Should You Buy a Short-Term Rental Before Year-End for 2024 Write-Offs?
Nov 10, 2024
As the year winds down, savvy investors may be eyeing one last opportunity to reduce their 2024 tax bill. Investing in a short-term rental (STR) property can offer powerful tax-saving strategies if the property is placed “in service” before December 31. In this article, we’ll dive into the tax advantages available through bonus depreciation, accelerated depreciation, and material participation requirements, and explain how you can still qualify for these tax benefits if you act quickly.
1. 60% Bonus Depreciation: A Key Opportunity
In 2024, bonus depreciation allows investors to deduct 60% of certain property costs in the first year. While this phasedown from prior years still offers substantial tax-saving opportunities, it’s important to understand when bonus depreciation can apply to real estate investments:
Eligible Property Components: Bonus depreciation is limited to assets with a tax life of 20 years or less. This includes items like furniture, appliances, and certain improvements, but excludes the building structure itself, which has a standard depreciation schedule of 27.5 years for residential properties.
Subtracting Land Value: For bonus depreciation, you first subtract the land value from the purchase price to get the depreciable basis, as land itself is not eligible for depreciation. For example, if you purchase a $500,000 property with $100,000 allocated to land, your total depreciable basis would be $400,000.
When Bonus Depreciation Applies Without Cost Segregation: If you’re buying standalone assets separately, like new furniture, appliances, or landscaping improvements with tax lives under 20 years, you can apply bonus depreciation directly to those purchases. However, for bonus depreciation to apply to assets already in the property at purchase, a cost segregation study is generally necessary. This study identifies specific components of the property that qualify for shorter tax lives, making them eligible for the 60% bonus depreciation.
Applying 60% Bonus Depreciation with Cost Segregation: With cost segregation, a study may identify items within the property, such as fixtures, flooring, or landscaping, that qualify for bonus depreciation. For instance, if the study reveals that $100,000 of the $400,000 depreciable basis qualifies for shorter tax lives, you could then apply the 60% bonus depreciation to deduct $60,000 (60% of $100,000) in the first year.
2. Material Participation: Qualifying for Active Loss Deductions
One of the most compelling reasons to own a short-term rental is the ability to use passive losses to offset ordinary income. But this benefit only applies if you meet material participation requirements, which demonstrate your active involvement in managing the property.
Defining Material Participation: The IRS sets several tests for material participation, with the most common requirement being at least 100 hours of active involvement (and more than anyone else) or 500 hours overall. This can include marketing, communicating with guests, and managing property maintenance.
Late-Year Purchases and Material Participation: If you’re buying a property in November, you’ll need to be strategic to meet the material participation threshold. Directly managing bookings, overseeing cleanings, and handling maintenance tasks can help you accumulate hours quickly.
Meeting the Threshold: Let’s say you close on a property in mid-November. To hit the 100-hour threshold, you’d need to dedicate roughly 10-15 hours per week to property activities. Using a tool like Material can help track these hours accurately to ensure compliance.
3. Practical Steps to Meet 2024 Requirements
If you’re serious about claiming these tax benefits for 2024, here’s a roadmap to get your STR investment up and running by year-end:
Place the Property in Service Quickly:
Ensure that basic amenities are in place and that the property is listed on rental platforms (e.g., Airbnb, Vrbo) as soon as possible.
Aim to secure at least one booking before year-end to demonstrate that the property is available and ready for occupancy.
Track Your Material Participation Hours:
Use a tracking tool like Material to document each hour you spend on qualifying activities like guest communication, marketing, and management. This will ensure you meet the IRS requirements for active participation.
Consult a Tax Advisor:
Tax law is complex, and maximizing your deductions requires careful planning. A tax advisor familiar with real estate investments can guide you through cost segregation and ensure your deductions align with IRS rules. They can also ensure you're fully aware of other tradeoffs like depreciation recapture upon resale of your property.
Final Thoughts: Is an End-of-Year STR Investment Right for You?
Buying a short-term rental before year-end can yield significant tax savings, but it requires meeting specific requirements and acting quickly. By leveraging 60% bonus depreciation, layering in a cost segregation study, and ensuring material participation, you can reduce your 2024 tax burden substantially.
However, don't a home purchase just for tax benefits.
If you decide to move forward, consider Material for tracking your Material Participation hours to help ensure you're compliant for tax time!