Monday I shared that we will write off $1.60 for every dollar of equity invested in our recent Laredo IOS deal.
The response in my DMs was: "Great. But does that work for me?" It depends entirely on who you are.
Here is why (and none of this is tax advice, so please bring a CPA into the conversation before you act on it).
WARNING: this is denser than usual. Read it anyway.
The IRS does not care about your bonus depreciation. It cares about your status. There are two kinds of real estate investors in the eyes of the tax code. Real estate professionals. And everyone else.
If you qualify as a real estate professional (IRS definition, not job title):
Three things have to be true:
1. You spend more than 750 hours per year on real estate activities
2. Real estate represents more than 50% of your professional time
3. You materially participate in the properties you own
If you check all three boxes, your rental real estate losses are classified as active, not passive. Subject to the usual loss-limitation rules, those losses can offset W-2 income, business income, and other nonpassive income in year one.
If you are a doctor, tech exec, lawyer, or anyone with a demanding day job:
Your rental income is passive by default. Passive losses can only offset passive income. If you do not have passive income, the depreciation losses accumulate and wait.
There is a $25,000 passive loss allowance that phases out completely above $150,000 in modified adjusted gross income. If you are making good money, it likely does not apply to you. Note: if you are a passive LP in a syndication, this allowance does not apply to you at all.
So how are the rules different for non-RE professionals?
1. The short-term rental strategy. If the average period of customer use is seven days or fewer, the activity is generally not treated as a rental activity under the passive-loss rules. Then the question becomes whether you materially participate. If you do, the losses may be nonpassive. This requires real management and documentation.
2. Carry losses forward and deploy them at exit. Passive losses do not disappear. They accumulate and offset the gain when you sell. You have been deferring taxes, not losing the benefit.
3. Build taxable passive income on the other side: income from other rentals, syndications, or businesses in which you do not materially participate.
4. Start tracking real operating hours: underwriting, leasing, asset/property management, and construction oversight. Not every investor hour counts, so records matter.
The bottom line:
Bonus depreciation is not a real estate professional benefit.
It is a tax deferral tool available to every investor.
Most people investing in real estate do not know which side of that line they are standing on. The difference between using these losses today versus waiting years for them at exit can be six figures. Find out before you close your next deal.
Wednesday Real Estate 101: Bonus depreciation. Part two
