Main Street Business

#612 Bonus Depreciation Explained: The Tax Strategy Everyone Gets Wrong

• Mark J Kohler and Mat Sorensen • Episode 612

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Are the tax benefits of bonus depreciation and real estate investing really as powerful as they’re advertised? In this episode, Mark J. Kohler and Mat Sorensen break down the truth behind the popular tax strategy that many investors believe will dramatically reduce their taxes. The reality may surprise you.

Using real examples, they explain how depreciation, cost segregation, and passive losses actually work — and why many investors misunderstand how those losses can (or cannot) offset income from a business or W-2 job. You’ll learn the difference between passive and active losses, why many tax pitches exaggerate the benefits, and how strategies like the self-rental rule, material participation tests, and the short-term rental loophole can legitimately change the outcome.

If you’re considering a real estate investment mainly for the tax benefits, this discussion will help you evaluate the opportunity the right way. Taxes can enhance a good investment — but they should never be the only reason to make one. Don’t forget to like, subscribe, and share this with other entrepreneurs and investors who want smarter tax strategies!

You’ll learn:

  • The truth about bonus depreciation and why many investors misunderstand how it actually saves taxes
  • How real estate depreciation works and why it doesn’t always offset your W-2 or business income
  • The difference between passive losses and active income (and why it matters)
  • Why investing purely for tax write-offs can actually cost you money
  • How cost segregation accelerates depreciation in real estate deals
  • The self-rental rule and how it can legally offset business income
  • When short-term rentals can unlock tax benefits that long-term rentals cannot
  • The material participation tests and why they determine whether losses count
  • Why some investment pitches exaggerate tax benefits to attract investors
  • How to evaluate whether a “tax-saving investment” actually makes financial sense

Get a comprehensive tax consultation with one of our Main Street tax lawyers that can build a tax strategy plan with an affordable consultation that will leave you speechless!!

Here’s the link - https://kkoslawyers.com/services/comprehensive-bus-tax-consult/?utm_source=buzzsprout&utm_medium=description-link&utm_campaign=main-street-business-podcast&utm_content=msbp612-the-truth-about-bonus-depreciation

The Tax Write-Off Trap

SPEAKER_01

Everybody, please.

SPEAKER_00

I know how bad you want that tax write-off. But does the investment make sense without it? It didn't save me$100,000. It cost me$100,000 to make$37K. So if I lose everything on that investment, I'm down$63,000. You've lost money.

SPEAKER_01

Ask your accountant, what is your commission on this deal? Because these promoters are paying the CPA under the table to sign off on these deals, and they're big money.

Setting The Agenda: Bonus Depreciation

SPEAKER_00

Let's say you do get audited and you lose. I'm just happy to be here because Mark is going to be carrying the show today. As he does many times, you know, I'm just going to be, you know, comedic relief, color commentary today. But uh Mark's like, I got a big topic we need to talk about. Well, truth about bonus depreciation. And I'm like, I need to hear some of that myself, actually.

SPEAKER_01

Well, uh, thank you for those kind words. I uh you carry the show many times, so we're team effort here. So everyone here, this is a critical topic. And it is about the truth, a bonus depreciation, and I'll give you the spoiler alert right now: material participation. And this is something a lot of uh very aggressive accountants trying to sell an expensive strategy will gloss over. And we just covered an audit uh that in our training program for our accountants this uh two weeks ago with Farisala, she's uh IRS resolution expert. She broke down the entire case for us on a short-term rental material participation issue, which frankly is one of the easier ones. So we're gonna be talking about this today. Everybody's looking for that hot tax strategy before April 15th. You're like, well, I'll extend and we'll massage this. And there's a lot of promoters out there selling strategies like solar, uh equipment leasing, uh crypto mining rigs, um, turrow, waverly, short-term rentals, long-term rentals, real estate professional, the Hollywood Production Tax Credit, oil and gas, all of these are related to material participation.

Why Material Participation Matters

SPEAKER_00

Yeah, I'm it's the promotion of this strategy is endless because there's always someone on the other end who knows that you hate taxes more than you like making money. And that's that's like I'm so serious. Like I meet so many clients, they hate paying taxes more than they make more than they like making money. And because of that, people raising money or they got some investment strategy, they lean into that. And so they're gonna say, this is a great tax write-off because you can use this loss if you just invest in my thing. You can use this loss to offset your day job, your W-2, your business income. And the reality is, is that's very limited in how you're able to do that. And a lot of times, we as tax lawyers and our law firm at KQS lawyers, and Mark and I, as we were speaking around the country, are like kind of bursting people's bubble. There are some ways to do it, but nine times out of ten, we're bursting someone's bubble and saying, eh, I don't think that's gonna work.

Real Estate Basics And Depreciation

SPEAKER_01

Yeah. And we're gonna break down, I want to start with an example, uh, just so everybody can get in context what the issue is. Then I want to talk about some um political industry factors I think we need to have on the table. And then we're gonna break down what do you need to unlock bonus depreciation? What is this material participation? What are the risks? How does it work? And um I think really put to rest what the issues are, and you'll be able to make an informed decision with your tax advisor. It's it's really not that complicated, and so regrettably, and we're gonna talk about those political dynamics and where this why this gets promoted so often. So let's start with an example. Um now, and I'm gonna probably give two because we the most common is real estate. In fact, Matt, why don't you you why don't you you give a real estate example and then I'll maybe give an equipment leasing or some other option that could be out there that's a little more uh unique. But whether it's short-term rental, long-term rental, yeah, what do you see so often?

SPEAKER_00

Yeah, I mean, you everybody says buy real estate, the tax benefits are great. Okay, all right. I I like that. There's some reality to that, even without this taking these losses and trying to offset other income concept. But when you buy rental real estate, whether short term or long term, you get to depreciate this. If it's residential, it's over a 27 and a half year lifespan of the asset. So if that was$275,000 to buy that property, and this is the building only, you don't get to depreciate the land, you're taking a$10,000 depreciation every year, right? Now we can accelerate that. You can do a cost segregation, you can start taking much greater write-offs now when you acquire that asset, and that is a lot of what gets promoted is let's take these write-offs. And when you get these losses, because the rental income that you're gonna get is gonna that's gonna all get offset by these losses from depreciation, especially if you're accelerating them. But what's left over, usually that just sits as a passive loss on your tax return. Well, the promotion is well, how do I get those losses? I'm a doctor or a physician. How do I take those losses and get them to reduce my income as a doctor? That's what I'm paying 37% on. I want to get it over here. And that's what we're talking about here is how do I move that over there instead of it staying stuck as a passive loss and getting bottled up to only be using its passive income.

Unlocking Losses: Passive Vs Active

SPEAKER_01

And a great example, and we could spend the entire show just on that strategy, and we have before, um, whether it's a long-term rental, a short-term rental, are you do you or your spouse qualify as a real estate professional? Um, that those are going to be uh that could be a factor, especially in the long-term rental. But in a short-term rental example, just to isolate this so you all get the point, is if I can put in enough time decorating, staging the short-term rental, maybe painting a few walls, get it on the market. I can even hire a manager to be my Airbnb manager. But I put in enough time, you cross this threshold of material participation. And the IRS says, oh, if you get that material participation, that loss becomes an active loss. You're now and qualify as an active trader business is the concept under these seven tests. You just got to meet one of them. And when we meet that test, in the example of a short-term rental, then I can unlock all of this, well, a good chunk of that depreciation and take it all in the first year that I bought this property. And you may be putting money down and getting a loan. So you could put, say, 50 grand or 100 grand down on an acquisition, but end up with a$300,000 write-off. Now that's pretty sexy. So that is where that short-term rental strategy finds its legs. A long-term rental strategy, you've got to be a real estate professional and then show material participation. So if you're a physician, doctor, maybe your spouse is going to manage the rental properties for the family. That very common. So another example just to give it that very uh is really gotten a lot of traction, but got shot down or modified in the one big beautiful bill was the solar strategy. You're gonna go buy these solar panels, use leverage, and then these solar panels are gonna go on the rooftop of a residential home or a commercial home, depending on which strategy you were using. And then some solar company is gonna manage the whole process for you. But for some magical way you have material participation, learning about this by going to a conference one weekend and then having a little laptop um application or phone app that allows you to manage your solar project to the point you have material participation. Uh so anyway, um, that gets to be one of those abused areas. Well, the solar strategy is coming to a close this year uh under the one big beautiful bill. But now there's equipment leasing, um, the production tax credit in Hollywood. You've got um people buying mining rigs for crypto and depreciating the mining rig, accelerating those. So these little things pop up all the time, and it's like whack-a-mole. So for any of you accountants listening, I I know you're torn. Because on one hand, you're like, man, I gotta bring my client something. Maybe this is a possibility. But then you've got others that are almost forced to do it. Their client finds this strategy, they show up and go, I want to do this, and I'm gonna fire if you don't do it. And man, it gets to if accounts that never ever had an ethical issue, this is where it starts to become a problem.

Short-Term Rental Playbook

SPEAKER_00

Yeah, and I think um this is with so much tax principles, just speaking to the investor here, is uh, you know, a lot of these assets you can be investing in in real estate, there is so much truth to there's great tax incentives for it. Even if I don't get to take this passive loss to make it active and offset other income. You know, I'm buying just a rental property, short-term, long-term, I don't care what it is. After all my expenses, I've made 20 grand in net rental income, and I probably have a$20,000 depreciation expense that year. Boom, zero. I have$20,000 of income in my pocket from cash towing that property over and above expenses. But because of that depreciation loss, it is offsetting that income. So it's good already, it's people saying, but what if that loss was$30,000 and I had an extra$10,000 over and above the rental income to wipe out? I want to use that. And that's what we're talking about here. But I also, and it could be other strategies here, as Mark was talking about, but I just want to say we're not crapping on chasing tax losses and good tax planning and making investments in assets that are tax efficient. We love that. Let's just get a reality check on how these losses can offset your other income.

The Solar Era And Its Pitfalls

SPEAKER_01

Yeah, and before we unpack material participation, everybody, we're gonna tell you what qualifies and what doesn't. But but Matt, I love what you brought up right now because this is one of those political dynamics we have got to talk about. And I say political or I mean it's a it's a factor you've investors have got to take into account. And I'm gonna restate what Matt said in this is and in this way. So many taxpayers let the tax tail wag the dog. They're just chasing the next cool tax strategy and literally have blinders on and don't care if it makes money at the end of the day. Because they're saying if I spend X and I get a tax write-off better than that, I don't care if it makes money. Do I need to go back to the savings and loan crisis in the 1970s, where people were buying properties that were complete failures just to chase a write-off? And then Ronald Reagan put a stop to that with the 1984 Tax Act. And that created that's when material participation was first introduced to the tax code. Investors could not just go buy a crappy building funded by a savings alone and take a write-off and have no business involvement. Wrong. And then Ronald Reagan added to that, you have to have basis. You have to have basis in the project. You just can't, meaning recourse basis, that you're on the hook for this. You can't just say I am and get a write-off. So that's where this all started. But Matt's point, I want to just re-emphasize this. Everybody, please, I know how bad you want that tax write-off. But does the investment make sense without it? That's your first question. And that's where I had a problem with solar. I can even make sense of it. I don't think what the hell do I have 10 years from now? Does it even make me money? Oh, but don't worry about it. You get the tax write-off. No, no, no, no. Tell me my money was spent wisely. That's what I mean. Can you re-emphasize that too, Matt? I know that that you could just you kind of you brought it up, but I mean, we really, I really want to drive this home.

SPEAKER_00

Yeah, I mean, if let's say you made a hundred thousand dollar investment and they're like, well, you can get a you get a loss of a hundred thousand dollars back in year one, the whole thing. Okay, you're in a 37% tax bracket. Did that save me$100,000? No, that saved me$37,000. It didn't save me$100,000. It cost me$100,000 to make$37,000. So if I lose everything on that investment, I'm down$63,000. You've lost money. Okay. So, so let's have perspective here. Let's not get too anxious about the tax benefits. To me, the the tax benefits are the fringe of why I'd invest in this over something else. Like, for example, if you could say, well, Matt, you could make, you know, if you put in$100,000 in the stock market, you can make 10% and have$110,000. Or you could make, you know, put in$100,000, you could make$10,000 and be$10K, but it not be taxable because it was real estate and that cash flow because of depreciation. I'd be like, I'll take that, I'll do the$110 in real estate. But I'm I'm it's still gotta make money.

ROI First, Taxes Second

SPEAKER_01

Yeah. Well, and um let's bring this home because this is a variation uh to the first point is does the investment is it sound? Number two, what is the tax write-off with the net tax benefit? Because I love your example, Matt. You put in 100 grand, you get a hundred thousand dollar write-off. Well, if unless you're in a hundred percent tax bracket, you're losing, right? And so this is where solar Which thank god thank goodness that does not exist. Yeah, yeah, we don't want that either. Um, but and I'm beating up solar because it it was such a blatant abuse of this strategy. But everybody, please take note of this. Uh, we would have constantly a turnstile of clients coming through our office the last five years, trying to take advantage of the solar strategy. And they would say, Well, I'm putting in 100 grand, but my tax write-off is 300. And I go, Oh, so you're signing on debt, huh? They're like, no, I'm not signing on debt. I go, really? Show me the prospectus or the contract that you're doing with this promoter. And in the last page or two, there's that, okay. Well, there is recourse debt here. You're actually buying$300,000 worth of solar panels with a hundred thousand dollar down payment. So you're signing on debt of$200,000. Now we're gonna get rid of that later because we're gonna donate what's left to charity or we're gonna sell it or whatever. You will not have to pay that. I go, are you sure? And they and so many clients were like, Whoa, I did not know I was signing on debt. And I said, Well, how in the hell did you think you were getting a$300,000 write-off with only$100,000? You have to have basis. And that's when a lot of times there's only one way the train stopped. Yeah.

SPEAKER_00

Yeah, there's only one way that that's happening. Yeah, you're guaranteeing debt, you're signing on to debt, which now is adding risk to the investment, which is probably something you're not controlling, you're not having eyes on anymore. And so um, so these have been a problem. Let's just like, I mean, looking, I think we've like put the nail in the coffin here. Yeah, this is what created a problem. Yeah. Clients overlooking the overall merits of the investment simply because of the tax pitch.

Basis, Debt, And Risk Explained

SPEAKER_01

Yep. Now, I want to say this too, Matt, something you said a minute ago that we're gonna break down these these ways you can qualify. You know, like say so so say you you weed through the crappy investments, all right? You understand is there debt involved? What is my investment return? What is my tax benefit? You let's say you go through stage one and you're ready to go to stage two. Well, now I want to analyze this and say, is this bonus depreciation going to benefit me on my tax return? Do I qualify to take the write-off? Maybe they're saying I get the write-off, but they're not the one signing the tax return. You are. You are the one ultimately on the hook signing this tax return. Do I qualify for this? And I want to just say bonus depreciation is great. It it this is not a bad thing. This is what stimulated the economy in a huge way. The one big beautiful bill, Donald Trump helping spearhead that, of course, love him or hate him, don't worry about that, is hey, if I go invest in real estate and help stimulate the economy and develop better equipment or more manufacturing and or whatever, then I can accelerate the depreciation. And as long as I'm making good cash flow and building equity in the property, sign me up. So it's we're not trying to, like Matt said earlier, poo-poo the idea. Just let's go in with our eyes wide open. So I I I wanted to not sound like the sky's falling either.

SPEAKER_00

So yeah, and look, we're gonna give you some some ways that do work and some things that we have seen that do work too. So this is not all just like, no, no, no, no, no, no. You know, the worst lawyers in the world are only the ones that tell you what you can't do. Like, okay, great. Like, give me a find the value of a lawyer is one who can figure out how to make it work or give you options of what's possible.

SPEAKER_01

Okay, so let's let's set the table. We we now need to determine do I qualify to take this depreciation and write it off against my ordinary income? That's the holy grail. Well, the concept is unless there's an exception, I need to show that I am materially participating in this. I'm not just a passive investor. If you're a passive investor, like Matt said, the depreciation will be there for you in the future. Oh, you'll get it. You'll get it as a carry forward until you sell other passive investments. Not a bad thing. But if you want to accelerate it, you've got to show you're actively, materially involved in this. And it rises from an investment to a business, unless there's an exception. So let's talk about the exceptions for a moment. Oil and gas. Oh, so cool. If you want to invest in an oil and gas exploratory investment in the US on US soil, you have what's called the IDC, intangible drilling cost, and you can depreciate, accelerate, depreciate the oil rig and tangible and intangible costs. Very, very common. We have got oil and gas companies and drilling companies that work with directed IRA, work with our clients that have great projects that make ROI return on investment sense. But you don't have to have material participation. That's an exception. That's a good thing. Yeah. Matt, the self-rental.

Does Bonus Depreciation Fit You

SPEAKER_00

You love this one. Yeah, yeah. I mean, like the if you're owning a building in your business or for your business, this can be in a separate entity, a separate LLC, but you rent it to yourself, your operating company, you can take the losses on that real estate and offset your business income because they're grouped together as one thing. This real estate is still real property. We can still have a separate entity for asset protection, but the activity of it with the operational business, let's say you're the dentist, okay? You got the dental office, you're drilling and billing all day long, making money. You also own the real estate that your dental practice is in. You own the building. Well, we're taking, let's say you can accelerate depreciation or even just your normal depreciation. You end up with a$50,000 loss on the building. Well, that$50,000 loss doesn't get bottled up over here with your other passive income. It can fly over here now to your dental income and reduce it$50K there. So that's the self-rental rule. So it's got to have common ownership, though. And this is the renting to your business. A perfect way of explaining it, Matt.

Exceptions: Oil And Gas, Self-Rental

SPEAKER_01

And for you tax advisors out there, it's called the dash four. And what you're doing is creating an economic unit, and that's what gets you over the material participation test because your hours in the ordinary uh operational business count towards the real estate. So you are exempt from this special rule that just applies to the real estate. It's wonderful. And people, the self rental trap is not making the election. So you accountants out there are like, I've had to fight accounts going, yeah, but that's a bad deal because of the self rental trap. Yeah, the trap is not taking advantage. Of the strategy. But that's a whole other topic for another day. Okay. So there's our two classic exceptions: oil and gas and a self-rental. Well, let's say I'm going to do the short-term rental. I'm going to go buy a little property and put it in an Airbnb scenario. And we'll come to equipment here. Oh, we'll give you the equipment. Let's knock out two birds with one stone. Or I'm going to go buy an expensive excavator or a truck or back, you know, some front loader or something in the construction industry. And you're going to buy this equipment and rent it to other contractors. Or you're going to buy mining rigs and put it in a crypto mine scenario. Okay, same concept. It's all assets, and you're going to rent them to other people, not to yourself. So it can't be a self-rental. You're going to rent this equipment to someone else or make money off of it. Well, there's seven ways that you could qualify as material participation. And if you can show that you check the box on one of those seven, you just morphed all that, those write-offs into ordinary write-offs. Now the one that's of these seven, I'm going to tell you the one that's most common. Well, the first three. Now, if you're married, you and your spouse's time combined can count towards that. But you put in 500 hours. Um, well, people, that's 10 hours a week. I mean, are you really gonna put in? That's a lot. And you may say, I put in 10 hours, but then you've got to say, do those hours qualify? Watching a computer screen make you money on your mining rig is not managing the mining rig. Having a property manager over your short-term rental and giving them a call once a week is not gonna graduate to 10 hours. However, giving them a call does count. So you, oh, there's 20 minutes. So you've got to not only make sure that time qualifies, but that you actually put it in. So number one could be a little hard.

unknown

Yeah.

SPEAKER_00

Let me say just on those hours, too, that if it's like work done is like in the capacity of an investor, like analyzing stuff, you know, reviewing financial statements and stuff like that, um, monitoring things and analyzing stuff. That's not the hours we're talking about here. That's investor hours. You do not get to count those.

SPEAKER_01

Correct. And there's a lot of case law and IRS regs on these. A lot of times they're specific to the industry, too. Because if you're talking about real estate, they're gonna say, what qualifies? Putting on a tool belt, going out and working on the property is one of the cleanest best. Going to a conference on how to invest in real estate is not gonna count. And if someone tells you that it does, say, great, will you sign my tax return? Yeah, and if I get audited, will you stand behind it? They're gonna change their tune real quick. Well, they're gonna say, well, go talk to your accountant, but I know, I'm sure. Well, I've never been audited. Yeah, you just got lucky. Doesn't mean it's okay. Hell. All right. Number two, your participation was substantially all of the participation and the activity of all the individuals. Meaning you're you pretty much ran the show. Now, this is a hard one when you need the third party to do the real work. Mining rig operation. You go out and buy$100,000 worth of mining rigs with debt for$25,000. You get a$100,000 write-off, even though you only put in$25,000. And you know what? That investment, in my opinion, I own mining rigs. It's pretty sound. You're going to make money on those rigs. You will get your money back. You just have to figure out what's my ROI and was it worth it. But you're going to accelerate all those write-offs. Do you know how to run a mining rig? Are you the one managing that operation? Is the mining rigs in your basement or in your building, or are they in some warehouse in the desert of Nevada and some IT guru is running the whole show for you? If they are, you are not substantially the one running the operation more than anyone else and in charge of it. You're not. Don't fool yourself.

Equipment, Crypto Rigs, And Rentals

SPEAKER_00

Number three. Yeah, can we just make a point here? Can we just make a point here on that one? Because sometimes, like in the real estate context, and I know you're giving examples here of equipment and crypto and construction equipment, which is important. Notice what Mark's not giving an example of is your rental property. Because you might be like, hey, guys, I'm I do all the work at the rental property. I go over and I visit it, I'm mowing the lawn or, you know, whatever. Like, and it, and it's not$500, but I'm the guy doing most of the work. And I maybe got a handyman that comes in that does the hard stuff if I don't know what I'm doing. Does this mean I'm I materially participate? It's a rental property, though. We're not talking about other types of equipment.

The Seven Tests Overview

SPEAKER_01

Yeah, you're in, right? Because there's no one else. I gotta be a real estate professional. Yeah, yeah, you're you're good. Um, and and that part number two, your participation was substantially all of the participation needed to operate the activity. And so you're like, guys, I am so good at this. I didn't put in 500 hours. So, but no one else is doing it. I'm in charge of everything. Okay. You can make that argument. I can I can live with that. Um, I'm gonna have a hard time with that, an equipment rental, but maybe in a short-term or a long-term rental property scenario, you could make it. Now, the third one, and this gets very this is the one Patty and I have used. I have personally used this, and Matt know I bragged with Matt all the time. I'm so excited. I love the short-term rental strategy. Patty and I are putting a fourth one online this year. Last year we put a third one online. We love to, rather than stay up sometimes and watch Netflix. Um, we do have a couple shows we like, but um, we'll put on our tool belts, and we love just working on the real estate together in the evenings and on the weekend. That's we geek out on that. So we love rule test number three. You participate in the activity for more than a hundred hours during the tax year, and it's more than anyone else. So I could have a property manager, but I put in more time than them. I could have a handyman, uh, a contractor come in and do something. Um, so I get my 100 hours and I make sure no one else puts in more than 100 hours, I can check number three because I'm not gonna reach number two. I'm going to use a property manager. I'm going to use other people. So I can't say I substantially do everything. And frankly, I want a property manager. I want to get in, get my 100 hours, and get out. So I like number three. Um, if you want to Google this, go out on AI, you can read the other four. They're gonna be more challenging. I, but the first three are where most taxpayers live. So if your accountant, in summary, and I'm gonna I want to talk about this audit example that I just referenced at the beginning of the show. If your accountant is glossing over this or making it sound too good to be true, and on one breath, they're gonna go, this is so easy, you don't have to do anything. And then the next statement, they're gonna go, but you got to show a hundred hours. Whoa, whoa, whoa, you just told me I don't have to do anything. Now you're telling me I have to put in time, which one is it? And they tell you anything you want to hear to get you to buy. Be careful.

What Counts As Hours

SPEAKER_00

Let let's talk about real estate because I want to clarify this. And this is something, and this is a I think a lot of investors get stuck on this, and this is why the short-term rental loophole is called a loophole. I just want to make sure we're on the same page here. Um what I mean to say, I want to make sure I'm not I understand this right. Is okay, let's say I can hit any one of those three. I got my rental property, long-term rental. Okay. I'm business owner, Matt. I'm not a real estate professional. I can meet one of those three tests for the amount of hours. I've got 20,000 in losses from depreciation. I want to bring that over and offset my business income. Or I'm the physician, the dentist, whatever. I'm not a real estate professional.

SPEAKER_01

Okay. Here's the problem there. How do I get there? Yeah, here's the problem in that fact pattern. You I thought you said it was a long-term rental. And I know, Matt, you have long-term rental. I did.

SPEAKER_00

Yes, yes, yes. See, yeah, I'm trying to illustrate here the problem where most people get stuck.

Running The Show Or Not

SPEAKER_01

Yep. In it is very important in this analysis that people understand the difference between a long-term rental and a short-term rental. And be and I'll say it now. A short-term rental means your average stay of all the people that stayed there during the year is less than seven days. So you can have someone rent it for two weeks, but someone rents it for two days. At the end of the day, you've never had a tenant, all of your tenants stayed for an average of less than seven days. Number two, you did not put in substantial services. You did not act like a hotel. You didn't clean it every day, you didn't act like a hotel. You um you are doing the basic Airbnb VRBO thing. Okay, everybody. So those are the now, if you have a long-term rental, that means it could be midterm. You're renting it for three months at a time or 12-month leases. That's long-term rental. In the long-term rental context, you have to meet two tests. You or your spouse have to be a real estate professional. Then you've got to get material participation. And I've actually sat at the table with an IRS agent with my client next to me in a case just like this. He was a realtor, he was a broker. Now, the real estate professional status is it's your primary job and you put in at least 750 hours. Anybody in real estate knows that. That's a real estate professional. If your spouse qualifies, you both qualify. Love it. Primary occupations is real estate, contractor, realtor, broker, whatever, and 750 hours a year. You're a real estate professional. Then when I was in this case at the IRS Service Center on 400 South in Salt Lake City, Matt, it was like an awesome case. It was the, you know, steel table, cold room with VC tile, and there was a hot lamp on my client, you know. It was, I mean, it was just a classic, right? And the IRS agent said, yeah, he's a broker with 30 agents. I mean, he was a real estate professional in every sense of the word. And he had 32 rental properties. And they're like, you don't material participate, you have a property manager with all those properties. So you're not doing the work, you're not doing 100 hours, you're not doing this, that, because all these other people put more time in than you, and they disallowed all of his depreciation. So now this was about 15 years ago. It was an awesome case. I've written about it and talked about it a lot. And I said, Well, Mr. IRS agent, we have seven ways he can materially participate, and we're gonna make the 469 election and group this 32 property scenario, where all as a group, he can now qualify under one of these seven. So I chose one of the seven, we grouped the properties. Case over, we won. And that was an example of how a real estate professional can grab the write-off if they qualify as a real estate professional, but they still have to hit material. With short-term rentals, you don't have to be a real estate professional.

SPEAKER_00

Yes. Okay, that's the big, yeah, that's the big takeaway is the long-term rentals, you've got to have both of those things material material participation and be a real estate professional, but short-term, you just need to satisfy this material participation that we've been talking about. And that unlocks it. But other stuff, the equipment examples you've been giving Mark, those, it doesn't matter what your primary occupation is. Right.

The 100-Hour Strategy

SPEAKER_01

And some of you may go, You still have to get the hours. Yeah. You you just have to worry about the um material one of the seven tests. Um, because who cares if you're a real estate professional? Because it's because you're renting things in less than a seven-day format in all of those examples, or you've got an active trader business. So you you just need to hit one of those seven. Now, some of you might go, well, why is this short-term rental strategy called a loophole? People, the IRS moves at the speed of uh well, you know, I don't know why they're currently they moved so slow. Um, and 10 years ago, short-term rentals didn't even exist. How many of you, 10 years ago, had a VRBO or Airbnb app on your phone? No one did. And so the there's this been this period of time where the IRS and I regs have not caught up yet and put the short-term rentals in the same bucket as long-term rentals. The short-term rental is in the bucket of a bed and breakfast. That's the rule for bed and breakfast.

SPEAKER_00

And so And it kind of looks like that too, though. I mean, I think it that's okay. It's true that they're they're behind, but it it it looks a lot like that. And it has more intensive work and management involved than the long-term rental, too. So I think there's an argument it could stay there too. But yeah, I hope it stays, depending on who's in the White House and Congress.

SPEAKER_01

Yeah, I love it. Um, so well, Matt, I'm glad you provided that um scenario, an example to get the distinction there.

SPEAKER_00

And so let let's hit a couple things just to illustrate this to make sure. I'm pitching an investment now. What should I be thinking about? They're starting to tell me you're gonna get all these losses, Matt. You're gonna use it on your, it's gonna reduce your income. You're gonna start going. What do I need to be thinking about? Okay, I need to be thinking about these, the seven tests and the three Mark talked about.

SPEAKER_01

No, no, no. I'm gonna take a different place. I I I'm gonna say number one, I'm gonna write these down to you. Does the investment make sense without the tax benefit?

SPEAKER_00

Number one we talked about already, but I'm trying to.

SPEAKER_01

Yeah, I'm just saying what's the checklist? Okay, I'm just saying what's the checklist where anybody comes and pitches you a strategy, say, okay, take the tax strategy off the table. Does it make sense? That's number one. Okay, cool. Number two, is there debt involved? And you want to tell them, show me where there's recourse debt and how I get a write-off bigger than the amount of investment I'm putting in. Tell me where the debt is and how that is dealt with in the future. Because that's recourse debt. I'm gonna have to come to the plate. And if it gets forgiven, I have debt forgiveness income. I don't need a 1099 C for cancellation of debt. Now I'm paying taxes on the strategy I employed. So I don't need that. So if you can get those two answers, then number three, say Can I can I yeah, go ahead.

SPEAKER_00

Can I jump in there? It's just like I'm just kind of telling you guys the only way your write-off is gonna be greater than the amount you invested is if you're taking on debt. Bonus depreciation, all this other stuff, only gets you to the value of the asset, not more. It's not gonna go over 100% of the value of the asset. So, how do I buy more assets? If I put in 100K in Mark's example and I got a$300,000 write-off, they bought$300,000 worth of equipment. How did they do that? They got debt. How are you able to get the write-off? You guaranteed that debt. Otherwise, you don't get to take it. Now, the so if they say, Well, we where we're getting the debt, don't worry about it. Well, if I'm getting the write-off, search somewhere buried in there that I'm liable for that. Otherwise, you can't legally take that write-off. Yeah.

Grouping Elections Win Audits

SPEAKER_01

Now, I I love it. Perfect way of explaining that. So, number one, does it make sense without the deduction? Number two, is there debt involved and how is it handled in the long run? How do I deal with that and pay it back? Oh, there's another topic that there are two, but oh my gosh. Number three, ask the promoter, how do I materially participate? Show me how. And I want to know that those activities are qualified activities to count and how I am gonna literally clock those hours. Now, these promoters are onto this. They'll say, We have an app where you track your time. We have a little logbook where you track your time. Say, okay, that's cool. Show me what I'm doing that qualifies under regs for uh the test. Which test am I qualifying under? And what is the services I'm doing and how it's tracked? They better have a darn good answer. Now, if it sounds too good to be true, people, I would ask you to, and I'll tell you what really happens, but I would have you say, Well, will you guarantee that those qualify? They are not gonna do that. They're gonna say, Well, your accountant will. Now, they love to recruit accountants to come verify for their client that this qualifies because that accountant is gonna sign the tax return. So these guys are off the hook. And your accountant now takes the heat if it doesn't qualify. And the taxpayer says, hey, if my accountant's gonna sign off on it and you guys are gonna make sure it has a good ROI, I'm all in. What the hell? Well, ask your accountant, and if they're a CPA, they have to disclose this. What is your commission on this deal? Because these promoters are paying the CPA, quote unquote, on the side, under the table, however the hell you want to say it, to sign off on these deals. And they're big money. I have literally had accountants call me and talk about the struggle they're facing ethically, that this is their major revenue source right now, is signing off on solar deals or whatever in the past, and they don't feel good about it, but they can't turn down the money, and they're it's a struggle. That's what's happening, people. So it's it's too bad.

SPEAKER_00

So yeah, so I think it and at the end of the day, I'll just say this too. Even if that accountant's like, you know, let's say you do get audited and you lose, guess who's paying the tax? If your attorney gets adjusted, you are. You might have a beef with your accountant and maybe they got, you know, or malpractice, or but but that's actually very hard to win from a tax uh like an individual client taxpayer against your tax professional. It's actually a very hard case. So um if you lose, that's your butt on the line, and you're the one paying that tax um back because the loss gets disallowed.

Why STR Is A Loophole

SPEAKER_01

Yeah, I great point, Matt. Well, everybody, I am so sorry if we uh burst your bubble, whatever you want to say. Um but you be careful chasing these write-offs. There are solid, uh long-term, good tax planning strategies out there. Um be careful what you agree to do. And I'm gonna say one of the best is not pay tax anyway in the first place. Let your retirement account do the deal. Then you don't even have to plan around this kind of stuff. If you're chunking, creating Roth IRAs and Roth 401ks every year, there'll be a tipping point where your tax-free money is bigger than your after-tax money. And when that happens, people, it's incredible. And we have thousands of clients that have made that shift at directed IRA. And we have a sister podcast called the Directed IRA podcast. And go check it out because what that's all about is avoiding this whole problem to begin with.

SPEAKER_00

Yeah. Let us know where we can help there. We want to, if you're like, what the hell are they talking about? Well, we have another whole entire podcast on this. We've both written on it, have books on the topic, and a company helping tens of thousands of clients every day doing that. And of course, our law firm, KQS Lawyers, if you need a check on this to be like, hey, what I need some real tax strategies. I need a reality check on some of the things I'm trying to do or I'm hearing. That's what we're doing every day with our clients at KQS Stories. You can book a comprehensive tax and business consult with one of our lawyers where we go over your specific situation and real strategies that could create real savings for you on your tax return.

SPEAKER_01

Thanks everyone for spending your valuable time with us. We'll be here next week and even more frequently uh doing open forum uh answering open forums answering your questions. So please uh give us a like, a follow, and stay tuned for future. episodes that will help you better live your American dream. Thank you.

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Mark J. Kohler

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