Episode 60. How to Handle Short Term Rental Audit

Short term rental audit rules can be confusing.

Especially if you used real estate losses, bonus depreciation, or cost segregation to reduce business income.

In this podcast, I explain how to handle a short term rental audit and how to prepare before the IRS or state ever asks for documents.

You will learn the main short-term rental tax rules, including the 7-day average guest stay rule and the 100-hour material participation rule.

I also explain why your hours need to be higher than anyone else working on the property, including a property manager.

Then I break down the documents you should keep before an audit happens.

This includes a detailed time log, guest records, travel receipts, repair receipts, cleaning receipts, and proof of business activity.

If you are already in a short term rental audit, I explain how to organize your response, prepare a cover letter, cite the tax rules, and make it easy for the auditor to review your file.

I also explain cost segregation and how it can create large first-year paper losses when paired with a short-term rental, bonus depreciation, and proper documentation.

This podcast is for business owners, S corporation owners, and real estate investors who want to use short-term rentals the right way and be prepared if an audit happens.

But this strategy has to be set up the right way. Before buying a short-term rental just for the tax write-off, speak with a Tax Advisor who can help you follow the rules and document everything properly.

🆓  Download FREE PDF: 7 Write-Offs Every S-Corporation Business Owner MUST Know:   https://7taxwriteoffs.com/?el=podcast&htrafficsource=buzzsprout

*Disclaimer This material & presentation content is for informational and educational purposes only. This material and presentation content is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Because each individual’s legal, tax, and financial situation is different, specific advice should be tailored to the particular circumstances. For this reason, you are advised to consult with your attorney, accountant, tax preparer, and/or other advisor regarding your specific situation or your client’s specific situation. The information and all accompanying material are for your use and convenience only.

Transcript

Why Short-Term Rentals Get Audited

SPEAKER_00 0:00

Hey, let's talk about how to handle your short-term rental audit. So if you are a person that owns a short-term rental or you're facing an audit or you want to be prepared for an audit in the future because you took some excessive losses on your short-term rental and you did everything legitimately, then this is for you. So what I'm gonna talk about is how to be compliant, right? First of all, you need to know how to be compliant before even taking those losses. So I will talk about that. Then we're gonna talk about the documents that you need before an audit. So SU are renting out your short-term rental, taking those nice losses, bonus depreciations, what you need to be doing, what type of documents should you be keeping before you ever have an audit. Okay, it's always good to be prepared. And number three, if you are undergoing an audit, how to handle an actual audit, what to provide, what is it that they're looking for, and how to win such an audit. I've done audits in the past, so I'll show you my way, the way I did it in the past, and how it was successful. So I'm just basically going to share it here as well. Also, as a bonus, for those of you that don't know that short-term rentals can actually generate really, really nice losses for you using cost segregation. So at the end, as a bonus, I will talk about what is cost segregation and how it's generates how it generates losses for you.

Real Estate Losses And The Goal

SPEAKER_01 1:15

Welcome to the tax reduction podcast for money-making entrepreneurs with Boris Mucheev. Boris has helped entrepreneurs across the United States collectively save millions of dollars in taxes with the power of tax planning and advisory. The only way you, the business owner, can save money on taxes is by using proactive tax strategies. And this podcast is all about saving you money on taxes. Boris will share with you in-depth and easy-to-understand tax reduction strategies that you can implement in your business within 30 days or less. Let's jump into today's

The Seven-Day Rule Explained

SPEAKER_01 1:48

episode.

SPEAKER_00 1:48

All right, let's talk about how to be compliant when actually having a short-term rental. For those of you that are watching live, or for those of you that are watching a recording, let me know in the chat if you know all the rules that I needed. Drop a one if you know all the rules that I needed to be compliant with it. Now, with the short-term rental, right? By the way, the biggest advantage, the biggest tax write-off. A lot of people say, Boris, what's the biggest tax write-off that I can have in my business or in my on my taxes, not to pay any income taxes? The real answer is real estate, right? The more real estate, the better. But a lot of business owners, they're not real estate investors or they're not considered real estate professionals by the definition of the IRS code. So they invest in short-term rental. But short-term rental, you need to be compliant to be able to take those losses because remember, when you invest in real estate, one of the goals is to have losses on paper so that you can deduct them. Now, to be compliant, number one, when you buy a short-term rental, you have to have an average stay of seven days for your guests. All right, so let's say guest one stayed six days, guest two stayed um uh what do we do? That's uh I'm sorry, guest one stayed uh ten days, and guest two stayed two days. That's average of six days. That's good. So you need seven days average stay, okay? So for guests. So IRS is if you if your guests stay on average seven days or less, we consider you a short-term rental. So you are no longer an investment property, but instead you are a business. That's cool. The second compliance that you need to be in compliant to be able to take these losses is to work 100 hours in this rental. So 100 hours is usually easy to meet. And the way what I've seen my clients do and the recommendations that they have given to other people as well, and which actually works very well, is that when you buy short-term rental, when you're setting it up and getting ready for rental and so forth, when you travel and stay there for a week or so, you will already meet 100 hours. Obviously, you're not traveling for vacation, you're traveling, hey, I'm getting the apartment ready, right? I'm getting the condo ready, I'm getting the cabin ready. Whatever that short-term rental is, let me know in the chat for those of you that are watching a recording on YouTube, or for those of you that are watching live, let me know in the chat. Chat, what type of a short-term rental do you have? Is it a condo by the beach? Is it a uh a cabin or is it something in the forest or just a big home that you have in the mountains and so forth, right? So you meet your 100-hour rules. So IRS says, look, if you rent it for seven days or less and you work a hundred hours, you're good to go. There's one little caveat that not everybody is talking about. Thanks, William Williams says uh cabin in the forest, Angela says mountain cando, right? Uh Jack says oceanfront house in Hollywood Beach, Florida. Nice, okay.

Property Manager Hours Caveat

SPEAKER_00 4:41

So, one little caveat that nobody talks about, generally, like for example, right? Jack says in Florida, Jack, do you live in Florida? If you don't live in Florida and you have a property manager management company, okay, what you need to do is that you even though you make more than 100 hours, right? Jack says I don't live in Florida, you probably have a property management company. What you need to do is that you need to make sure if you have a property management company, you're doing more hours than them, even though you meet 100 hours, but you have to do more hours than them, right? So I'm just gonna write you more. So you have to work more than them. Now there's nothing wrong with having a property management company or people that clean up your property, whatever it is, but the amount of work that you're putting in, you have to meet that. You have to do, I'm sorry, the amount of work that you're putting in has to be more. So, now the biggest thing to be compliant, right, with it is to track your hours, and that's what I'm gonna talk about next. Hey, thanks so much for watching. Just a quick break before we continue. Uh, if you want some free resources, I'll put them in the description below. So, if you're an escorporation owner, I have a seven tax stride-offs that every escorporation owner must know. The uh link is below, but you can also get it at seventax writeoffs.com. Also, if you are a business making more than a million dollars, I have a training totally free to show you how you can save more than $100,000 on taxes in just 30 days. You don't even need me, okay? Just watch that training. It is save100k now.com. The link is also in the description below. And if you like, no boris, but just want to speak to your team about tax strategy and we need a tax advisor, then you can go ahead uh you can go to taxplanningcall.com, but the link

The Documents To Save Now

SPEAKER_00 6:24

is also below. Now let's talk about documents needed before an audit, okay? And this is part of the compliance as well. One of the things that when you get audited, right, when you claim all the expenses, the IRS or state authority doesn't really care as much about your expenses as your qualification in terms of hours. Did you meet a hundred-hour rule? And do you have a good log? So, right now I'm going through an audit with a friend of mine, and you know, he prepared a bunch of documents. I said, look, one of the most important things they're going to be looking at is a log. Okay? Log. A time log. So what do you put on the log? What do you spend hours on in your property? So every time you travel, okay, every time you travel to your site, let's say Jack said it's in Florida. So when Jack travels to Florida, Jack, when you travel to Florida, right, save your tickets, save your receipts, because that is a good indication and prove that not only do you have an expense, but you actually now travel there and you spent some time there. So it was three days. And out of the 24 hours that you were there, um I'm I'm look I'm counting like uh eight hours a day work there, right? Out of the seven to two hours that you were there, you worked 24 hours, what about to care of the property, to care of the condo, called the insurance company, called the utilities, whatever it is that may be. But they want to see a detailed time log, okay? Detailed time log. And do not prepare this after you get audited after three years, because you're gonna not gonna remember what did they do to prepare for this, right? What did how many hours did I spend? Yeah, I think I traveled, you know, uh two times. So, what did I do during during those two times? So remember, you are preparing for an audit in advance. Just have your documentations ready. Number two, have all of your receipts. So, a lot of times I've spoken to a lot of business owners that have real estate property. They hire a contractor, and the contractor says, No bueno, no, no, no, no, cash only, right? Like, all right, I'll pay cash. Do you now have receipts of payment? No. Can you take those payments as deductions? No. Okay, because you you don't have proof. There's no receipt, there's no but no record of who you paid. So make sure you keep receipts of everything. Okay, have receipts of everything. People ask me, Boris, is credit card statement good? This is what I uh answer them, right? Like, just let's be realistic. On credit card, generally, let's say, for example, QuickBooks Online, okay? If you get audited by the IRS and like, hey, I spent on software, let's say a thousand bucks, okay, whatever, I'm just making the number up, and they'll see that it's like QuickBooks Online, like Adobe, and whatever. Like, could they request receipts from you? Yes, but they won't, right? It's it's a recurring charge, it's on a credit card. Kind of everybody knows that Adobe is used for the office, QuickBooks Online is used for the business, right? But if you've got repairs, cleaning, maintenance, somebody came and fixed the AC, have the actual receipts, okay? Even though you pay them, you could have seldom, have always ask for actual receipts, put it in a folder, scan it in, but always make sure you have these documents ready if you ever need it. So a friend of mine that is going through an audit right now, he actually did a great job. They actually saved all the documents, all the receipts, all the uh trips that they took so they could back it to that. Like, for example, if they paid for uh repairs on July 3rd, there's a um an airplane ticket, right, from July 1st to July 5th. Like, oh yeah, well, he was there, he paid for it, whatever that may be. So make sure you have all of these documents. But what I tell everyone all the time is that it's good to have receipts for expenses, it's good to have receipts for income that you made, whatever that is. What they're really interested in is log. Did you meet this 100-hour rule that we spoke about, right? Did you meet this 100-hour rule? That's what they want to know. And did you was the average stay less than seven days? And property management, right? Did you um have anybody that worked more than you? So, in the case of a friend of mine, like I said, what happened with him is that he his property man he has a property manager, but he he just basically doesn't rent out the space, he just makes sure the guests are taken care of when they get there. So he actually had to write a letter saying, hey, this is how you know there were 11 bookings, and I spent like three hours per booking taking care of the guests when they came. If they needed anything, they called me, so forth. So he definitely spent more hours and he met the seven-day rule.

SPEAKER_01 10:45

If you have a tax preparer and you do not have a tax advisor, the only way you can save money on taxes is by using proactive tax planning strategies that only a tax advisor can give you. Boris put together a free PDF for you, the business owner. Seven tax write-offs every S Corporation business owner must know. In this PDF, you can find seven tax strategies that you can start using in your business to instantly start saving money on taxes. Click on the link in the description below for a free download.

SPEAKER_00 11:16

Let me know if you guys have any questions. Uh let me know if you guys have any questions live or if you guys are watching a recording, let me know in the comments and we'll we'll definitely get those answered. Alright, so the third thing I want to talk to you guys about is the last thing. Oh no, we also have the bonus, right?

How To Respond To An Audit

SPEAKER_00 11:32

Let's let's talk about how to handle the actual audit. I'm gonna give you my process, what I do. So, for example, again, this is a friend of mine that came in and said that Boris, I've got this audit and I'm being audited by the New York State Department of Taxation for this short-term rental. So, first things first, um, we obviously put together all the expenses, right? So obviously gather all the documents. Gathering is gather documents. So gather documents, time log, very important. Okay, uh average the tenant information, like for example, the name of the tenant, how many days they stayed, right? Information. So you gather this. Then the second thing that I usually do, I respond to the audit. Let's say if the audit is about short-term rental, respond with citations, right? So I say, look, this taxpayer took a loss on this property because he met the short-term rental rules and everything that is uh needed. And we basically cite the IRS code, code, regulations. You might be like, Boris, why would you cite an IRS code and regulations, everything that's needed? Because believe it or not, not every auditor that is going to be reviewing your case knows the tax law. It's just the sad truth, okay? So they don't. So you have to let them know. By the way, if you look over here and if you look at this publication, if this IRS tax code, and if you look at this uh treasury regulation, and whatever that is, this is where you can find these things, right? So I for I'd be like, hey, I gather all the documents, I start writing a letter, explaining, and then I say, Alright, here it is. And the way I do it is like I stack it, right? So I stack the documents. So first I have a cover letter. Cover letter, and then in a cover letter, I define everything that I am including, like, because remember, it's like spoon feeding it to a child, uh, what is it, spoon feeding it to the child, right? Because you don't know who's sitting. It could be a first-year order, it could be a fifth-year order, somebody who just got hired, right? So here it is, and every expense that I have, like, for example, let's say there were like seven expenses on the short-term rental. I don't know, let's say this is uh repairs, this is cleaning or whatever it is, right? So I would do just one paper, label it repairs, tie it to a schedule E, wherever he took the report of the short-term rental, and then I put all the receipts here. And same thing for the cleaning, label it cleaning, and then that. But I know that IRS or the New York State or whoever's whichever state is auditing you, they don't really care about expenses as much as were you compliant in meeting the short-term rental rules. Once they see that, then they're gonna look at this, all right? Because that's what matters. So that's why I told you guys documentation is very important. Save all the receipts, make sure you have a time log, and obviously you have a log of all your all of your tenants. That will be the first thing that they're looking at. That's exactly what I told my friend. Let's just prepare this and then we'll put all the expenses and receipts and everything else. It's all in there. But this is what they're looking at. So when uh handling an actual audit, be super prepared, but also prepared in a way that when they receive all the paperwork, they can just close your case very quickly. Because believe me when I tell you this, that the auditor that is auditing you has many, many, many, many other cases on his desk that he just wants to finish. If you're just gonna send him the information, just whatever, yeah, I gathered it and sent it, and he and you're gonna make him work through it, he's gonna hate you, he's gonna try to make your uh audit fail, right? Or he's like, I didn't find this, just right, whatever it is. But if you organize it in such a way where they like everything is available to them, it is going to be a quick turnaround. Okay, I've experienced that in the past. I've met with an auditors in the past uh before, face to face, I came with a bunch of documents, put it in their desk. I they had an exact copy, and I had an exact copy of what they had. I'm like, all right, let's go one by one. Then we were out very quickly. Alright, ladies and gentlemen, this is how you handle an actual audit for

Cost Segregation And Big First-Year Deductions

SPEAKER_00 15:40

short-term rentals. Now, let's talk about bonus, which is cost segregation, okay? So I said that I'm gonna talk about what is a cost segregation. So a lot of people commented that this abortion, we don't know what cost segregation is. So here's the thing: let's say you buy a residential property. I'm gonna draw a nice house, okay? Here's a door, here's a window. You got a house, okay, and you're gonna put it on Airbnb. You purchase this house for $800,000. Because it is a residential property, let's say this is $800,000 net of land, okay, because it's a residential property, you would depreciate it normally over the course of 27 and a half years, and whatever the math is on that, okay. Cost segregation means you segregate the components of the property into different classes of assets. By the way, that is the right way to take a depreciation deduction. Okay, if you look at the IRS tax code, you will see. So what happens is that approximately just the back of the napkin, dirty calculation, 25% of the building value can be depreciated in the first year. In this case, it's $200,000. So if you purchase an Airbnb and the net of land, let's say you purchase for a million dollars after the land, it's $800,000 as a building. Instead of dividing by 27 and a half years the entire amount, $200,000 of it is deductible in the first year. Okay, the remainder $600,000 is now divided by 27.5 years. But the 200,000, so 200,000 is taken the first year. That is why you do cost segregation study. Okay, the study is usually done done by an engineers, it's outside firm, they come in, they do the whole study, costs a couple of thousand dollars, they give you all the paperwork that is needed to be compliant with the IRS and tax filings, and your tax advisor will be taking care of that. Cool.

Wrap Up And Free Resources

SPEAKER_00 17:33

Guys, thank you all very much. And then uh I'll see you all next week. We'll be doing another workshop next week workshop. And for those of you that are on our email list, we'll send you a private Zoom link so you can join me on this workshop. Thanks so much.

SPEAKER_01 17:46

That's it for today's episode. Be sure to check out the description below for some free tax reduction resources that Boris put together for you. If you're ready to work with a tax advisor on your tax planning, be sure to schedule your call by heading over to www.taxplanningcall.com. That's www.taxplanningcall.com. And be sure to subscribe to our podcast to be notified when the next strategy is released.