Accelerated depreciation offers significant upfront tax benefits for real estate investors, but it also comes with notable challenges:

• Depreciation Recapture Tax at Sale: Accelerated depreciation can create large upfront tax savings, but when you sell, you may face a significant depreciation recapture tax bill, reducing your profit.
• Reduced Deductions in Later Years: Frontloading depreciation means fewer deductions in future years, which could lead to higher taxable income and taxes in those later years.
• Complex Bookkeeping: Accelerated depreciation and changes between STR and LTR status require careful record-keeping and sometimes filing additional forms. This adds upfront costs and ongoing complexity, as you’ll need to maintain multiple depreciation schedules and update them if you make significant property improvements.
• Audit Risk: Errors in tracking hours, documentation, or depreciation schedules can increase your risk of IRS scrutiny and penalties.
• Misclassifying Rental Type: Mixing short- and long-term stays or failing to meet material participation requirements can disqualify you from the loophole’s benefits.

In summary, STR Loophole through accelerated depreciation can provide powerful short-term tax savings. Investors should carefully weigh these benefits against the potential for higher taxes at sale, reduced future deductions, and increased administrative complexity.

Common Mistakes:

• Hire Property Manager: It may be difficult to qualify for the material participation rule if you have a full time Property Manager.
• Insufficient Documentation: Not tracking hours or participation can make it hard to prove material participation if audited.
• Misunderstanding Personal Use Rules: Excessive personal use can limit deductible expenses and disqualify the property from STR tax benefits.

Next Steps:

• If interested in pursuing the STR Loophole strategy, inquire your tax professional: 
  • STRs are treated differently from long-term rentals (LTRs) under IRS rules.
  • The loophole is based on Treasury Regulation Sec. 1.469–1T(e)(3)(ii)(A) and Section 469 of the tax code.
  • Owners do not need to meet the stringent REPS requirements to benefit.
• Not all tax professionals understand this strategy – look for one familiar with cost segregation and short-term rental rules. Nudge us for a referral to tax professionals with STR expertise.