Many people dream of earning extra income or even finding a way to eliminate their federal tax burden each year. While it may seem impossible, one strategy that is gaining traction is acquiring short-term rental properties like vacation homes or apartments. With the right planning and execution, it is entirely possible to generate income from short-term rentals (STRs) like Airbnb and VRBO properties while paying zero federal income taxes.
Many of our clients at Epsilon Accounting Solutions have found success managing short-term rental properties as a side business or investment. As your trusted accounting advisors, we've seen first-hand how tax incentives like bonus depreciation can truly make this strategy lucrative when executed properly. Here is a step-by-step guide to making this short-term rental tax-saving strategy a reality.
Step 1: Acquire Two Vacation Rental Properties
The first step is acquiring at least two properties that can be used as STRs. Ideal options include standalone homes, condos, or apartment units located in popular vacation destinations. Properties near beaches, national parks, or major cities tend to attract more bookings. Look for properties priced around $320k each so the mortgage, taxes, and expenses can be covered by the rental income.
Step 2: Get the Properties Ready for Rentals
Once you have identified suitable properties, spend time furnishing and decorating them so they are attractive and functional for guests. Equip the kitchens, living areas, and bedrooms with all the necessary amenities. Also, purchase any rental items like bedding, cookware, towels, and small appliances. Take high-quality pictures for online listings, too.
Step 3: List on Airbnb and VRBO and Manage Bookings
List your furnished STRs on popular rental platforms like Airbnb and VRBO. Be sure to include many photos and detailed descriptions. Promote any special amenities too. Respond quickly to all booking inquiries yourself. Having prompt communication will help build loyal guests over time.
Step 4: Track Your Time Spent Managing Properties
To claim the rental income, you'll need to meet the IRS' material participation tests. Track all the time spent maintaining the properties, communicating with guests, and carrying out any repairs. Document at least 100 hours in each rental annually to meet one test for active activity rules.
Step 5: Hire Local Help for Cleaning and Maintenance
While you need to track your time for tax purposes, hire a local cleaning company to tidy up between guest stays. This ensures quick turnarounds. Outsource any non-emergency repairs to local contractors too, rather than handling these tasks yourself.
Step 6: Get a Cost Segregation Study
Cost segregation is the process of reallocating already-capitalized costs from one asset type to another to maximize tax savings. A study identifies portions of building improvements that can be deducted as repairs versus depreciated over many years. This includes things like kitchen appliances or bathroom fixtures. A study allows for a bonus depreciation of 80% on these costs in 2023.
Step 7: Work with a Knowledgeable CPA
Consult a CPA experienced with STR tax treatment to ensure all income, expenses, and depreciation are properly reported. The deductions from a cost segregation study combined with passthrough losses from the rentals could eliminate your entire federal tax liability, depending on your other income sources. Your CPA can also advise on the risk of an audit.
Step 8: Reinvest Tax Refunds into More Properties
If done right, the losses from your rental properties may fully offset your regular wages, generating a tax refund. Reinvest these funds into acquiring another STR property to continue growing your real estate portfolio through leveraging tax savings. Over time, the rentals themselves can become a full-time income source, paying little to no federal taxes along the way.
While undertaking a STR business requires work upfront, leveraging tax incentives like cost segregation, material participation rules, and depreciation deductions can make this strategy more lucrative than simply earning wages. With careful planning and record-keeping, two rental properties could potentially bring in $400,000 per month in rental income while wiping out your entire federal tax burden each year. Start small, reinvest wisely, and continue scaling up over time.
Maximize Benefits with Expert Guidance
Consulting with a knowledgeable CPA is crucial to properly take advantage of deductions and ensure the risk of audit is minimized. Here at Epsilon Accounting Solutions, our team of CPAs has extensive experience navigating the intricate tax rules related to vacation rental income and expenses. We can advise on the cost segregation study process, material participation requirements, and accurately reporting everything on your tax return to maximize benefits.
Rather than simply earning wages and owing taxes each year, leveraging a short-term rental business allows for growing wealth in a tax-smart way. As with many of our clients, the tax savings from an initial two-property portfolio could fund the acquisition of additional rentals. Come chat with us about how we can help you implement this strategy successfully while reducing your tax burden. Our goal is to find new ways for clients to keep more of what they earn.
Disclaimer: This article does not constitute tax advice. Please consult Ahmed Baqir, CPA at Epsilon Accounting Solutions PLLC, before making any tax-related decisions or taking any actions based on the information provided in this article. Ahmed Baqir, CPA, has the expertise and knowledge to provide personalized advice tailored to your specific financial situation and goals.
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