. Like, oh, we'll just rent it to one guest for the off season.
Natalie Kolodij:Or if they switch over a property, if it was a long term rental and in June they hear about short term, and they're like, oh, I'm gonna switch it over. Well, now you've got 6 months as one of your stays, so your average is going to be skewed substantially. But the cool thing with short term rentals is all of these tests we talk about are an annual test. So you they're almost like a chameleon. You can kind of choose whether you're gonna pass or fail them in a year.
Natalie Kolodij:So you can choose whether it's a passive or nonpassive rental. You got a little bit of, planning opportunity.
Chris Picciurro:Absolutely. And especially for someone that that maybe it's year 1 of the property, they're putting a much time into it, get it prepared, get it turnkey. Maybe they rent it out starting, oh, I don't know, in October. They do short term, you know, 7 days or less. They're self managing it, and they meet the short term rental loophole that 1st year and then the second year.
Chris Picciurro:They you're right. They could intentionally not pass the the they could turn it over to a property management company and say, my significant other and I don't get along trying to manage this property together. So we're gonna for the sake of our relationship, we're gonna turn it over to a 3rd party or I want to or okay. That that property is moving, and I wanna move it to a 3rd party, and I'm gonna go buy another short term rental property. Kinda I've seen people kinda stack that as an annual tax plan.
Chris Picciurro:Again, don't let the tax tail wag the dog, but it I've seen that happen also. So that's a great point that you say it's really an annual test.
Natalie Kolodij:Yep. Absolutely. So you can kind of choose back and forth. And as you mentioned, you can do it towards the end of the year and it still counts. I typically recommend 2 or more stays because you can't average anything under 2.
Natalie Kolodij:So if you can buy it and get it in service by year end and have those 2 stays, you you might only need to deal with managing it for 1 month. There's just gonna be a single month that your wife's mad at you. And then in January, you can do whatever you want with it, but you've gotta just make those one. It is a there's no, like, clawback if you change your mind the next year. So as long as you can meet that definition, even if it's only in December, you're ready to rock.
Chris Picciurro:I agree. That and that's where it gets tricky. You know? Obviously, there's some peep there's there's some aggressive tax preparers. There's some aggressive taxpayers and and, you know, we've run all we've all run into them.
Chris Picciurro:We're not gonna dive into them too much on a podcast. That's that's not a smart move. But the thing is, you know, I agree a 100%. To have an average, you've gotta have at least 2 stays. You could potentially argue one stay, but I could tell you this, nothing divided by 0 is an average.
Chris Picciurro:So you it's very difficult to substantiate that that that, you know, the that you have a average day of 7 days or less with you with 0 stays.
Natalie Kolodij:Yep. Absolutely.
Chris Picciurro:Couple so when we talk about when the El Paso versus nonpassive. So we talked you touched on that. So we we have a I think we have a good idea of what is a short term rental property. I mean, that's that's the first because the the stays do do matter, the average stay. And you did touch on when does something go from passive to nonpassive treatment?
Chris Picciurro:What's that your kinda trigger?
Natalie Kolodij:Yeah. So for your normal long term rental, they're passive by nature, which is great. It means if you make money, you don't pay self employment tax on them. The downside is if you have losses, there's a lot of limitations on when you can when you can use those losses. So by moving something to non passive, we don't have to face those same limits, so that's a huge benefit.
Natalie Kolodij:And as we mentioned earlier, the first thing is you need to have that guest stay be an average of 7 days or less. But then the second part to getting to use losses from anything really is you need to have material participation in that activity. So if we can hit these 2 triggers of 7 days or less, and where the owner or taxpayer materially participate, And we can change that over to being nonpassive and circumvent those standard income limits.
Chris Picciurro:Right. And so just like any other activities, you know, in could be a rent another rental property, it could be a business. To deduct losses, you have to have material participation. We know that there are several tests for material participation. What I found 99% of the time on short term rentals is that the material participation test that they're meeting is the 100 hour rule, which, you know, can you touch on that a a bit?
Natalie Kolodij:Yeah. Absolutely. So for material participation, there's a list of 7 tests. You can use any one of the 7, but most of them are pretty obscure. So the most common ones are 500 hours in a year or a 100 hours, but more time than anyone else.
Natalie Kolodij:And this gets tricky because it is hard enough to get clients to track their hours, but now they also need to track the hours of their cleaner or their property manager or whoever else is putting in time on that property. Now there's a number to beat, and you need to find out what it is.
Chris Picciurro:Absolutely. And that's the responsibility of the taxpayer. We can put in the show notes some recommendations. I know, Natalie, we'll we're gonna put all your information. You have some amazing resources, you know, that you put out and and have a a I think you have a sample hour log out there that we can and some guidance.
Chris Picciurro:As far as the hours, you know, the 100 hours versus the 500 hours, it seems like it's pretty hard to if you're using a third party property manager, it's pretty hard to say that you're putting more hours in than somebody else. Some people might argue they are. Could you give us an idea of, you know, what hours in general? Do general hours qualify for this? Because I know a lot of times clients or taxpayers ask about, do my hours before I buy the property potentially count?
Chris Picciurro:Do they count start counting when I buy the property, or do they only start counting after the property's placed in the service, which I'd love for you to touch on that just a little bit, what that means. And then sometimes, especially I'm a resident of Tennessee, we get a lot of people that buy in the Smoky Mountains and travel there. So can you kinda give us some guidance on not to get in the weeds too much, but what hours count in general?
Natalie Kolodij:Yeah. So for those hours for material participation, it's typically going to be any of the hours required for the day to day operations. So if you are meeting with tenants or meeting with contractors or doing work on the property or hiring people to do work on the property, all of this sort of standard operating time will count. Another cool thing with material participation is if you're married, you are allowed to combine hours with your spouse. So if you're trying to hit 500 and you each spend 2.50 during the year, maybe it's a huge beach property so it takes a lot of time, then you're good to go.
Natalie Kolodij:You can combine them. Hours you can't count are going to be your investor hours. So I don't wanna hear that you were at home looking over financials for 4 hours every Sunday. We don't get to count it. We can't count your education hours.
Natalie Kolodij:So if you're taking a class on how to better run your short term rental, we're not taking that. Also, any of your prepurchase hours or time, like, searching for properties, I hear that a lot. Like, Natalie, well, I spent 2 1,000 hours last year looking at houses. Like, okay. Yeah.
Natalie Kolodij:I spent 2 1000 hours watching HGTV, but we're not counting it. Like, it has to be on your property. So it has to really be day to day hours. And one of my favorite hours you cannot count that people have tried because it made it to a court case is your on call hours. If you are just sitting around because there's a chance a toilet might break and you might have to go work on it, those hours also do not count.
Chris Picciurro:You're not a you're not a firefighter that you're getting paid to be on call for 24 hours. It does not count. And random side, there's been some very interesting house hunters lately. That's one of those shows my wife and I really love. This is hopefully a PG one, but for the first time I saw you might know what I'm talking about.
Chris Picciurro:There was a nudist couple looking for property in Florida, and they actually did an episode on it and just blurred out certain things. I thought it would never make it to house hunters. I thought it was hilarious.
Natalie Kolodij:I hadn't seen that one.
Chris Picciurro:They're driving around, and the guys are like people are cutting their lawn. But the thing is they toured the properties completely naked. They're sitting on the people's couches talking about it. They're go the the whole community is holding optional where, like, even the everything was. People cutting their lawn, people they showed people playing pickleball, John.
Chris Picciurro:We're not gonna get into pickleball today.
John Tripolsky:How do you how do you test those properties? Right? Like, you're like, let's just walk around and see how the breeze is going. Like, what's that?
Chris Picciurro:Yeah. We wouldn't have no listener. We'd have no followers with me on the show.
John Tripolsky:I'm get yeah. That's where you find paint where paint doesn't belong. Just and and for everybody, a little disclaimer. Right? So everybody that's listening to this and obviously not watching it, this is not a clothing optional podcast.
John Tripolsky:For the sake of Natalie and Chris, I promise that you'd prefer it this way. So any anyway and and and, honestly, like, Natalie, you you mentioned this a while ago too, which, I mean, we don't have to go too too in-depth on it, but I guess it really does boil down. You know, a lot of the you know, we'll get into the short term rental loophole specifically. But just for short term rentals alone, really, you know and I'm I'm not gonna say it verbatim, but how I wrote it down here is it actually presents a lot of planning opportunities. Right?
John Tripolsky:So I think the big thing, right, is obviously knowing what opportunities there are. And as in the teaching tax side of things, I mean, me and Chris are always talking about a personal board of directors, which if anybody's not familiar with that, you know, who's your tax pro? Who's your attorney? Who's your people, basically? And having everybody kinda ready to roll or be the resources for all those questions.
John Tripolsky:So maybe even talk to us a little bit about, a, the planning opportunities as much as you as much as we wanna go down that hole. But then also to just, you know, how a lot of other people get into these. Right? Is is it something that is presented possibly to a potential client? Say, oh, you know what?
John Tripolsky:We're talking about tax planning. Have you considered, short term rentals, or are a lot of them now coming to you saying, hey. I have this short term rental. What in the living beep do I do with this thing? I'd love to hear what what your day to day is and some of your experiences there.
Natalie Kolodij:Yeah. I think we're seeing more of both now. For a while, it was really unknown, and I think this is where a lot of tax pros got sort of the wrong idea stuck in their head of where to report it and how to report it, because we didn't see it a whole lot. But it became more and more popular because short term rentals tend to cash flow really well. And during COVID, we couldn't fly, so people were staying local and renting a cabin with the family.
Natalie Kolodij:And so when things get popular, the Internet ruins them. And so then what happened was it was all over social media, which was great that people were learning about it, but they would learn, like, the tip of the iceberg. So they would learn 30% of what you had to do. So a lot of people got into it for either the cash flow or hearing about tax benefits, but not really understanding what they were or how to get them. That's been a little bit of both, but it is something that we also implement and suggest pretty often as a strategy.
Natalie Kolodij:If someone is investing already or they've got short term rentals or they're considering short term rentals, it can be a huge determining factor because there is a ton of tax planning with it. There's very few ways you can shift your income by, you know, 6 figures in a single year with just a little bit of planning and not anything that's really that complicated, but that sort of lined up with what you were gonna invest in anyway. Right.
Chris Picciurro:I mean, Natalie nailed it. I mean, this is a great opportunity for planning, and there are a lot of people that might is you know, there are more restrictions with what can be a short term rental and what can't be as far as from, like, a local government perspective. But, you know, a lot of we've seen people convert former long term rental properties to short term rental properties. And and the the fact that you can, you know, combine the hours as is a or you can have one spouse you know, typically, the fact pattern, you might have one's one person that's maybe a higher w two earner. The other person, might not you know, maybe they work part time or they're they don't work, and they really manage the property, and they can offset that that high w two wager earning and still have something that that produces income.
Chris Picciurro:And and I really like the breakdown of just mentally thinking about the hours. You know? We're talking about those hours counting of investor hours versus, you know, operational hours. And and maybe that's, you know, another thing with a lot of times like, Natalie, you mentioned you took that that guru course and and wasn't the best of experiences. I think but a lot of people would just think, oh, oh, I that's, you know, that's 40 hours right there because I drove to God's green earth and sat in a conference room for 40 hours and, that's you know, those are investor hours, I guess, you could say.
Chris Picciurro:I do wanna touch on something really awesome that you said that those operational hours start once you close. Because a lot of times, depending on the depending on some people like buying turnkey, but some people like buying a value add property. So once they close on that property, the hours they put into the remodeling and the decor and those just to confirm, those are gonna those are gonna count, even if the property isn't placed in the service right away. Right? Available for rent.
Chris Picciurro:Is that correct?
Natalie Kolodij:So it's gonna be a little bit of a gray area. I think if we didn't count those hours that almost no one would qualify. I think this is where most people get their time is that setup, that 1st year. But from a pretty technical standpoint, like, if the business isn't opened yet, it's hard to count your time in it. But there's sort of some back and forth on that as well.
Natalie Kolodij:So I will typically include those hours, but I would just say try to be a little bit, like, cautious with those, a little bit conservative. If those are sort of the icing on the cake for all of your hours, great. Try not to have that be, like, 490 of your 500 hours maybe just to make it. Yeah.
Chris Picciurro:And what I've seen too, sometimes people that are pretty savvy, they might buy a property that has existing reservations on it that still needs some work. They might honor those reservations. So, really, they're buying something that's already in service, and they might take a take a pause on it for a little bit and and do those value adds and then put it back on the market. I've seen that utilized as well. So, there's there's a lot.
Chris Picciurro:The point is there's a lot of planning opportunities for people in this space.
John Tripolsky:Actually, Chris, I never thought about that. Here's a so here's a question a little bit different for both of you, but related to that, Chris, since you mentioned that, if somebody I mean, this is kinda related to this, but not really more of personal interest. Say I have a short term rental. It's January, and I'm booked out for the majority of the summer or the winter. Have you guys ever seen it where somebody has sold a short term rental, but also taking into consideration all the revenue that's on the books.
John Tripolsky:Obviously, that's part of the value of it, but it's like a business. Right? Like, you're not selling accounts receivable in a sense, but I don't know. I don't even know exactly how I'm asking that. But it's just very it's interesting.
John Tripolsky:Like, does the does the future bookings that you already have reservations for add value to the property more than if you just, you know, like, appraised value, technically? Because it's more of a business.
Natalie Kolodij:What I've seen is it depends. Like, a lender is not going to care if you're doing a traditional home loan on it. But from a, like, just fair market, like, what someone's willing to pay, if you can show that you have those consistent bookings, it might have more value to someone. But if an appraisal can't meet that amount, it's not really gonna help you either. And if they're through a platform like Airbnb, they won't transfer them typically.
Natalie Kolodij:So there's a lot of kinda caution with what you're buying because mostly you're just buying a house. You gotta remember at the core of what you're buying is a house.
Chris Picciurro:Yeah. What I found is most the the the the bookings don't transfer. So what what typically is gonna happen is the person buying the home, if they want to keep the bookings, it's in their best interest to, to have some type of transition and try to reach out and honor the prices, cancel the reservation, and then rebook it. And maybe they give them the same price, hopefully, and that's that's the challenge too when you're, you know, when you're renting. I mean, how many stories have we heard from friends and they're like, hey.
Chris Picciurro:3 weeks before my I was gonna go on vacation, my booking got canceled because the property got sold. It happens. Now from a tax perspective, I don't know where Natalie's mind is, but I'm already thinking, you know, do we have recapture? Do we have, do we have a potential 10 30 one exchange? Are they going to get out what's going on with this property?
John Tripolsky:So Well, thank you both for responding to that. I'm kinda proud of myself. That's the dumbest question I've asked all day.
Chris Picciurro:Well, good. Congratulations. I'm gonna send you a trophy for that one. Right here.
John Tripolsky:No. Thank you. Thank you. I mean, it and it makes perfect sense. You know, thank you for for your description.
John Tripolsky:And, Chris, obviously, yours too. So you're right. So I I wasn't sure about that if Airbnb or or Vrba actually transit the transit those. So, really, in a case, maybe it maybe it's easier if it's, you know, you're doing private bookings through your own site, and you're managing it obviously more hands on. We talk about this as
Chris Picciurro:a short term rental loophole, and we haven't even talked about the biggest elephant in the room to make it you know, the point is when you have a short term rental property that meets what we the short term rental loophole strategy, and it gets nonpassive treatment, the losses from that property are not considered passive losses now, and they can offset other types of income, most likely dealt with 2 wages, maybe even retirement income. So self employment income, although not self employment tax typically. But to do that, typically you're going to have someone come in and look at the property and do what's called a cost segregation study. And what that means is that someone's gonna come in and instead of depreciating the property over a straight line basis, they're gonna identify the 5, 7, 15 year asset class properties. And, man, there's a lot of strategies with that, not only for properties that are placed in a service in the current year, but potentially properties placed in the service in prior years.
Chris Picciurro:And I know, Natalie, you do an amazing job working with clients that might come to you, and they might have have properties that have they've been operating as a short term rental since 2020 and never did a cost segregation study. So in that case and other and so other tax pros understand. Is that a strategy that could be used only in the year they place the property in the service, or could they potentially do a cost segregation study in in a subsequent year? And what kind of, I know there's what kind of adjustments and, you know, maybe we touched on the 31.15 and 41 a adjustment. What kind of considerations would you have with that?
Chris Picciurro:And then I think a lot of people get tripped up, and then I wanna really hear from the master. On the property, how many times do you see him as a 27 and a half year asset as a short term rental? It kinda drives us a little batty. And how do how should we fix that? So I know I threw a lot at you, but this is really interesting for the tax pros.
Natalie Kolodij:Yeah. So we do a lot of cost segregation studies. And as you mentioned, it separates out assets into those shorter classes, which is loud and it's more accurate actually because when you buy a house, mostly there's a lot of other stuff with it, right? It comes with floors in it and appliances and ceiling fans and all kinds of things. So it's having an engineer separate them out.
Natalie Kolodij:Now what's cool is instead of, you know, a $100 expense getting spread across 20 to 30 years, if we can take it across 5, your annual write offs is so much higher. The kind of counter or, like, next step to that is bonus depreciation, which we've heard in the news a lot lately. It might be going away. It used to be a 100, now it's dropping down and phasing out. But bonus depreciations is anything with a life under 20 years, we can let you take a huge chunk the very 1st year.
Natalie Kolodij:So this is what kind of created this loophole was it gave us an opportunity to buy a property, rent it 7 days or less on average, materially participate. And then that year, you do this bonus depreciation after your cost seg and have a huge loss for that 1st year. And this was a tremendous planning opportunity. With bonus depreciation, the cool thing is it's based on the year the property went in service, not the year you do this study. So anyone listening, if you have clients who have short term rentals or, where they might need rental losses for any reason, but if they have a rental that was put into service between 27 2017 and 2020, they still qualify for that 100% bonus.
Natalie Kolodij:It's not too late. It's based on the year it happened. And you can do a cost segregation study at any point. So even if they put that rental and service back in 2020, and this year you decide to do that study, you can absolutely do that. And then the difference is you don't go backwards.
Natalie Kolodij:We can't amend. You are going to do the study, figure out the difference in depreciation, what your amount of loss would be, and it creates a 481 a adjustment, which is basically gonna be your extra expense for the current year. And in that current year, you're gonna file form 3115. That's a change of accounting method, saying we're changing from straight line on a whole house to breaking it out into all these other little things, and we wanna take this adjustment. So there's not a cutoff for when you can do it.
Natalie Kolodij:I will say the longer the property's been rented, sort of the value of the study starts to go down because you've already used up chunks of that depreciation. But, definitely, if it's been 5 years or less, I would look at it. And with consideration, so any tax pro who's done a 31.15 knows it's not the most fun time you've probably had. I think the instructions say it takes, like, 28 hours or something to complete that form. So if you do the cost seg in the very first year, you don't need that form.
Natalie Kolodij:You're setting it up broken out to start with, which is much easier. If you do it in a later year, you need the form. The biggest consideration for me is during which year will it best benefit the taxpayer. So if it's the 1st year right now and it would be easier to do the study, but we know 3 years from now they're gonna have a huge gain on something and a big loss would be really beneficial that year, we might wanna wait a couple years and make sure we meet that short term loophole in that big gain year instead.
Chris Picciurro:Absolutely. That's a tax planning tool, and and I feel like I love cost segregation studies as well. But what what really irks me sometimes, and I when I'm reviewing a tax return and especially if it's we're just doing a tax planning engagement and we didn't prepare the return, is that someone has a cost psych study with a $250,000 loss, and their w two wages are, like, a 100 and 50 or 200. And now they just have an NOL that they're carrying forward, and they ultimately wiped out a bunch of income in a very low marginal tax rate. And I I think to myself, man, in this maybe they should have elected out of a portion of that, you know, bonus depreciation, or maybe they should have done a Roth conversion if they have those dollars and 4 zero one k's and let that grow tax free.
Chris Picciurro:So the the cost segregation survey that Natalie's mentioning is a great tool, and it could be used with other tax planning opportunities in concert with it. One thing I think that get that a lot of tax professionals get tripped up on is if you have a a residential property that's a short term rental property, what would be the default depreciation time frame on that?
Natalie Kolodij:Yeah. So by default, a short term rental is 39 years and not 27 and a half, even if it's a single family house. And this is the fact that, like, all but gets, like, tomatoes thrown at me when I teach this at tax conferences because it it is very upsetting for tax professionals. But the reason being, like I said, with short term rental, almost everything about them is an exclusion. It's like, but it doesn't meet this criteria.
Natalie Kolodij:And for a property, for a building to qualify as a residential rental, 80% or more of rents have to come from rental of a dwelling unit. Then there's an exception that it doesn't include units that are used where more than half of them are on a transient basis, which is typically 30 days or less. So even if it's a single family house, if your average guest stay is that 7 days or less short term span, you're gonna be on a 39 year depreciable life.
Chris Picciurro:Mhmm. And that's that I see that all the time. And then this kinda ties into the next question, you've talked about on your podcast, which we'll put a link into, which is which is amazing. But, you know, if as a tax professional. And let's say you're looking at a tax return for a potential client.
Chris Picciurro:What's and and you feel like a cost segregation study would make sense. When would you amend the return versus just file it as a 31.15 the next year? And I agree pairing that cost side with their highest marginal tax rate here is a good tax plan. But when should they amend a return? I, like you, love tax extensions.
Chris Picciurro:We won't go down that rabbit hole for many reasons versus when they would do the change of accounting method the next year.
Natalie Kolodij:Yeah. So if you see someone where last year, they just bought a rental and it was a short term rental, and you can run the numbers and see a cost segregation would have been a huge benefit to them. If a depreciable item either, like in this case, something that would benefit them to change or if something was incorrect, if it's only been on 1 year's tax return, you are allowed to go back and amend because you haven't established a method yet. You have to report 2 or more years to kind of show this is, like, 1st year, could have been a fluke. 2nd year, you're like, yeah.
Natalie Kolodij:No. We mean it. As long as it's only been 1 year, you can either go back and amend or file that 31 15 in the current year. So another kind of planning choice there, what year would be better. If it's been on 2 years before it gets to you, you have to do a 31 15.
Natalie Kolodij:I know it sucks, but you cannot amend anymore. Like, we do not have the option. The only only time you can is if it was also sold already. So, like, if the property was gone on 2023's return and it comes to you and you're like, wait. You didn't claim depreciation.
Natalie Kolodij:You get to amend it if it's, like, the final year it existed. But, otherwise, 2 or more years, and you have to do a 31/15. Right.
Chris Picciurro:And can they amend a tax return? Let's say it's someone bought something in 2023 and it and they had their tax return prepared in March, and it's July of 23. It was the first year. Could they go back into a cost segregation and amend 23, or they can do the adjustment in 24, basically?
Natalie Kolodij:Anytime up until 24 is filed. They're still in the clear to amend.
Chris Picciurro:Well, that that is good. Really good because, you know, there's there's a lot of confusion out there on it. And the good news is most cost segregation study companies that are very reputable are gonna help you with that 3 31 15 forms. A lot of them prepare it. You might have to either, you know, p d attach a PDF or you might have to re put it in your tax software.
Chris Picciurro:But, definitely, you know, having that prepared by the cost segregation study company does help quite a bit.
Natalie Kolodij:Yep. Absolutely. I will add a little caution for tax pros, which is the DIY cost seg studies where people can go online and do it themselves. I've had 2 colleagues who had those just thrown right out in audit recently, so they're not even considering that that's a valid reason if it was created by a computer software. And on top of that, even with the full firm studies, right now they're looking at them pretty close.
Natalie Kolodij:So, something that I don't think a lot of tax professionals realize is if you have a cost seg firm do a study and your client comes to you and you set it all up based on those numbers, you still need to look over that study and make sure you agree with what is listed as 5 year, 7 year, 15 year. If they picked something that was, like, obscure, it is a stretch to call it 5 year, it's on you if you sign off on it. So I would, like, add, like, the reputable firms normally nail it. There's no questions. But definitely take a look over it now because we've had an uptick in auditors looking at this because it's a huge tax benefit.
Natalie Kolodij:They're losing money, so we wanted that.
Chris Picciurro:Absolutely. And and most you know, the reputable firms are gonna stand by their work, and they are gonna offer the representation assistance or auto protection or whatever they do whatever they want to call that. You know, I agree. The DIY stuff, I mean, when you're talking about, you know, 100 of 1,000 of dollars of deductions, it's it's worth it to to make that investment. You know?
Chris Picciurro:Yep. So, yeah, I would say a couple more questions for you. You know? I and just really thinking about the questions I get from practitioners and people that listen to the podcast. Cautioning, you know, maybe helping advise clients that are that are married.
Chris Picciurro:A lot of times, they wanna set up a multi member LLC and start putting properties in it and and, you know, depending on if they're enough community property state. But I see a lot of unintended consequences of the multi member LLC as far as from a compliance standpoint. Most of them don't realize those returns are due on March 15th, and now they're getting a nasty letter in the mail. You know, are are the do you have any words of wisdom for for tax pros when, you know, thinking about these, properties owned owned jointly by a spouse Yeah.
Natalie Kolodij:Spouses. The first one is always check the title because often who people think owns a house is not who owns the house. So double check it's even in that l c to start with. That's like your get out of jail free card. It's maybe they didn't actually put it in there.
Chris Picciurro:Right.
Natalie Kolodij:The next thing I look at is the LLC. I think it's often that people think it was both of them and it might have been 1 or vice versa. So I always double check that. If they actually have a house in an LLC they're both on, your next sort of out of jail card is going to be, like you said, a community property state. If you're in a community property state, even with a 2 person entity, you can opt to have it treated as disregarded for tax purposes.
Chris Picciurro:Right.
Natalie Kolodij:So you've got that option there where you could keep it on their personal return. If all of that has happened and we have a partnership, well, at this point, we're we've got a whole lot to worry about. If it is past the due date and they didn't know they had a partnership and now that return is late, there is a rev proc that you can sometimes use for late relief on a small partnership as long as there's some criteria met. So, that is something to be mindful of as well in case we sort of missed the boat and the boat sailed. We might be able to, swim out, put on a little life raft, pull back in.
Chris Picciurro:So look into qualified joint venture potentially treatment, look into that first time or one time abatement to what I call the yeah. I call it the get out of jail free card also. And I'll tell you, there's so many times where I said a meeting with someone today that that's a potential client. They said, yeah. I formed this LLC.
Chris Picciurro:You know, my but we never put the property in it. So, basically, they have this dormant entity with absolutely no activity. So, really, the property's owned should be put on 2 personal returns on schedule e, him and it was him and his dad. You know? So it's it's funny, which actually is kinda good for him from a tax perspective, from a compliance perspective.
Chris Picciurro:So, in in kind of my final technical question is, this is another thing that that I think that I see people get feisty about, and I know that, there's a difference. You can't double dip your hours. Right? Sometimes people get confused between the rep status or real estate professional hours and your short term rental property hours. Can you kinda con compare and contrast those just from a Yeah.
Chris Picciurro:30,000 foot view?
Natalie Kolodij:Yeah. Absolutely. So they're both being either a qualified real estate professional or meeting the short term rental 7 day or less rule. Either one leads to the same end result, which is the property can be nonpassive. Then there's additional steps.
Natalie Kolodij:So for Real Estate Professional, at its core, only one person. We can't combine hours between husband and wife or spouses. One single person has to hit at least 750 hours on 1 or more real property trades or businesses and spend more time on real estate than anything else. That's the one everyone forgets about. So if you have a full time w two job, probably not gonna qualify.
Natalie Kolodij:Secondly, so like I said, real estate professional just means your rental's non passive, but we talked about it earlier. Even if something's non passive, you still have to materially participate. So there's a second step of still needing to prove that 500 hours or more in your group of rentals if you want to use the losses. So that's the real estate professional status. On short term rental, that specific property, it's looked at kind of property to property, not as a group.
Natalie Kolodij:And on the property, 7 days or less, you also need to materially participate there. So if you are both a real estate professional with short term rentals, you might have competing hours because you need material participation in your group of long terms and in your short term. They're different sort of buckets. And so if you have those 2 on the short term, then it is non passive there. But the difference in hours, they're pretty similar.
Natalie Kolodij:Just know that for real estate professional, you can't share hours with your spouse. For material participation, you can. And the hours for your short term rental do not count in your rental group. If you say I'm treating all of my rentals as 1, short terms are their own outlier, so they've gotta stay separate. So you might have separate categories, doubled up hours.
Chris Picciurro:Right. So a lot because a lot of people with rep status like to use the, they they like to use the rental grouping election, and yet that doesn't count for their STR hours. So each STR property is in its own bucket autonomously. If, I guess, if you have, you know, if you have a a short term rental property with it's one property in a duplex, I mean, that would be one bucket to me because it's on, like, the same piece of land, but ultimately, they're they're different they're different buckets. So I know we we have so many fun situations we could run through, but that's why we're gonna tell people about your CRUTS program and you offer opportunities for tax professionals because if you're listening to that, if you're not a tax professional and listening to this, you're not even my my wife doesn't even list it.
Chris Picciurro:I don't know. You must be really like us. But but, hopefully, you're getting your CPE. But Natalie has an amazing program that, not only educates you and empowers you as a tax professional, a CPA, or an enrolled agent that needs CPE, but I will I found that every time I've invested time, energy, and money into continuing education, I make it back multiple times on on my value and and who you can help out. But, you at least developed a CRUTS program, certified real estate tax strategist.
Chris Picciurro:Can you tell us a little bit about that?
Natalie Kolodij:It's a 10 week deep dive into all things real estate. It is 20 plus hours of IRS CE. And my biggest goal for it is for you to understand all of these things in-depth at the end. I talked 2 people out of taking it today because I didn't think they were ready or it wasn't the best time. It is there for you to understand real estate.
Natalie Kolodij:Investors are begging for professionals who really understand what they do, and a lot of tax professionals are really wanting to learn more about this area of tax. So it's a perfect way to align both of those things, gives you all of that education, weekly q and a's, ongoing membership for more questions and answers, and client leads. So if you're looking to deep dive into real estate, it's a fantastic way to do it all in one spot.
Chris Picciurro:And get your CPE.
John Tripolsky:Also, you guys well, I know we can talk on this. You know, we've gone in a 1,000,000 different directions and run with it for a while. So I'd I'd almost pose the last kind of question for you, Natalie, if, you know, this being a show targeted towards tax professionals. Say somebody doesn't do a lot with real estate investors. They'd like to.
John Tripolsky:Obviously, you you have resources for that. But what are some maybe high level little tips to give them? Just a couple. Willie, just to say, you know what? You can do this, and, you know, these are a couple of things you can do.
John Tripolsky:Maybe they just say say, no. No. I don't deal with it. Right?
Natalie Kolodij:So I think the biggest things to kind of learn about first or focus on if you're gonna start doing real estate investors is depreciation. You can't depreciate land, figuring out land versus building value, that's huge. And really then understanding the common expenses associated with it, when it's in service, and what is a capitalized renovation versus an expense. Those are where I see the most errors related to rentals. So if you can hone in your skills there, that's where I would start and start with kind of the easy ones and work your way up.
Chris Picciurro:Great advice, and we so appreciate you being on the show. And, John, I feel I know you feel more educated now.
John Tripolsky:Oh, always. I'm sitting here again. I kinda have my sticky notes. Right? Can't find my pad of paper anywhere, so I have, like, 6 blue sticky notes all over the place.
John Tripolsky:My daughter's gonna come home from daycare and think that daddy was doing art projects today. But, but, yeah, obviously, Natalie, let's tackle Chris a little bit too. We, you know, we obviously appreciate your time. Again, to me not being in the tax pro environment all the time, obviously, I do a lot with Chris. So I'm kind of, you know, through osmosis.
John Tripolsky:I hear a lot of stuff and and more personal interest. But I can tell you firsthand going to, tax pro conferences, events, being in conversations, there are so many potential clients out there. And, Natalie, as you mentioned, they are literally begging. As bad as it is, they'd probably settle for somebody that's not the greatest, but they handle it and understand a little bit. So I'd say the opportunity is there for the understanding.
John Tripolsky:So, obviously, we talk about opportunity. We have the resources. As mentioned too, we'll put those in the show notes, for Natalie's contact information for that course, but then also some stuff that we have through the monthly recurring revenues too. And also, I wrote down a couple of things that we've done with teaching tax flow too, so I'll drop those in the show. So lots of full work.
John Tripolsky:If you want it, anybody, it's here. But, again, thank you, everybody. Thank you. Thank you, Natalie, and thank you, Chris.
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