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May 23, 2024 | read

169. Tax Q&A from the Tax Smart Investor Facebook Group – REPS, STRs, and More!

Thomas Castelli

In this episode, Thomas answers questions from the members of the Tax Smart Real Estate Investors Facebook Group.

This episode is sponsored by Landlord Studio.

Full Transcript:
This podcast has been transcribed using AI, please excuse spelling, grammatical, and other errors.

Thomas Castelli 0:00
You’re now listening to the tax smart Rei podcast.

Brandon Hall 0:03
Your source for all things real estate, accounting and tax. Here we reveal our secrets that can save you 1000s in taxes, streamline your accounting process and help grow your business. Stay tuned to hear insightful interviews with industry experts, successful real estate investors and current clients on what strategies they use to grow their business, and how they steer clear of Uncle Sam.

Thomas Castelli 0:29
Thanks, everybody, for tuning into this episode of The Tech smart Rei Podcast. Today we’re doing something a little bit different. We’re going to be taking questions from the Facebook group and answering them here on the podcast today. If you’re not already a member of the tech smart real estate investors Facebook group, you can become a member by going to w.facebook.com/groups/tech smart investors or just search for tech support investors on Facebook. And you’ll be able to go ahead and join that group. We’re actually hosting our next live q&a Where I will be answering questions live from our tax smart insiders community on Wednesday, March 13, which is coming up at 7pm. So if you want to become a tech smart insider, you want to join the live q&a And get your questions answered. You can do that by going to WWE tech smart investors.com and becoming an insider today. But with that being said we’re going to dive right into the questions after a quick word from landlord studio. If you’re doing yourself landlord managing rental properties landlord studio is made for you. The software helps landlords simplify income and expense tracking. With their easy to use app, you can digitize receipts record income and expenses in real time and generate reports and even manage leases and tenants plus landlord Studio makes late rental payments and bank visits a problem of the past with secure online rent collection get the rent paid directly to your bank account. And you can even automate rent reminder emails and late payment fees. Landlords studio is also the best way to stay tax compliant. They offer a range of financial reports including Schedule II and supplier expense reports designed for tax time, you can learn more about landlord studio and start your 14 day free trial at landlord studio.com/cpa. And use the coupon code real estate CPA at checkout to get 25% off your plan. Again, that’s landlord studio.com/cpa and use the code real estate CPA to get 25% off your plan today.

Brandon Hall 2:20
Alright, so let’s talk a little about why we rebranded from the real estate CPA podcast to the tax my real estate investor podcast or tax smart Rei podcast, whatever you want to call it, I guess we’ll figure that out as we go. Because this is our first real podcast episode that we’ve hosted. Since the rebrand right?

Thomas Castelli 2:38
I think it’s actually might be the second the second or the third actually.

Brandon Hall 2:41
Well, the last episode was tax and legal summit recording, right? Yeah, true. True. The first one that we’re here. So let’s talk about that a little bit. I mean, you know, the real estate CPA is such a strong brand, I feel like but we’ve been building out the tax smart real estate investors, brand in group, we’ve got that free Facebook group, we have our Insider’s paid group, that we’ve got the courses and everything. And I think that we kind of got together and just decided, you know, this, this podcast is really meant for that type of an audience. It’s meant for the listeners who have a handful of rentals, and they’re trying to learn the fundamentals of tax are trying to get a little more sophisticated so that they can go and have better conversations with their own CPAs. Or I mean, heck, a lot of our clients listen to this too. So you guys can have better conversations with us. But the idea, I guess, behind this was the purpose isn’t necessarily the real estate CPA, the purpose is to become a tax smart investor. So who kind of wanted to rebrand and align more with that audience?

Thomas Castelli 3:44
Yeah, it just makes a lot more sense. At the end of the day, the real estate CPA, it’s very much about CPA, right. And tax warn investors is actually about becoming a tax smart investor. And that’s why many of the listeners of this podcast are listening is to become tech smart until they learn and have better conversations, like you said. So I just think it makes a lot more sense. It’s much more in line with that brand and what we’re building with the tech smart investors brand. So it’s just an appropriate change. It’s an evolution. And you know, what’s the same great podcast at the end of the day, the same exact hosts the same exact type of content we’ve been putting out. Nothing’s changing, except for the name and the artwork a little bit, except on iTunes, iTunes, giving us a lot of trouble actually just updating the image. So if it’s still coming up as the real estate CPA on Apple, just know that it’s something with Apple, we’re still trying to figure out literally updates everywhere. But on Apple podcasts.

Brandon Hall 4:38
Yeah, yeah. I noticed that yesterday morning. I looked up the podcast and saw there’s still the real estate CPA. Well, there was like years old artwork that was still there. So not even our modern real estate, CPA artwork. Yeah. Anyway, I mean, I know that everybody has been listening to this. We have a lot of listeners. We have 90,000 a month, which is awesome. I mean, that’s incredible. Somebody told They recently that puts us in like the top 3.5% of podcasts or something you you, you said we’re ranked what like 200 something? Yeah,

Thomas Castelli 5:07
we’re 205 on us. podcast, which is fantastic. I never knew that I never knew how popular the show really was until I started looking into the charts. And yeah, you told me it was in the upper like 3.5 or 2.5%, or whatever it was.

Brandon Hall 5:19
Yeah, yeah, it’s pretty cool. We’re getting sponsors. I mean, things are happening here. But it’s all because you listener are listening to our content and digesting and absorbing and listening to more and more and more. So something that would really help us really, really help us. And we would really appreciate it. If you’ve gotten any value out of this out of any of our podcast episodes, please go leave us a five star rating on Apple, iTunes, Apple podcasts, whatever it is, these days, go in this five star rating, it’ll help boost the podcast and get in front of more listeners, in our goal with this is to help all real estate investors across the country become tax smart real estate investors like you. So share this podcast and and we will be forever forever grateful for your help.

Thomas Castelli 6:05
Right, right. And if you’re on Spotify to Spotify actually has their own rating system. So if you are listening in from Spotify, you just give us a five star review on Spotify. If you love the podcast that really goes a long way as well. But we don’t only just have the podcast is not the only part of the tech smart Rei ecosystem, if you will. We also have the free Facebook group, which we’ve talked about here on the show before a lot of great things happen in there. I think there’s over 9000 members at this point, great conversations take place every single day. People are asking questions not only about real estate tax, but also questions about how they’re building their real estate investment business. So it’s really cool to see all that type of conversations taking place in there and see how everybody interacts together to really help each other grow their real estate ventures.

Brandon Hall 6:49
Even just recently, we had somebody come in and say my CPA said that my short term rental, I can’t take the losses as non passive because I have to qualify as a real estate professional since I earn above $150,000. And so we were able to go in and help him and really I mean, the community started it by saying no, that’s not right. Because all this stuff go listen to the to the tax smart Rei podcast. But I was able to jump in there too, and kind of explain like look, real estate professional status, though 150k cap, but doesn’t apply to short term rentals, because short term rentals are not rental activities. And, and he was able, I think I think he’s still going back and forth the CPA on it. But I’m telling you like, that’s the whole purpose of this podcast of the Facebook group, that free Facebook group is just to help everybody become a little more sophisticated, so that you can at least have these conversations with their CPAs. Because think about it, if I don’t want to sound all high and mighty, I guess. But if it wasn’t for our group, he would have probably just accepted a CPAs word and moved on. But now he’s he’s looking for alternative options. And he might find one, I’m sure he will, because he’s correct in the way that he should be treating it. And the CPA is incorrect. But I think the tax swing was like $15,000, that that was the refund that was on the line. So definitely worthwhile to get just a little bit of knowledge contacts, you don’t have to be an expert. But that’s what we’re trying to help you do is just gain that fundamental knowledge so that you can have better conversation with your CPA. So you mentioned the insider group at the beginning here before our break for landlord studio. And I want to kind of just talk about that too, because you said there’s a live q&a Coming up our insiders group is a $50 a month group that we have our clients get it as part of their advisory packages, if our clients have advisory packages. And what we do in that group is we have discussions we moved all of our blogs in there are tax smart blogs in there. So we closed down the website and moved it all into this private gated group and the blogs, resources, discussions, live events. The one thing that we’re adding, which I think will be really cool is masterclasses our guest mastermind groups, we were kind of still trying to figure out what’s called, but it’s basically a monthly meeting where we’re going to talk about different pieces of investing in real estate. So for the first few months, we’re going to hit short term rentals. But it’s not going to be taxes, right? It’s going to be how to acquire short term rentals, how to do the due diligence, how to operate short term rentals, find your cleaners, your linens and all that stuff. And we’re going to be having people come in and talk that have short term rental experience. Like we’re trying to bring more to this group, this insider group, then just taxes in accounting, you’ll get really good knowledge on taxes and accounting, but we’re also gonna help you build wealth at the same time. So if you want to check that out, it’s tax smart investors calm, go there, and you’ll see the information and how to sign up

Thomas Castelli 9:48
now. Absolutely. And one last thing before we dive into today’s episode with the questions is I just want to kind of mention, you know, in the free Facebook group, we have about 9000 members and scrolling will probably soon have 10,011 and so on and so forth. And it’s really difficult for Brandon and myself and our other team members to really answer all the questions ended up getting put in there. So a lot of times you’re getting answers from the community. And those answers are sometimes really great. Other times, they’re not so great because they’re not tax professionals. But the insiders group, which is great is that there’s a lot less people and the people who are in there are a lot more dialed in, or generally more dialed in, because they have been through our courses. But they’ve gone through a bootcamp, they’re already tech smart, they’ve already kind of crossed the threshold, from becoming tech smart to being tech smart. So you get a lot more high quality answers. But not only that, Brandon, myself and other team members are able to dive in there and really answer the questions ourselves. So you’re getting answers from the tax experts and the people who do this every day day in and day out, and who really know this stuff. So just something to kind of add in there with another benefit of being an insider. But having said that, we’re going to dive into some q&a is from the Facebook group. So what I’ve done today is I compiled a bunch of questions that were recently asked, we’re just gonna go through them one by one and provide answers. So kind of kicking it off. First question is from Lonnie and Lonnie asks, is providing soaps, lotions, cleaning supplies, and linen change outs between guests, or upon request considered substantial services for short term rental? What do you think? I do not think merely leaving soap lotion and cleaning supplies in the short term rental unit will rise to the level of providing substantial services or cleaning in between stays, I think that’s just normal par for the course of business, I think really where you are rise to the level of substantial services, as when you’re providing services that are hotel like, and that is, you know, provides more specific examples, it’d be cleaning, while the guest is staying there, providing like transportation services, providing a vehicle that they could use while they’re at at the location at your place. There’s been people who’ve mentioned that to me before they’re considering doing that. If you wanted to do that and not make it substantial services, you probably be better off renting the vehicle on a service like Toro. And just seeing if there’s a way you can kind of package it all together, where it’s not actually being provided as part of the rent you’re receiving from the short term rental. But the bottom line is if you’re providing things you would see in a hotel like environment, those are substantial services like the daily cleanings while they’re there, and like breakfast, like if you came in and eating breakfast or transportation, like I said before, that’s when you’re kind of rising into that level of substantial services.

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Brandon Hall 12:28
Right, and there’s a CCA, which is a chief counsel advice memorandum that came out in December, it’s 2021 51 005. And they actually address this. So anybody that thinks that the seven day rule in Section 469, if you meet that seven day rule, anybody that thinks that that automatically makes you just subject to self employment tax, you need to go read the CCA. If you just Google cca 2021 51 005 Then the memorandum will pop up. It’s a PDF and you can read it in in this CCA they specifically say, look, section 469 has no bearing on section 1402, which is that self employment tax section, completely different analysis. So don’t fall for the trap of like your CPA saying, well, less than seven days not a rental activity has to go on Schedule C must be subject to self employment tax. That’s not true. But to answer this question, one thing that they did address was what are substantial services. Now, the way that this works is there was a fact pattern that was presented to them. And they looked at that fact pattern, so it’s not really going to answer lonnis question, but it could potentially help give you an idea. So in this fact pattern, they said that the taxpayer provides linens, kitchen utensils, and all other items make the vacation property fully habitable for each occupant. In addition, the taxpayer provides daily maid services including delivery of individual toiletries, and other sundries access to dedicated Wi Fi service for the rental property, access to beach and other recreational equipment for use during stay. And prepaid vouchers for ride sharing services between the rental property and the nearest district. So when they did the analysis, they decided that all of that was substantial services and did subject the rent the net rental income to self employment taxes. But in this fact pattern, those daily maid services were daily I mean, the tenants were there. And so we still think that hey, if the tenants aren’t there and you’re just turning the unit over, that’s different that’s not providing substantial services to my guests. That’s simply getting the the residents you ready to go for the next guest 100% 100% But But I did find that it was interesting that they said access to beach and other recreational equipment. So, you know, I guess you got to potentially weigh the fact that if you have access to amenities that are beyond simply occupying the property, potentially that trips that substantial piece.

Thomas Castelli 15:05
Yeah. And they also mentioned in there that they had vouchers to and from the local district. I mean, at that point, you’re definitely, no, you’re sure. You’re definitely getting substantial services. I, I know, they also mentioned they had like the utensils and everything in there. I don’t know that that’s providing substantial services, like how substantial can that really be, you know, but anyway, we’re gonna move on to the next question. If we have no w two income, and not much other self employment income any more would we want to try to get the short term rental to qualify for Schedule E by providing substantial services? What are the drawbacks, more benefits of having our property on Schedule E for the purposes of paying taxes for Social Security later. So kind of break this down? The benefits of doing this the benefits of paying the self employment taxes you are paying into the Social Security system, which could help you qualify for Social Security benefits in the first place, you do need to have to be currently insured, you need to have 20 quarters paying into the Social Security system to be fully insured, you need to have 40 quarters. So if you haven’t hit those thresholds, yet, paying into the Social Security system can help you hit those thresholds. And also, the more you pay into Social Security system, the more you get out when it’s time to take your Social Security benefits. So that’s kind of the benefits there. Now, the downsides are you’ll usually have to pay 15.3% of the Social Security tax on the net income from your short term rental business. And that’s up to I think it’s $148,700 of income this year, doesn’t sound like you’re going to hit that based on the short term rental income alone. But the downside is you’re paying 15.3% tax on your net income and additional 15.3% tax in addition to federal and state taxes.

Brandon Hall 16:46
I don’t know that it’s a benefit to pay into the Social Security system, though. I mean, I feel like it’s legalized robbery, because I’m going to pay into the Social Security system, I’m going to pay what potentially millions are the opportunity cost is millions. I remember looking at somebody’s analysis, it was like, if I earn, it wasn’t even an incredible amount of money. It’s like if I earn $150,000 a year, and I maximize Social Security out if I if I didn’t have to pay Social Security, and I could have just invested that money in the spy ETF. So not even anything crazy. It was like over 30 years, you end up with some like $3 million, or something like that. And you could draw down on that at a 4% rate. Yeah. Which was, was that 34% of 3 million or 20k? Yeah. 120k A year 20. Okay, so he was like, you could draw down on that, or 120k a year. And then he compared it to the Social Security and the Social Security drawls on the same amount were like, 4000 a month, basically, just this is legalized robbery.

Thomas Castelli 17:45
Yeah, you know, I mean, I would agree, I mean, look, you’re paying as if you’re an employee of a W two job, you’re paying 7.65%, right. And if you’re self employed, it’s 15.3%. Now, my humble opinion, I agree with you here, I’d rather take that 7.65 for 15.3%. And just throw it in the s&p 500 index, and invest myself and then self Insure Right self insure myself for the future. But way back in when they put FDR put this in there, the economy at the time was very much hurting, and they felt like this type of social assistance was necessary. But it’s I guess it’s important to note, too, that the Social Security is not only the payments you get in retirement, but it also helps with Medicare disability, there’s other factors that go into Social Security. But no doubt in my mind, would I rather just take my 7.65 or 15.3% back and reinvest it myself? And I do think I do think it’s a shame that they have this system in there. But you can’t even stop it. Because it’s a big Ponzi scheme at this point. Yeah, too far, but the

Brandon Hall 18:43
UK reform because it’s like you, all these other people are depending on it already. Right?

Thomas Castelli 18:48
Right. Right. And they’ve already paid it, they’ve already did their share. So if you stopped it right now by having us say stop paying in our generation. Anyway, the bottom line is that’s the benefits. That’s the drawbacks of putting your yourself your short term rental on Schedule C by providing substantial services and paying the self employment tax.

Brandon Hall 19:05
So don’t provide substantial services, own passive income, and will force a reform of the Social Security system.

Thomas Castelli 19:12
Yeah, you know what, actually, you would be better off if based on our discussion, if you believe what we just discussed, then you’d be better off by not putting on Schedule C taking your 15.3% self employment tax back and just reinvesting it yourself. It’s the path to independence. Right, right. So we got another one here. All right. If I build an adu on my primary residence and uses a short term rental to meet the material participation tests, can I bonus depreciate the space or at use any different than an investment property? Not part of my primary residence?

Brandon Hall 19:46
Ooh, that’s a good one. That’s a really good one because especially in California right now, they just they relaxed all their adu laws to actually allow people to start building to, I believe curb the homeless issue, right? Or the housing issue has a shortage. Yeah, which is executed interesting stuff. I’ve talked to a few California developers, and they’re all like, it’s gonna be insane here in a couple years because they’re all putting these four unit properties up now, in neighborhoods that were designed for one family to live on on these lots, right now, you’re gonna add four new families. So it’s like, the infrastructure is not actually there to support the population that’s gonna like be moving in here. But anyway, guess that’s beside the point. What so what’s, what’s the,

Thomas Castelli 20:36
I think about property tax there, too. If you have four people, if you have a four Plex, they’re probably not paying as much property tax. Now, I don’t know the exact numbers as they would on a single family house. So that’s also not going to be able to support the infrastructure. But anyway, the the actual question was, if I build an adu on my primary residence and uses a short term rental and meet the material participation test, Kai bonus, appreciate it.

Unknown Speaker 20:58
Do you know the answer to that?

Thomas Castelli 20:59
I believe you can. So when you rent out a portion of your residence, you’re able to appreciate that portion of the residence that you’re renting out. And in this case, you the adu would be fully used for business purposes. And that would be the portion of your house you’re renting out so you’d be able to depreciate that portion of your home and improve your last I checked it’s right in it’s either in the Schedule II or it’s in the it’s one of the one of the IRS publications on rental of how to treat rental income and expenses. That if you rent a room in your house on a short term basis that it’s treated as if it was rented on a short term basis. So the short answer is that you can bonus depreciate the adu assuming you don’t use it personally.

Brandon Hall 21:42
One of the two uses separate structure, the answer won’t change. But but I’ve got different question what if the adu is a separate structure? And you’re renting the main house and the adu out? Do you report that as two separate entries on Schedule E? Or is it one property?

Thomas Castelli 21:58
I don’t know. I don’t honestly know. It’s it’s one of those things where we’ve looked for guidance and our advisory team is researched and researched and research I there doesn’t appear to be a clear answer to this question. I think what a lot of people gotta remember when it comes to short term rentals, is the rules around section 469. And all these rules that were written the tax laws were written way back in the 80s and 90s, when Airbnb wasn’t the thing, so people weren’t renting out at us on a short term basis. On You know, as a business, it just wasn’t it really wasn’t a thing. And if it was it was very unique and small and in the big picture. So really wasn’t popular. So unfortunately, we don’t know there’s no real clear answer to that at the moment. If we do find a clear answer to that at some point in the future. I’m sure we’ll be making a podcast about it. Yeah. Got another one. Okay. We’re closing on a short term rental in California, but live out of state. Can we still use 100% bonus depreciation this year? I saw that California does not conform to the federal special bonus depreciation properties. Since we do not live in California, does this still apply?

Brandon Hall 23:05
Yes, it still applies, you could still bonus depreciate it just it’s at the federal level that you’re going to get the 100% bonus depreciation in at the California level, you’d have to add it back, you won’t be able to claim 100% bonus or any bonus at the California level. So it’s not it’s not based on where you live. It’s based on where the property is located. Or well, let’s just say if you have California Nexus, whatever income stream is associated with real estate, it has to pass through California. So if it’s located in California, or if you live in California, then those the rules you get to add back that bonus depreciation on your California tax return. So you can still you can still claim it at the federal level, you can still benefit there, so will be beneficial. But you’re not able to claim at the California state level.

Thomas Castelli 23:47
Yeah, bummer. Bummer.

Brandon Hall 23:48
One other thing that I do want to mention on that before we move on to the next question is if you have a rental that’s out of state, you know, press pause on the bonus depreciation piece, until you can figure out if you can actually materially participate, because most people that are out of state cannot justify or substantiate their material participation, just because it’s going to be a slog to win that battle. If you ever audited there are a couple people that do it. We have a client that’s doing it right now, I believe, but the client works their butts off. And it’s a lot of work. Like what I’m trying to say is it’s not easy to materially participate at any time, but it’s significantly harder when the property is out of state. And you may say it’s not harder, I can do the exact same thing. But the point is, it’s harder to substantiate and win an argument with the IRS. That’s the point.

Thomas Castelli 24:44
So just take when you’re doing that just make sure you are you’re crossing your T’s and dotting your eyes. Now we do have another question. This question is about repairs and capital improvements that it goes if I have an expense such as an H vac repair or parts replacement that could be considered on the bubble, I guess the way you know they kind of meet on the cusp between a repair maintenance verse capital improvement, is it generally more advantageous to book it as CapEx or repairs and maintenance, and then assuming it qualifies for repairs and maintenance expenses, assuming it’s definitely not a capital improvement, then it’s going to be more advantageous for you to deduct it as a repair main expense, because you can deduct it immediately in the full year, excuse me the full cost in the year that you performed the repairs and maintenance. And as well as you’re going to avoid depreciation recapture down a line. That’s generally speaking, very, very clean cut. Another question, are the interest payments on the construction loan tax deductible for a business partnership building a single family house? And the answer that question is generally the interest on a construction loan during the construction period of the house being built will be added to the basis of that property? So is it tax deductible? Kind of sorta not as immediate in a way, but yeah, it gets it gets capitalized, and then you’re gonna eventually depreciate that building. So it will be deducted a little bit over each year that it’s depreciated. So we got another question was fine right through these today. So we got looking into a 401k liquidation. I know it was a 10% penalty. But can I use a cost segregation to help offset the tax hit at the end of the year with the income after the penalty be considered active? Looking for additional funds to purchase real estate?

Brandon Hall 26:29
I love this question. I love this question. Because I’ve seen people I believe even in our Facebook group, say no, you cannot do something like this, because this question comes up probably once once every quarter. So in that Facebook group, and every once in a while somebody say no, you can’t use your non passive rental losses to offset this rollover or this liquidation income. But the answer is yeah, you can you can because section 469 Does it distinguish between portfolio and inactive income and earned income and all that stuff? Section 469 simply says, you either have activities that are passive or non passive. And if you have non passive activities, those non passive losses can offset any type of income. So the answer here is yes, you can use rental losses from bonus depreciation from caustic studies to offset rollovers, maybe you want to roll over a traditional into a Roth or a Roth into traditional or whatever, whichever way that goes, maybe you want to do a rollover and that creates taxable income even though you didn’t receive any income. Cool, caustic study on a rental, create a tax loss, bam, you can offset that rollover taxable income. Maybe you want to liquidate your retirement accounts like this, like this question asks, yeah, you can use your rental losses to offset that income.

Thomas Castelli 27:45
All right. All right. So here we are. Another question. This one’s about the real estate professional status. I am a real estate professional licensed 1099 working in the industry 40 plus hours per week and my husband is a W two earner. Can we offset depreciation losses for rental properties that we have we have a short term rental managed by us a long term rental under a pm company, a mid term rental managed by us against our W two income since we file jointly, if we own properties with other partners through LLC, can any of those losses be used to offset our income as well? Now? That’s kind of a loaded question. There’s a lot here so it’s break it down. Before we get started, I want to say there’s no such thing at least for tax purposes as a quote unquote mid term rental, right, you’re either having a long term rental, or you have a short term rental. And if the again, to define a short term rental average stay is seven days or less, or 30 days or less, and you provide substantial services. That is a short term rental, right? If you have an average of 31 days or more, it’s a long term rental mid term, you might categorize that for your own purposes. But for tax purposes, there’s either short term or long term, so your mid term rental that you manage, and your long term rentals under a property management company, you could theoretically group them together using the dash nine election. And if you’re able to prove that you spent more than 500 hours on that activity, then you would be able to turn those losses non passive. And the same thing with your LLC that you have, I assume in your LLC, that you have long term rentals, if you would group them all together under the dash nine election. And you would have to meet the 500 material participation test on those between you and your husband in order to make those losses non passive. Now as for the short term rental that’s in a different bucket. Now, that’s not being grouped in with the long term rental properties. So between you and your husband, you’d have to meet one of the material participation tests on the short term rental and there’s three as you can generally meet 500 hours if you hit 500 hours, doesn’t matter how much time anybody else spends, you either do substantially everything yourself, which means you pretty much do everything between you and your husband, or see you spent more than 100 hours on the activity and no one other individual spends more time than you. So if you meet one of those three tests on a short term rental that will be non passive to. So I believe that answers the question,

Brandon Hall 30:05
though I want to just add, add my two cents. And real quick to this person said that they are a real estate professional. They’re licensed, and they’re working in the industry 40 hours a week. The one thing that I want to point out here is that if you are a real estate agent, you’re working 40 hours a week in the industry, you are a real estate professional. For tax purposes, you meet the real estate, professional status tests, 750 hours and more time in real estate than anywhere else. But what we often see with these professionals, is they forget to come back and materially participate in their own rentals. So it’s really critical to take Tom’s advice and make sure that you do figure out how to materially participate in your rental activities. Because if you don’t, even though your real estate professional status, even though you meet that your rentals will still be passive.

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Thomas Castelli 30:52
Right? Right. That’s good. It’s good clarification. Because a lot of times, you know, people sometimes forget that just because you’re a real estate professional by working at another real property trader business doesn’t automatically make your rentals non passive, you still do have to materially participate. So having said that, we’re gonna move right along to the next question. And this is actually a non real estate question. I was advised by my previous tax repair, that as long as I have a high deductible health care plan, that I can open up an HSA account, even if my employer does not sponsor the plan, or offer to sponsor the plan. Can anybody shed light on this, please? Yes. So there’s really easy answer. If you have a high deductible health care plan, you can open up your own HSA. I personally use lively.me for my HSA. So why is the firm has an HSA? Because I set it up before the firm had one or performed okay.

Unknown Speaker 31:44
So was a problem?

Thomas Castelli 31:46
Yeah, well, yeah. Anyway,

Unknown Speaker 31:48
I guess the firm doesn’t contribute to your HSA?

Thomas Castelli 31:50
Yeah, I just contributed to myself. But the bottom line is, you’ve had that to health care plan, you can contribute to an HSA? Yeah. And I’m gonna have to look into maybe switching over to the firm’s but anyway, that’s the you know, the reason

Brandon Hall 32:02
the firm just so that it was like, why would the firm contribute to Tom’s HSA, he’s a good guy, Tom was a partner at the company, so we get treated a little bit differently. One cool thing about HSAs, though, is you can make retroactive contributions. So like, like, we’re recording this March 2022. But if you had an HSA in 2021, and you just never funded it, but you’ve like you spent out of pocket all these medical costs, you can retro actively contribute to your HSA for 2021 taxes, like if you’re filing your tax returns right now, so you can get a deduction for those medical costs. And I believe you can also turn right around and distribute the funds to yourself right from the HSA as a qualified distribution. So it’s like, it’s kind of just a shell game of money to get a tax deduction. And then to put it right back in your pocket,

Thomas Castelli 32:50
right. And there’s some people I’m not gonna go too far into this. There’s some people that say that you should stack up all your medical it put all your money in your HSA, right? Put will max out your HSA, invest your HSA, save all your medical receipts, let your HSA grow. And then at some point later on down the line, cash in all your medical receipts, like a bunch of tickets and cheese. Yeah, and get and get your money out at some point in the future.

Brandon Hall 33:14
Wow, dude, that’s so smart. You let inflation he away at your old medical costs or something, some way

Thomas Castelli 33:22
to save $10,000 in your HSA, you invest in the s&p and earns 8%. Well, the next year, you’re gonna have, what is that $10,800. And then it’s going to keep compounding and over time you keep adding to it, blah, blah, blah. And so you’re just earning a return your money, your wealth, it’s grown through the investment, but your cost that you incurred years ago stays fixed. So if you were to reimburse yourself out that year, or the next year, like like you just said, you can do and you absolutely can do that, by the way, but then you’re losing that ability to let that money grow within the HSA, because you cashed it out and took it in cash. But if you left it in the HSA and let it grow, now you’re earning a return on that money. And then you can later on at some point in future years, 10 years from now, however many years, go ahead and cash it in after the money is grown and compounded. Well, he casts

Brandon Hall 34:09
it out. If you reimburse yourself, though, could you just invest it personally?

Thomas Castelli 34:13
Sure, but it’s not tax free, right. So let me let me say put $10,000 into an HSA, right. So you have to know I was there. Right? And I just say over 10 years that accumulates to $100,000, right? That interest is compound rules compound and let it compound over time. And it’s tax free compounding to write. So when you sell it, when you sell the investment, say the s&p 500 index, you’re not paying tax on that. So it grew. It went in tax free because you got a tax deduction. It grew tax free, and now you’re taking the money out tax free. So if you would have reimburse yourself for say $9,000 in medical expenses, shortly after you put the money in there. Well, you’re going to not allow that money to grow. And sure you could take that $9,000 out and reinvest it yourself and say The s&p 500 A taxable brokerage account. But then in 10 years when that grows that $100,000 In this theoretical example, you go and sell that s&p 500 index, you’re paying capital gains tax on it. So the bottom line is HSA is a very tax efficient vehicle to let your money grow. It’s a very good self insurance vehicle for future medical expenses. And the last thing I’ll say on it is that if you are eligible for an HSA, you should go and invest because it’s really a no brainer. If you live long enough. If you live long enough, you will have health issues probably, that will need to be paid. And it will be we’ll be able to use your HSA for that your kids, your wife, your spouse would need it. So there you go. Awesome. All right. Moving on to a travel related question. So can I deduct the travel expenses? If I am doing real estate recon while traveling, for example, I fly to Costa Rica, to meet with a real estate agent and discuss the possible purchase of a rental property in Costa Rica, can I deduct those travel expenses.

Brandon Hall 35:57
So let’s forget Costa Rica, let’s just say we’re traveling somewhere. And we’re meeting with a real estate agent to discuss potentially purchasing a property, the travel is not going to be deductible. If you end up purchasing a property in that location, then the travel is either deductible or it’s capitalized to the property’s basis, and it’s depreciated over time. So the issue here is that, historically, the tax court has ruled that a landlord is in business in a small geographical area, wherever you own property. So if I own property in Raleigh, North Carolina, I’m in business as a landlord in Raleigh, North Carolina. If I traveled to Charlotte, that’s a new geographical area. And that’s not a place that I’m in business. So if I’m just going to go and meet with potential brokers and stuff, and I never actually open up business, by buying a rental property there, then that travel cost is not going to be deductible to me. So I would need to be in business. If I already owned a rental in Charlotte, and then I was going there to discuss buying another one, then you’ve got the argument that that travel could be deducted. But if I don’t have any business activity in Charlotte, even though it’s only, you know, two hour three hour drive from Raleigh, where I am in business, I can’t deduct that travel.

Thomas Castelli 37:20
Makes sense. All right. So we got our final question for today. It’s another short term rental slash real estate professional question, very popular strategies. Okay. If you have a rental real estate activity with active participation, we’ll have to clarify that in a second. Are you able to use your passive losses from your other investments such as a limited partnership stake in a syndication against your W two income, my wife is managing my short term rentals as her primary quote unquote, job. And I’m the one with w two income. So we have to break this down a little bit, because I think there’s a lot to take apart here.

Brandon Hall 37:58
Yeah, they’re sorry, I got excited with this one, because I thought it was just Can I use my LP losses to offset my passive income? And the answer is yes. And I got excited, because I just went back and forth with somebody in our Facebook group about this. And it was actually a really good discussion. And he ended up saying, Wow, you’re right, I just back checked all the stuff, you’ve provided citations, and nobody else does. This is incredible. So in general, the way that this works is the passive activity rules create two buckets of income. It’s a passive income bucket and a non passive income bucket. My passive income bucket includes any trade or business where I don’t materially participate, and any rental activity. So that’s my passive bucket, my non passive buckets, my w two income, business income, gain on stock, sale, interest, dividends, all that stuff, that’s all non passive. I know that some of that sounds like it should be passive. But for the purposes of these rules, it’s all considered non passive. So two buckets of income. The key to understand it’s complex, and there’s a lot of CPAs out there a lot of tax advisers to say no, it doesn’t work that way. And I’m going to tell you how to school them on it because it does work this way. The key is that if it’s in the passive bucket, everything can offset each other it all nets out. So if I have long term rentals that are producing positive income, I can have a limited partnership investment, produce a loss, a passive loss, and that passive loss can offset my long term rentals, passive income. If I sell a rental at a gain, then the gain is ultimately going to flow through that passive bucket. My Limited Partnership losses from syndications can offset the gain on sale from the rental activity. Even though it’s considered a capital gain. It’s first considered a passive gain or passive income. And my limited partnership losses can offset that income. Okay. And same thing if I if I owned a hair salon, and I love this hair salon example one day I will own a hair salon. So anyway, you put $100,000 into a hair salon. The allocate $10,000 A year to you in income, that’s passive income, I’m not participating in management, I don’t participate at all, I just put $100,000 up and I get $10,000 as a result. So that’s passive income, my rental losses, my limited partnership losses can offset that $10,000 of income, even though it’s not a rental activity, because the key is, is that passive activities, offset passive activities, that’s the key. And everything that we’re talking about right now is passive. So we’re not talking about reps, we’re not talking about, you know, material participation, we’re just talking about passive activities, that they all net out. And if anybody ever challenges you, if your CPA challenges your tax advisor challenges if anybody ever tells you, you know, ask them to prepare form 8582 form 8582 And they will be shocked, because form 8582, line three nets everything together, nets, everything, so all passive income, all gain on sale from rental activities, all passive losses, all prior suspended passive losses, gets netted together online three, so they all net against each other. Now, to circle back to this question. The question here is my wife is managing short term rentals as her primary job, I have w two income, can I use the limited partner losses to offset my w two income? So the answer is going to be no. And the reason the answer’s no is because short term rentals are not considered rental activities. And because short term rentals are not considered rental activities, you cannot use the nine election to group short term rentals with rental activities. So I cannot group My short term rentals with long term rentals or with limited partnership interests that where I’m investing in a syndication that owns rental activities, right. And because I can’t group My short term rentals with rental activities, I can’t materially participate in my short term rentals and then make the syndication activity go non passive as well. So my syndication activity is always going to be passive. My short term rentals could be passive or could be non passive, depending on whether or not your spouse materially participates. But one interesting thing here is that if your short term rentals were passive, and let’s say you’re passively involved in the coming years when your short term rental is producing large amounts of cash flow, because you’ve stripped the bonus depreciation out up front, so now you’re producing large amounts of cash flow. If you’re passive at that point, you’re limited partnership interest, you’re limited your syndication losses, can offset the short term rental income at that point.

Thomas Castelli 42:40
Awesome. Awesome. Alright, so that’s gonna be the last question for today. Now, if you have questions that you want answers to, you have a few options. So you can either go into the tax warn investors Facebook group posted there, and who knows, you might get an answer from one of us there, or we might do it on our next q&a episode of the podcast. Now, the other way to do it is by joining the tech support insiders group, we will be hosting that live q&a This upcoming Wednesday, March 13, at 7pm. Eastern, where if you join that live q&a, you’re basically gonna be on a zoom call with myself and a bunch of other tech smart insiders where you can just ask your question live. So if you’re gonna join that, we’ll see you there, but if not, we’ll catch you in the next episode of the tax smart Rei podcast.

Brandon Hall 43:23
Thanks for listening to today’s show. If you enjoyed the show, please find us on iTunes and leave us a review. You can also email us at contact at the real estate CPA comm with any feedback or topic suggestions, we are always taking on new clients and with the new tax laws in play. You really don’t want to navigate this alone. Let us help you save money on taxes with your accounting and CFO needs. To become a client navigate to our client page at the real estate CPA calm and fill out a webform with as much detail about your situation as possible. Thanks so much for listening. Have a great rest of your week.

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