Summary: If you’re a high-income earner, you know that taxes are your single biggest expense line item. As soon as you see the amount, you’re paid versus the amount that ends up in your bank account, you feel it. You feel it at tax time when you see the five or six figure tax bill. Most assume that there aren’t great options for someone who is working full time. However, you’d be wrong! In this article, we’re going show you the secret for maximizing rental property tax deductions while working full-time.
[Disclaimer: We are not accountants, lawyers or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
As a salaried high-income earner, you probably have given up on the idea of maximizing rental property tax deductions.
While you’re painfully aware that taxes are your single biggest expense each year, you also know that there are few options for lowering your tax rate.
One option you may have heard about (probably from us) is Real Estate Professional Status (REPS).
This is a great option for someone who is willing to cut back at work and who wants to focus on building their portfolio of rental properties. Also, it’s perfect for a spouse who stays at home, since one spouse can focus on real estate while the other still works full time.
But what about someone who can’t afford to cut back on their day job or who doesn’t have a spouse who can be the real estate professional?
Answer: Invest in a short-term rental.
Be sure to download our FREE short-term rental cash-on-cash calculator below to ensure you are getting the maximum profit for your STR!
If you haven’t heard about this tax loophole, you’re not alone. Very few people outside of our community of real estate investors know about this loophole.
But the ones who do know about it are taking full advantage. Not only do they get to own a beautiful short-term home on the beach or in the mountains, but they can also cashflow A LOT and enjoy maximizing rental property tax deductions at the same time.
And it’s completely legal.
So, what is this tax loophole and how does it work? We’ve laid out the steps for getting this tax break in a different article, so in this article, we’re going to focus on the question of how YOU can do it while maintaining a full-time job.
The bottom line is, it’s very doable. But rather than just tell you that it’s doable, I thought I would walk through just how to do it.
Know That it’s Possible to Lower Your Taxes with Short-Term Rentals
The first step to achieving something is to know that it’s possible. Once Roger Bannister ran the four-minute mile, something everybody thought was impossible, thousands have achieved the same feat.
So, I thought it might be helpful to tell you about a member of our community, Alisa, who owns and manages six short-term rentals.
Alisa is a full-time gastroenterologist and on top of that, she’s the medical director for an inflammatory bowel disease center. On top of that she’s a mother of four (two have special needs) and a wife to another doctor.
Over the past two years, she has grown her short-term rental portfolio from zero to six properties. She has done everything from acquiring the properties, furnishing them, setting them up and on top of everything else, she self manages all of them!
So, there’s no excuses if you’re working full time and you think you don’t have enough time. Know that it’s possible for you, go out there and do it!
Know How to Materially Participate to Lower Your Taxes with Short-Term Rentals
If you don’t know what material participation is, don’t worry. For now, just know that there are seven different material participation tests, and you only have to meet one of them.
The one that most people start with is the 100-hour rule and more than anyone else. This is perfect for someone who is just starting out and only owns one short-term rental. It’s also a fairly easy test to meet. You can easily accumulate 100 hours. Any busy professional can spare 100 hours.
In order to meet this test, you count the hours you spend buying your property, buying the furnishings, setting it up and ideally you self-manage the property.
While the prospect of listing your short-term rental on Airbnb and VRBO and interacting with guests may seem daunting to you, just remember Alisa. She responds to guests on the fly, in between patients, whenever she has down time. You can do it. Material Participation is key to lower your taxes with short-term rentals!
The Year-End Strategy to Lower Your Taxes with Short-Term Rentals
I haven’t seen many people talk about this strategy, so this may be the first time you’re hearing about this.
This is how it works.
If you buy your short-term rental towards the end of the year, you can self-manage the property for a few stays at the end of the year and then hand it over to a property manager in January.
This is what we did with one of our short-term rentals. We bought the property in September, did some light renovations, furnished the property and then started listing it in December. We rented it out three times and then handed it off to a property manager in January.
Now some would argue that you don’t even have to rent it out. The rule is that your short-term rental has to be “placed in service.” Some CPAs interpret this as listing your property for rent. So technically, you could list your property for rent on 12/31 and you can now begin maximizing rental property tax deductions.
However, we don’t like to leave any room for interpretation in case of an audit, so if we’re using the “year-end strategy,” we like to get at least a couple of stays in before the end of the year.
A common question we get is, can you rent to friends and family? We’ve spoken to many CPAs about this, and they tell us that as long as you charge them market rate, you can rent it to friends and family.
One other benefit of this strategy is that you have two major holidays at the end of the year, so it should be very easy for you to rent it out and get credit for placing it in service.
Don’t Be Stubborn and Do it Alone
This last one is maybe self-serving because we run a short-term rental course, but that’s not my intention.
Bottom line is, go find someone who can guide you through the process because it’s not worth missing deadlines or making mistakes.
If you had the luxury of time, then maybe go out and do-it-yourself.
But with the short-term rental tax loophole, you don’t have this luxury. You have a deadline. You have to get it all done before the end of the year.
Below is a high-level list of the things you need to get done before the end of the year:
- Choose a short-term rental market
- Purchase a short-term rental
- If your property needs a refresh, you may need to hire contractors to renovate it
- Buy furniture as well as all of the other furnishings like accents, TVs, kitchen supplies, etc.
- Get professional photography and list it on Airbnb and VRBO
- Get at least two or three stays before the end of the year at market rate
- Arrange a cleaner to clean your rental in between stays
- Keep track of your material participation hours
- Do a cost segregation study so you can claim bonus depreciation
- Be sure that none of the people you hire are doing more hours than you
- Find a real estate savvy CPA who is very knowledgeable about the short-term rental loophole
If you aren’t intimately familiar with how to do every step above, the likelihood of you getting stuck is high. Getting stuck means delays and worst case, you fail to buy a property. Or worse, you buy a property but fail to get it placed in service before the end of the year.
Think about the cost of waiting another year to start maximizing rental property tax deductions!
Or worse, let’s say you do get a property but fail to place it in service. This means you have to self-manage the property for an entire year. For someone with a full-time job and who thinks they don’t have enough time, this isn’t a great outcome.
At the end of the day, it’s just not worth it. Find a mentor or take a course.
Want to learn how to build a significant source of income from investing in real estate while reducing your taxes? Join us in one of our courses, Zero to Freedom, or Accelerating Wealth.
Have you found a way to creatively fund your real estate portfolio and achieve financial freedom? Join the conversation! Follow our Semi-Retired MD Facebook page and join our Physicians (for MDs or DOs only) or Professionals group!
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