But if you can’t move to another state—and most people can’t—another option possibly exits: You can move some assets to another state.

To begin this discussion, let me start with a quick example of how the state’s estate tax formula works. (I’m going to use the estate tax formula for 2025 because that makes for rounder numbers.) And then I’ll get into the exporting assets thing.

Quick Review of How Washington State’s Estate Tax Formula Works

In 2025, a decedent dying in the last half of the year pays zero estate taxes on the first $3,000,000 of their net worth. (The amount inflates in subsequent years. For 2026, for example, that nice round $3,000,000 ratchets up to $3,076,000.)

On the next $9,000,000, they pay an estate tax rate that starts at 10% but quickly escalates to 35%. In total, though, on that $9,000,000 “band”, they pay $1,930,000 of estate tax.

On the rest of their net worth, they pay a flat 35% estate tax.

Thus, for example, the estate (or really the heirs) of someone who dies with $22,000,000 in late 2025 pays $5,430,000 in estate taxes.

How Out of State Assets Affect the Taxes

But here’s something else to note: Washington state doesn’t “estate tax” residents on out of state tangible property.

For example, while a Washington state resident who died in late 2025 with a $22,000,000 of net worth pays $5,430,000 if the assets are all located in Washington state? If a taxpayer stored or situated half of their assets, or $11,000,000 of their $22,000,000, out of state? That allocation halves the estate tax bill.

Thus this idea to export assets…

How Would Someone Export Assets?

To make this illustration easy, I want to use some big round numbers. So, let’s say two Washington state residents, Tom and Pete, each have $22,000,000. Both own a $10,000,000 retirement account, a $10,000,000 rental income property, a $1,000,000 rare coins collection, and a $1,000,000 condominium where they reside.

I also need to tell you something else here. Washington state sources intangible assets to the state of domicile. Thus, that giant retirement account holding $10,000,000? That’s an intangible asset. No matter what, for both Tom and Pete, Washington state treats it as located in Washington state. (This bit becomes important in a minute.)

But the tangible stuff? So, the $10,000,000 rental property and the $1,000,000 rare coins collection and the $1,000,000 condo? State law sources those to the state where the property is.

If Tom’s rental property, coin collection and condo are all in Washinton state? All $22,000,000 of his stuff sits in Washington state. And he pays the estate tax on the full $22,000,000. So, $5,430,000.

If Pete’s condo is in Washington state but the rental property and coin collection are in Nevada? Yeah, in that case, $11,000,000 of his $22,000,000 estate is tangible property outside of Washington. And therefore, his estate only pays Washington state estate taxes on half of his estate, so $2,715,000.

The obvious maneuver then: If Tom moves his coin collection to another state and exchanges his Washington rental property for one in some other state, voila.  He halves the estate taxes his heirs effectively pay.

Three Wrinkles Related to Exporting Assets

You want to know three other things as you think about this strategy of exporting assets. The first one? You want to export assets to a state with no estate tax. (That should be pretty easy. Most states don’t levy estate taxes. And none levies an estate tax as high as Washington’s 35% rate.)

The second thing to know: If you invest in tangible property through a limited liability company, Washington state sees that as intangible property. Not tangible property. Intangible property, as noted earlier, gets sourced to the state of domicile. Thus, you need to directly own the property. Tom then, in the example above, needs to exchange his $10,000,000 rental property in Washington state for a $10,000,000 rental property in Nevada. Not for a Nevada LLC that owns a $10,000,000 rental property in Nevada. (The Washington Department of Revenue explains and confirms this treatment here.)

A third thing to know and this is common sensed: A person needs to move tangible assets out of the state before they die. This “exporting assets” tactic isn’t something an executor or personal representative does while administering the estate.

Other Resource

Our Washington State Estate Tax Calculator

How Washington State “Estate Taxes” Income in Respect of a Decedent

Powerball Estate Tax Planning

The post Exporting Assets Avoids Washington State’s 35% Estate Tax appeared first on Evergreen Small Business.

The Basic Idea

Bonus depreciation (IRC §168(k)) lets you immediately write off the cost of certain property with a recovery period of 20 years or less. You can think personal property, land improvements, and some interior improvements identified in a cost segregation study. (We talked about this in our last blog post: The Section 168(k) Bonus Depreciation Purchased Requirement.)

A 1031 exchange lets you defer gain when you swap one property for another of like kind. (We’ve also described how these work in past. For example, see Like Kind Exchange Rules Powerful But Tricky )

Here’s the twist: Treasury regulations say that when you exchange into a new property, the basis that carries over from the old property and any new money you invest can be eligible for bonus depreciation. The key cite is Reg. §1.168(k)-1(f)(5)(iii)(A). And the main thing to know: Combining these two laws can potentially result in gigantic tax savings.

A Simple Example

Let’s start with a practical but simple example. Suppose you:

1. Buy a $1,000,000 rental property. A cost segregation study finds $300,000 of 15-year improvements. You claim 100% bonus depreciation = $300,000 deduction in Year 1.

2. In Year 2, you exchange that property for a replacement worth $1,000,000. Basis carries over at $700,000.

3. Regulations let you treat that $700,000 as if newly placed in service for bonus depreciation purposes. Another cost seg shows $210,000 of short-life property — and you get another big deduction.

4. Do it again in Year 3, and the same mechanics apply (though the numbers shrink as the basis shrinks).

It’s a bit like a geometric series of deductions: $300K, then $210K, then $147K…

Obviously, transaction costs matter. The timing needs to work right. (You can’t both acquire and dispose of a property in the same year, for example, to point out one of the important requirements.)

But, wow, that’s surprising, right?  If you’re a high income real estate investor, you may want to exchange existing properties for new properties simply to trigger bonus depreciation. Further, if you’re a high income taxpayer looking for a way to really dial down your federal tax burden? Now would not be a crazy time to look into this investment category.

Who Benefits?

This isn’t for everyone. To make it work you need:

• The right timing (properties bought and exchanged while bonus depreciation is available).

• A cost segregation study on each property.

• Enough participation in the rental activity to avoid falling into the passive activity category. (The three most practical ways to avoid passive losses are described here: real estate professional status, short-term rentals, and self-rentals to a business you own.)

But for active real estate investors, especially those moving up in property size, this can be a powerful way to defer gain through §1031 while still accelerating deductions with bonus depreciation.

The Bottom Line

Most investors think they must choose between a 1031 exchange or a large depreciation deduction. The truth? Under the right circumstances, you can have both.

As always, details matter. Talk with your tax advisor before trying to apply this in your situation.

The post Bonus Depreciation and 1031 Exchanges: A Hidden Opportunity appeared first on Evergreen Small Business.

The date part of that? Easy. You can read a calendar.

The tangible property part? Mostly easy, too. The main rule is anything with a class life of 20 years or less? You can bonus depreciate.

But that “purchase” requirement? Trickier that you might guess.

The Technical Purchase Requirement

So, the Section 168(k) statute says we look to Section 179(d)(2) to determine what a purchase is. And that chunk of the law says this:

For purposes of paragraph (1), the term “purchase” means any acquisition of property, but only if—

(A) the property is not acquired from a person whose relationship to the person acquiring it would result in the disallowance of losses under section 267 or 707(b) (but, in applying section 267(b) and (c) for purposes of this section, paragraph (4) of section 267(c) shall be treated as providing that the family of an individual shall include only his spouse, ancestors, and lineal descendants),

(B) the property is not acquired by one component member of a controlled group from another component member of the same controlled group, and

(C) the basis of the property in the hands of the person acquiring it is not determined—

(i) in whole or in part by reference to the adjusted basis of such property in the hands of the person from whom acquired, or

(ii) under section 1014(a) (relating to property acquired from a decedent).

Which provides most but not all the rules you need… so let’s just step through this.

No Bonus Depreciation for Related Party Acquisitions

A first observation? Someone can’t purchase property from a related party.

That simple rule makes sense just from a loophole prevention context. Without that prohibition, families and family-owned businesses could manipulate bonus depreciation deductions at will.

No Bonus Depreciation for Purchaser Contributed Property

A more subtle requirement. If you purchase some property and then contribute it to a partnership or corporation? No bonus depreciation.

This wrinkle may matter more than you think. For example, if you and your spouse buy a short-term rental thinking you should be able to get giant bonus depreciation deductions? That may work, sure.

But then if you contribute that property to an LLC which you and your spouse both own and then treat that LLC as a partnership? Okay, now we got a problem. The reason? The bonus depreciation deduction would need to go on a partnership tax return. Except the partnership didn’t purchase. You and your spouse did.

No Bonus Depreciation on Inherited Property

Bonus depreciation doesn’t apply to inherited property someone acquires from a decedent and for which tax law (specifically Section 1014) resets the basis to the fair market value usually at time of death.

You can read this rule right in the statute I quoted above. But so you understand and so this makes sense, assume you and your spouse own property—maybe it’s an income rental—and you’ve already depreciated it fully. Maybe you bought the property for $200,000 decades ago and have long since deducted all the available depreciation meaning the adjusted for depreciation “cost basis” now seats at $50,000.

In a community property state, the death of one spouse resets the basis to the fair market value. If the above property at the date of death of the first spouse is now worth $1,000,000? The surviving spouse can again begin depreciating the property. And based on that new $1,000,000 basis. But he or she can’t use bonus depreciation. Rather, the surviving spouse uses regular old MACRS depreciation.

Note: Bonus depreciation would not apply to much of an income rental. Only the parts of the property that represents tangible personal property with of 20 years or less.

No Bonus Depreciation for Section 754 Elections

A sort of related issue: If someone buys into a partnership with tangible property or inherits an interest in a partnership with tangible property? Their purchase price or the Section 1014 basis adjustment can, if a Section 754 election has been made, cause the partnership to adjust the basis and depreciation numbers for that partner’s share of, say, the machinery.

However, the regulations for Section 168(k) specifically exclude taking bonus deprecation on this amount created via the Section 754 election. (Let me cite the actual regulation in case you’re a tax practitioner and want to read this: Reg 1.168(k)(f)(9).)

Yes Bonus Depreciation on Section 1031 Like-Kind Exchanges

So, you might guess that the statute quoted earlier prevents you from deducting bonus depreciation on a least some of the basis you count after a like-kind exchange. But that’s not exactly right. In general, if you want, you can take bonus depreciation on the new property you acquire via a like kind exchange.

Example: You trade land worth $1,000,000 but with a basis equal to $100,000 for a building worth $1,000,000. You can use Section 1031 to avoid paying taxes on the $900,000 realized gain. And the probably you can bonus depreciate the part of the new building that counts as tangible personal property. If 20% of the new building is tangible personal property and your basis is only that $100,000, probably you can deduct $20,000 of bonus depreciation.

If you trade the $1,000,000 piece of land and use a $2,000,000 mortgage to acquire a $3,000,000 building and 20% of that building counts as tangible personal property, you can probably bonus depreciate 20% of the $2,000,000 and the $100,000 so roughly a $420,000 bonus depreciation deduction.

Yes Bonus Depreciation on Section 1033 Involuntary Conversions

A quick final point: If you use Section 1033 to handle an involuntary conversion? Roughly, the accounting for a Section 1033 involuntary conversion works like the accounting for a Section 1031 like-kind exchange.

In other words, if the involuntary conversion causes you to lose one property (a vehicle, a building, or whatever) and you replace that property, you can potentially use bonus depreciation on the carryover basis and the new property’s excess basis.

A fire destroys equipment with basis $400,000 and FMV $1,000,000. The taxpayer receives $1,000,000 insurance and reinvests it all in similar equipment (qualifying under §1033). Basis in replacement equipment = $400,000 (carryover). Under the §168(k) regs, that $400,000 basis qualifies for bonus depreciation (since equipment has a recovery period <20 years)

The post The Section 168(k) Bonus Depreciation Purchased Requirement appeared first on Evergreen Small Business.

But you need to know the rules. And plan ahead. The paragraphs below give the low-down. And maybe the good news here? None of these tips are hard to use. Or too complicated.

Tip #1: Invest in Short-term-rental Properties for Profit

Let me start with a subtle but probably the most important point. Your short-term-rental investment? You need to be doing this to make money. As a way to build wealth. Maybe to prepare for retirement.

Vey frankly? The right way to plan this all out is that you will ultimately invest in multiple properties. Gain some economies of scale. Build expertise.

The reason this “pursuit of profits” angle is so important? The best and really the only big tax savings come when you invest in short-term-rentals for profits. And to grow your wealth.

Note: Section 183, commonly known as the hobby loss rule, and Section 162 set this requirement.

Tip #2: Average Rental Intervals of Seven Days or Less

The next tip: You want to average rental intervals of seven days or less. And for a simple reason: If your average rental interval is more than seven days? You probably won’t be able to use the big tax deductions your property or properties generate.

With intervals of seven days or less, you can probably get big tax savings if you (and your spouse if married) spend more than 100 hours a year. You may even be able to get big savings if you spend just a few hours a year.

With intervals of more than seven days? Tax law considers your short-term-rental a real estate trade or business. And in that case, Section 469(c)(7) of the Internal Revenue Code says you or your spouse will need to qualify as a real estate professional by spending more than 750 hours and more than half your work hours on real estate businesses if you want to deduct losses. That qualification? Obviously much harder for new and very part-time investors to achieve.

Tip #3: Track Your Time

A third really important tip. You need to track the hours you spend on your short-term-rental business starting with the minute you begin your search for your first property. Here’s why: Even if your average rental interval averages seven days or less, you also need to materially participate in the short-term-rental business.

The lowest-hour route to achieving material participation: Be the only person who spends time on the rental. For example, you’re single. You buy a property late in the year. Say mid- to late-November. You rent the property once for a week in December. And the only person who works on the rental—the only person—is you. (For example, if the property is a cabin in the woods? You do any maintenance. And you do the housekeeping before and after your guests stay.)

The most practical route to achieving material participation however? Spend more than 100 hours working on the rental and more time than anyone spends. You can combine the hours that spouses work. But some hours don’t count. (More details on that here: Grouping activities to achieve material participation.) And then this predictable tip: You want to document your hours—and the hours others spend.

Tip #4: Expense as Supplies Everything You Can

Assuming you’ve followed the first three tips, you’re ready to begin loading up your tax return with deductions.

And here’s the tip for doing that: Expense any individual thing that costs $2500 less as “supplies.” So, the $400 chair, the $800 sofa, the $1800 TV, and so on. Appliances, you should be able to expense too.

One caution: You can’t expense individual components of some bigger thing. For example, if master suite bed includes an $800 mattress, a $600 box spring, and a $1200 antique frame thing? You look at the total $2600 of cost to provide someone a place to sleep.

If just writing off as supplies seems funny? You should know that Treasury regulation 1.263(a)) says you can do this by making an election in your tax return.

Tip #5: Pay for a Cost Segregation Study (Maybe)

Another tip related to ginning up deductions. You maybe want to pay for a cost segregation study. That study, conducted by a civil engineer or consultant (so not your tax accountant probably), breaks apart the price of the building into real property and personal property.

Without a cost segregation study, you’ll depreciate the building part of the short-term-rental over 27.5 or 39 years. For example, if you buy a $1,000,000 property, you might call $200,000 of that land and $800,000 of that building. And you depreciate the $800,000 of building over basically three or four decades.

With a cost segregation study, probably, you might instead (in effect) look at the $1,000,000 of purchase price representing $200,000 of land, $600,000 of building, and $200,000 of personal property. That $200,000 personal property chunk you will write off in the first few years of ownership. That frontloads the depreciation into the first few years.

Note: We have a short-term rental depreciation calculator you can use to estimate what a cost segregestion study does to your depreciation deductions.

Tip #6: Consider Bonus Depreciation

By the way, if you do a cost segregation study? Consider using bonus depreciation to immediately deduct some large percentage of the personal property. The bonus depreciation percentage is slowly deflating: 60% in 2024, 40% in 2025, 20% in 2026 and 0 in 2027.

But if you can use bonus depreciation to create a big deduction? And then use that big deduction to save highly taxed income? That’s a no brainer.

Tip #7: Consider Section 179 Depreciation

Bonus depreciation, if it’s available, works best for frontloading depreciation. But some short-term-rental investors may be able to use a similar depreciation trick: the Section 179 election. A Section 179 election allows a short-term-rental business to deduct 100% of most of the personal property shown in the cost segregation study.

To use Section 179 for a short-term-rental, however, your short-term-rental operation needs to rise to the level of a “Section 162 trade or business.” That’s technical tax law concept that looks at your profit motive and then at whether you show continuous, considerable and regular involvement in the business.

Note: The Section 179 method of loading up deductions creates a depreciation recapture risk. Thus, confer with your tax advisor if you want to even think about using this tip.

Tip #8: No Personal Use

A quick caution: You should not use your short-term-rental for personal use. That use triggers Section 280A, a chunk of tax law that explicitly exists to limit or eliminate deductions stemming from a home or vacation home.

The one exception to personal use? If you stay at a property and you (or your spouse if you’re married) works full-time during maintenance.

By the way, if you go spend a week at the Hawaiian condo? And you work full-time during the regular work days but then “take the weekend off?” Now you have two personal days. And Section 280A will basically dial down your tax deductions because some of your use during the year was “personal.”

Tip #9: No Family or Friends

A related point: If you rent to a family member? That counts as a personal day, triggers the Section 280A formulas and probably limits your short-term-rental deductions.

And if you rent to someone at  discounted rate? A good friend you don’t want to charge the regular full price? That then counts as a personal day, triggers the Section 280A formulas, and again probably limits your deductions.

A consolation related to tips #8 and #9. A few years down the road? Once you’ve burned off a bunch of the depreciation? You’ll be able to use the property for personal days, family or friends with less disastrous consequences. But not early on. (And also, just to say this, not if you use the Section 179 election described in tip #7.)

Tip #10: Invest Out of State (Maybe)

A final big, move-the-needle tip. If you reside currently in a high-income tax state and you plan to someday move to lower tax state? Consider investing in short-term rentals in that other state.

The out of state property’s depreciation creates deductions and tax savings on your, say, California state income return while you’re a California resident. But later on, when you reside in some no-income-tax state, say, Florida, you can sell the property without having to pay any state income taxes. Including to your original home state.

Closing Comments and Caveats

Part-time real estate investors often struggle to harvest tax savings from their real estate properties. But for investors willing to plan ahead and think outside the box? The Short-term-rentals tax tips and tricks described above can allow most taxpayers to shelter very large chunks of income.

The post Short-term-rental Tax Tips and Tricks appeared first on Evergreen Small Business.

Some folks can also prudently buy the home or apartment where they reside. But after those obvious options? I’m pretty agnostic. Except, that is, for the real estate investment every entrepreneur should consider: Self-rental property your business occupies.

Why Self-rental Property is So Attractive to Entrepreneurs

Self-rental property works great for entrepreneurs for a simple reason. As long as they follow the rules, they can pretty effectively unlock depreciation deductions that normally other real estate investors can’t unlock. Or unlock without spending tons of time or doing lots of fiddling.

A real estate professional by the way can unlock depreciation deductions. But to do that, she or he will need to spend more than 750 hours and more than 50 percent of their time working in a real estate trade or business. They will also need to materially participate in the properties they own if they want to deduct the depreciation—and this can be problematic.

And by the way? Short-term-rental investors? Yes, they can get giant deductions on their return too. And they may be able to materially participate with very modest hours. But they also need to manage the average rental interval of guests. Because in order to qualify as a short-term-rental investor? Your average rental interval needs to equal 7 days or less.

A self-rental property, however? Easy for entrepreneurs if they do it right.

The Self-rental Property Depreciation Deduction Estimator

Take a peek at the simple JavaScript Calculator below. It shows the depreciation deductions you can probably get from a owner-occupied commercial property that cost $1,000,000. The calculator defaults to 100% bonus depreciation (the right percentage for property placed into service on or after January 1, 2025), and it assumes a cost segregation engineer has broken down the price into real property and personal property.

To summarize, once you click the Calculate button, the Self-rental Property Depreciation Deduction Estimator calculates depreciation deductions for the first year through seventh years. These calculations assume a $1,000,000 price broken down into 25% land, 15% five -year property, 30% fifteen-year property, 0% 27.5-year property, and 55% 39-year property. But what’s unique here? As compared to most real etate investors who will not get to use those gian depreciation deductions? An entrepreneur very probably will.

Tip: Replace the percentages, or decimal values, for your potential real estate investment to estimate actual depreciation you might deduct on your return. And then click Calculate again.

Note: The seventh year’s depreciation is also roughly the depreciation deduction for years that follow the seventh year.

The Usual Problems with Real Estate Depreciation and Other Deductions

The problem with those big deductions however? In many, perhaps most cases, you can’t actually use them. Section 469 of the Internal Revenue Code limits your deductions on a passive investment like real estate to the income you earn from other passive investments. (This is the usual rule for real estate investments, by the way.)

Something special happens with self-rental property that the entrepreneur correctly sets up, however. First, if the entrepreneur groups the rental property with the operating trade or business? That grouping causes Section 469 rules to see the grouped rental property and active trade or business as not a real estate rental activity.

The second thing to happen? The entrepreneur looks at the hours she or she spends on both the rental property and the other active trade or business to determine whether they materially participate. If they spend more than 500 hours on the grouped activities? Bingo.

The First Requirement for Grouping the Rental with the Active Trade or Business

You have two requirements to get a grouping to work. First, the ownership of the rental property needs to perfectly match the ownership of the other operating trade or business. For example, if two shareholders own 60 percent and 40 percent of say an engineering firm? They would also need to own those same percentages—so 60 percent and 40 percent—of the building the engineering firm rents.

Note: You typically would put the real estate into one entity, like a limited liability company. And treat that entity as a partnership. And then the other operating trade or business might be a different partnership. Or a corporation.

The Second Requirement for Grouping

You need to make the grouping in the first year you own the property or operate the trade or business. For example, if this year, you buy a building to house the engineering firm you and your partner have operated for decades? You need to make the grouping election on this year’s tax return.

Note: Not all grouping and aggregation elections need to be made in the first year an activity or trade or business exists. With Section 469 grouping elections like a self-rental, however, the decision not to group the first year is treated as a default grouping. And then the problem that creates? You can’t regroup later on except in special circumstances. And then only with the Internal Revenue Service’s permission.

A Predictable Caveat

Let me end with a predictable caution. One you really don’t even need me to give. (Sorry. But accountants have pretty conservative, compulsive personalties.)

The tax deductions you generate by buying a building and renting it to your business? Very high impact. You may be able to in effect save hundreds of thousands of dollars pretax by using this gambit. (In comparison, remember something like a Section 401(k) plan in the absolutely best case scenario maybe lets you save $70,000-ish of pre-tax money.)

But the tax savings? Not so good an entrepreneur can ignore the return on investment. Thus, we want to treat a prospective real estate investment that same way we’d treat any other business investment. We probably want to calculate the anticipated return on investment. Consider whether and how we can safely use borrowed funds for some of the purchase price. Stuff like that.

The post The Real Estate Investment Every Entrepreneur Should Consider appeared first on Evergreen Small Business.

If you have questions? No problem. Detailed instructions and additional information appear below the calculations.

Collect Home Investment Analyzer Inputs

Forecasted Cash Flows

Internal Rate of Return on Home

Note: The Cash Flow column shows the down payment including closing costs as a cash outflow at the start of the investment timeframe. The Cash Flow column adds the net sales proceeds after adjusting for mortgage balance to the tenth year’s cash flows.

Additional Information and Instructions

The Home Investment Analyuzer calculator calculates a pre-tax internal rate of return, which is equivalent to a geometric average return and to a compound annual growth rate. With example inputs like those that initually show, you can compare the calculated return to other pre-tax rates of returns. Note that some homeowers such as those who use the current standard deduction amount and who qualify for tax-free gain due to the Internal Revenue Code’s Section 121 exclusion may enjoy an after-tax rate of return equal to the pre-tax rate of return. In other words, regularly with homeownership, the homeowner pays no income taxes on her or his profits.

A key component of this analysis: The calculator assumes that if you own a home, you don’t have to pay rent for the home. Thus, the calculator imputes rental income if you buy a particular home rather than rent that home. (Buying the home intead of renting, of course, also burdens the home owner with the operating costs of the home and with, presumably, carrying a mortgage.)

The calculator makes a number of simplifying assumptions in order to limit the number of inputs required. For example, the calculator assumes that the home value, rent and expenses all increase annually by the inflation rate. The Home Investment Calculator assumes a taxpayer will use a 30-year mortgage and sell the property after ten years. Rather than use detailed schedules of operating expenses and selling expenses, the calculator assumes that the property’s maintenance costs, property taxes and insurance equal a steady percentage year after year. Further, the calculator assumes the selling costs (real esate agent commission, escrow costs, transfer taxes and so on) can be expressed as a percentage of the sales price too.

And a Caution

The Home Investment Calculator won’t prove that home ownership always works as an investment. Or that it always fails. The point here, really: You want to do the calculations. Sometimes home ownership generates attractive tax-free returns. Sometimes it doesn’t.

Other Resources You Might Be Interested In

Are Houses Investments (a blog post we wrote a while back to try and explain in words why homes can be investments)

Lessons from the Rate of Return of Everything paper (an academic research paper about what home ownership returns have historically looked like).

The Rate of Return on Everything, 1870 to 2015 (the actual working paper.)

The post Home Investment Calculator appeared first on Evergreen Small Business.

The phrasing often goes like this: Okay, Steve, so assume my rental income covers my expenses including the mortgage interest. A breakeven situation, in other words. I’m also going to get depreciation deductions on the property. And if that happens, how big are those deductions going to be?

The calculator below makes this estimate based on real-life guesses about how the cost segregation engineer breaks out the costs. Just enter your own numbers and click Calculate:

Tips for Using the Short-term-rental Depreciation Deduction Calculator

The initial default inputs reflect a cost segregation for a $1,000,000 residential property the engineer “segregates” as 30 percent five year property, 10 percent fifteen-year property, and 60 percent residential property. These percentages are just guesses–though also actual percentages we’ve seen in real-life studies.

Cost segregation engineers may alternatively assume a short-term-rental is not residental property but rather nonresidential. So, like a hotel. In that situation, you might use a different set of inputs. For example, .15 for the five-year property, .3 for the fifteen year property, and .55 for the nonresidential property. These would also be examples of real numbers we’ve seen on real studies.

Note: The actual percentage allocations depend on the property. Thus, use my examples for seeing how this works. Not for preparing an actual tax return.

The bonus depreciation percentage equaled .6, or 60% for 2024. In 2025, the percentage dropped to .4, or 40%. for property placed into service after December 31, 2024 but before January 19, 2025. Then, the Big Beautiful Tax Bill bumped the percentage to 100% permanently for property placed into service on or after January 19, 2025.

Some Caveats and Qualifications

The short-term-rental depreciation deduction calculator simplifies some of the calculations. It assumes, for example, you use a mid-year convention for the five year and fifteen year property. That’s often the case. But may be overly optimistic if you buy a property late in a year.

The calculator gives you a half year of depreciation on the real property for the first year. That will be close but probably a little too high or little too low in most cases. Depreciation of real property uses a mid-month convention and so looks the actual month you place a property into sevice. Thus, consider the depreciation numbers slightly rough for that first year. They should be close. But not perfect.

And one final comment: The depreciation deduction calculator assumes the short-term rental property is in the United States. Not outside the county.

Additional Resources

The Vacation Rental Tax Strategy (A primer)

The Section 183 Short-term Rental Problem (How hobby loss rules can goof up your investment.)

Surviving Short-term-rental IRS Audits

The post Short-term-rental Depreciation Deductions Calculator appeared first on Evergreen Small Business.

What is Section 183?

First, some background. Section 183 is a part of the tax law that says you can’t deduct expenses of activities you’re not engaging in for profit. You possibly know this law by another name: the hobby loss limitation rule.

But it applies to short-term rentals too if you’re losing money most years. Or if you run up a string of losses in the early years.

To be clear, then, Section 183 creates another way you can lose your deductions on a short-term rental. This law adds to the headaches and requirements of the Section 469 “passive loss limitation” rules and Section 280A “rental of vacation homes” rules.

However, the good news here? The Section 183 risk falls entirely within your ability to manage and control. All you need to do is engage in your short-term rental activity for profit. Seriously, that’s it.

But let’s delve into the details because you’ll want to know the specifics.

Dodging the Section 183 Deduction

The Section 183 Treasury regulations outline nine factors used to determine if you’re engaging in an activity for profit. I list these factors next. Consider each carefully.

1. Manner in which a taxpayer carries on the activity: Is the activity carried on in a “businesslike manner” similar to other profit-oriented activities?
2. Expertise of the taxpayer or his/her advisors: Does the taxpayer rely on expertise or experts?
3. Time and effort expended: Does the taxpayer devote substantial time and effort to the activity, especially if it lacks substantial personal or recreational aspects?
4. Expectation of appreciation in the value of assets used in the activity: Even if the activity doesn’t produce an operating profit, will it produce a profit when liquidated?
5. Success of the taxpayer in carrying on other activities: Is the taxpayer a serial entrepreneur?
6. History of income and losses with respect to the activity: A history of losses during the early years may not be problematic, but sustained losses year after year might be.
7. Amount of occasional profits earned: Occasional small profits may suggest a lack of profit motive, while occasional large profits or the possibility of a large windfall profit may suggest a profit motive.
8. Financial status of the taxpayer: Someone who lacks substantial income or financial resources likely cannot afford to lose money in an activity unless they expect profits eventually.
9. Elements of personal pleasure or recreation: Deducting expenses from an activity others consider a hobby could be problematic.

In an audit, predictably, you want to be able to point to several of these and say, “See that? And that? And that? Yeah. Profit motive.”

Because the challenge with Section 183 and short-term rentals is convincing an IRS auditor, appeals officer or judge that your short-term rental activity was pursued for profits.

Examples Where Section 183 Short-term Rental Problems Crop Up

The Section 183 regulations (specifically Reg. Sec. 1.183-2(c)) provide examples of activities that probably qualify and probably don’t qualify. Practitioners should read these if they’re working with clients who may risk disqualification of deductions.

But let me highlight some situations that either strengthen or weaken the pursuit of profits argument.

In the category of situations that weaken? As compared to other alternatives in the area, you only infrequently or “lightly” rent the property. Maybe you never or almost never show a profit. Perhaps you operate only a single property. Maybe the property is a legacy your family appears to own because dad or grandma owned the property? The property is filled with family photos and personal items. Or, perhaps most problematic: After operating the short-term rental for a year or two, you convert it to personal use. All these situations? Probably bad. Maybe even really bad.

In the category of situations that strengthen your profit motive argument? You either have enjoyed or expect large gains on the sale of property. The deductions and any losses stem from cost-segregation studies (so in a sense Congressionally approved tax accounting tricks that create large losses). You book similar numbers of guests as competitive rental properties. Or you own multiple short-term properties, far more than you could ever personally use or enjoy. All of these situations? Probably okay. And possibly very helpful.

Final Comment about Section 183 and Short-term Rentals

If you’re investing in short-term rentals as a way to invest pre-tax money and build wealth—similar to investing in 401(k) or IRA accounts—you’re clearly doing this for profit. And you should be safe. However, develop and save good documentation to support this.

On the other hand, if you’re investing in a short-term rental to afford a second home for your family? Sorry. Section 183 likely limits your deductions.

Some Other Articles about Short-term Rentals

Vacation Home Rental Traps

Surviving Short-term Rental Audits

The Vacation Rental Tax Strategy

The post The Section 183 Short-term Rental Problem appeared first on Evergreen Small Business.

But first a bit of background about what material participation is and why it matters. And then I’ll talk about how grouping activities sometimes makes a giant difference on your tax return.

Why Material Participation Matters

Okay, so here’s the main thing: You can’t deduct losses from a business venture or hands-on investment except if you materially participate in the activity.

Example 1: Two brothers, Pete and Tom, invest in a new venture. Say a restaurant. The brothers agree to each invest $100,000 and will proportionally share the losses and the profits. Tom will also receive a salary from working in the business. Pete won’t work in the business. He’s keeping his regular job. If the first year, the business loses $100,000, each brother suffers a $50,000 loss. Tom, because he materially participates, can deduct that loss on this tax return. Pete, because he doesn’t participate at all, can’t.

That’s the  basic concept.

The Seven Material Participation Recipes

Next question: How does someone materially participate? Well, tax law provides seven recipes:

• You spent more than 500 hours on the activity.
• You spent more than 100 hours but nobody else spends more time.
• In essence? You were the only person who spent any time in the activity.
• You spent more than 100 hours in the activity, also spent more than 100 hours in some other activities, somehow fail to materially participate in any of these activities using some other recipe, but in total, your hours spent in all of these “significant participation activities” exceed 500 hours.
• For five of the last ten years, you materially participated (for example, using more than 500 hours recipe) .
• You materially participated in a personal service activity for any three years. (Again, for example, by spending more than 500 hours those years.)
• You’ve been involved in an activity on such a “regular, continuous and substantial basis” that you material participated even if one of the other six material participation recipes doesn’t work. (This is an impractical recipe. Too vague. Please don’t think you can use it.)

And one important wrinkle to this discussion for married people. Spouses combine hours to determine material participation. For example, if two spouses each spend 300 hours, the total material participation hours equals 600 hours.

Grouping Activities: Backdoor Material Participation

If you don’t materially participate using one of those seven recipes just listed, however? You have one other gambit you can maybe use: Grouping activities.

The best way to understand grouping is to copy and paste an example from the relevant Treasury regulations at 1.469-4(c)(3):

Example 2: Taxpayer C has a significant ownership interest in a bakery and a movie theater at a shopping mall in Baltimore and in a bakery and a movie theater in Philadelphia. In this case, after taking into account all the relevant facts and circumstances, there may be more than one reasonable method for grouping C‘s activities. For instance, depending on the relevant facts and circumstances, the following groupings may or may not be permissible: a single activity; a movie theater activity and a bakery activity; a Baltimore activity and a Philadelphia activity; or four separate activities. Moreover, once C groups these activities into appropriate economic units, paragraph (e) of this section requires C to continue using that grouping in subsequent taxable years unless a material change in the facts and circumstances makes it clearly inappropriate.

I boldfaced key part of the copied text above. But let me summarize how I think you read this. A taxpayer invested in and works in four activities. Possibly she or he doesn’t materially participate in an activity at least using one of the usual recipes. But the taxpayer can combine activities in any reasonable method. And once activities get aggregated? Probably, the taxpayer does materially participate.

For example, maybe the taxpayer in Example 2 doesn’t qualify as materially participating in the bakery in Philadelphia. And maybe she doesn’t qualify as materially participating in the bakery in Baltimore either. But if she or he combines the Philadelphia bakery with the Baltimore bakery? Maybe that works.

Rules for Grouping Activities

As noted earlier, you can use “any reasonable method.” The Treasury regulations flesh out what that means. And they provide some logical instructions.

You need to look at all the relevant facts and circumstances. Further, a logical handful of factors should be given the “greatest weight” in determining whether it’s reasonable to treat “more than one activity as a single activity:”

I’m going to again copy and paste the actual language from the regulations. (See the bulleted list below.) But think about how these apply to the fictional business owner with bakeries and movie theaters in Baltimore and Philadelphia.

• Similarities and differences in types of trades or businesses
• The extent of common control
• The extent of common ownership
• Geographical location; and
• Interdependencies between or among the activities (for example, the extent to which the activities purchase or sell goods between or among themselves, involve products or services that are normally provided together, have the same customers, have the same employees, or are accounted for with a single set of books and records).

Limitations on Grouping Activities

Because grouping activities is so potentially powerful, limitations exist.

You can’t group a rental activity with a non-rental trade or business except in usual situations. (We’ve described those situations in another blog post here: A Dozen Ways to Deduct Passive Losses. But the common exception to this limitation: You can ignore this limitation when one of the activities is insubstantial in relation to the other. Another common exception: Self-rental situations.)

You can’t group real property rentals with personal property rentals.

You can’t group limited partner and limited entrepreneur activities except when the activities are in the same type of business. (This limitation applies to farming; movie and video production, distribution and holding; leasing Section 1245 property (so mostly depreciable personal property); oil and gas exploration; and geothermal exploration.)

But other than these limitations? In many cases, business owners should be able to group activities to achieve material participation. If they need to.

Grouping Activities Paperwork

You or your tax advisor need to add some paperwork to your tax return to group activities. For example, you include a grouping election with the first tax return you combine activities.

If facts and circumstances change and the original grouping no longer makes sense? You regroup and disclose that action on the first affected tax return.

If you haven’t made a grouping election but should have? Yeah, you should talk to your tax advisor about that. Typically, you can make a “backdated” grouping election.

One predictable and fair caveat?  The IRS may regroup activities if (1) a group is “not an appropriate economic unit” and (2) a “principal purpose” of the grouping was to “circumvent” Section 469’s passive loss limitation rules.

Crazy Grouping Activities Examples That Work

Let me share three example groupings that probably work.

Example 3: A contractor works full-time in his own construction business. His spouse spends 50 hours a year on a short-term rental business—which tax law doesn’t consider a rental activity. But the short-term rental housekeeper spends 80 hours a year. Thus, without grouping the businesses? The taxpayers can’t deduct short-term rental losses. However, if the couple groups the activities, they achieve material particpation. Note that it should be reasonable to group these activities. In addition to the common ownership and control, the husband maybe does construction and repair work in both activities. And then the wife may do the accounting in both activities.

Example 4: A real estate broker qualifies as a full-time real-estate professional, and also spends 75 hours per property per year managing two rental properties. But if he uses separate landscapers for each property and the two landscapers each spend 100 hours a year? He doesn’t materially participate and won’t be able to deduct rental losses. Unless he groups. And in that case, bingo, he material participates. Because his 150 hours exceeds the 100 hours spent by either of the landscsapers. (As mentioned earlier, you can’t group his real estate sales activity with the rental activity.)

Example 5: A taxpayer rides horses professionally (one activity) and operates an interior design business that specializes in equestrian-themed home interiors (another activity). Very possibly, she can group the horseriding with the interior design. Risk exists here that the IRS might see the horse business as a hobby, something I discussed here: What Ms. Topping Learned. But ignoring the hobby loss issue, if someone owns and operates two businesses that together create synergies? Grouping might be reasonable. (Be sure to consult your tax advisor if you want to try something like this.)

A Final Caution Here

And let me end with a caution. The IRS regularly rejects taxpayers grouping an airplane business with another business. Which maybe doesn’t seem to matter to you if you don’t own an airplane. But the rejected airplane activity groupings highlight a risk.

The pattern that seems to show up when the IRS removes an airplane business from grouping? Common ownership and control isn’t enough. You need more than that. You want interdependencies or similarities in the activities. Probably some synergy. And then you don’t want huge differences in the activities. (Grouping a doctor’s office with an airplane charter, for example? Yeah, that’s stretch.)

Other Related Resources:

Real Estate Professional Audits

Surviving Short-term Rental Audits

The post Grouping Activities to Achieve Material Participation appeared first on Evergreen Small Business.

Here’s why: Vacation home rentals present some tax traps for unwary owners. Some big ones.

But learn where the traps are? And how they hurt you? You can limit the damage. In same cases, you can even avoid getting blindsided or beat up. This article reviews the rules.

The General Vacation Home Rental Tax Rule: Proportional Allocations

A chunk of tax law called Section 280A describes the basic rule regarding accounting for vacation homes.

You need to calculate the percent of rental use. And then you can write off that percentage of the expenses but no more than the rental income you earned.

This sounds complicated. But in practice? Pretty easy. An example illustrates.

You personally used a vacation home for 25 days. You rented the home for 75 days.

The rental use equals 75 percent of the overall use. Therefore, you can write off up to 75 percent of the expenses.

If your expenses ran $40,000, for example, you can write off as much as $30,000 of expense.

But the rub: You can’t write off more expense that you earned in rent.

If your rental income equals $40,000, for example, you get to write off the $30,000.

But if your rental income equaled $20,000? You can only write off $20,000. Because the last $10,000 of expenses? Disallowed.

One bright spot here: Disallowed vacation home expenses—like the $10,000 in the previous example–carry over into future years and may be used then to shelter rental income. Potentially. (You’re subject to the same income limitation.)

Anyway, that’s the usual rule. And the main thing to note: You can subsidize the costs of a vacation home by renting. But you can’t generate tax deductible losses.

The De Minimis Vacation Home Rental Tax Rule

A variety of exceptions to the general vacation home rental rule of Section 280A exist.

One is sometimes called the Augusta rule because homeowners in Augusta Georgia, rumor says, make heavy use of it.

Note: The real name of this exclusion is the Section 280A(g) exclusion, which you’ll want to know for a reason I’ll explain in a minute.

If a homeowner rents her or his home for fourteen days or less and uses it as a residence for more than fourteen days? The homeowner can exclude the income.

Note that the homeowner doesn’t get to deduct expenses. But the homeowner enjoys tax free income.

Another example illustrates.

You own a home in  Augusta Georgia. During the Masters Tournament, you can rent your home for $25,000 a week. Due the crazy crowds, you leave home during the tournament and rent your home for two weeks for $50,000. That $50,000? Tax-free income because you rent for fourteen days or less and because you use the home the rest of the home (so more than fourteen days.)

Note: You technically shouldn’t have to report the $50,000 of income on your tax return. But because the payor probably will report the income to the Internal Revenue Service? You’ll possibly want to show the income on a Schedule C or Schedule E form. show the Section 280A(g) exclusion as a reduction in that income,  and then explicitly calculate the resulting taxable income as  “zero.”

Minimal Personal Use Dodges Loss Limitation

Another common scenario with vacation rentals. When your personal use is very minimal.

When personal use is minimal? You also allocate expenses between personal use and business use. But Section 280A doesn’t prevent you from deducting a loss on the rental.

And what level of personal use counts as so minimal it doesn’t trigger the limitation? You need to use property for the lessor of fourteen days or ten percent of the days rented.

Another illustration to show the accounting.

Suppose you used a vacation property for ten days and rented it for one hundred days. In this case, because your personal use days are not more than ten percent of the one hundred rented days? And also not more than fourteen days? You allocate. But you don’t limit.

To be extreme, say you incur $110,000 of expenses. With ten personal use days and one hundred rented days, you treat $10,000 of the expenses as personal expenses and $100,000 of the expenses as business expenses.

And the kicker: Because the personal use was so minimal? You wouldn’t get limited to the income. If the rental income equals $40,000 for example? You would still get to deduct $100,000 of expenses. The loss on the property would the be $60,000 (Because $40,000 minus $100,000 equals minus $60,000.) And you’d get to deduct that $60,000 at some point during your ownership of the property.

Note: When you can deduct the $60,000 of losses would depend on Section 469 of the Internal Revenue Code. In another blog post, we describe how and when you can deduct these sorts of passive losses.

Counting Personal Days Trickier Than You’d Guess

A sidebar: You need to be careful about counting days as personal days. Or as rented days. The Section 280A chunk of law makes it easy to lose vacation home rental tax savings.

A day spent on maintenance, as long as an adult in the family, works fulltime? That day does not count as personal day. Even if the rest of the family is lounging around. This loophole, by the way, specifically applies to days spend on repairs and maintenance. To be safe, don’t assume you can use a property for some other business-y purpose and call the day a non-personal day. You can’t.

Another related wrinkle: Any day you rent a property to someone at below market value? That automatically counts as a personal day. Sorry.

Yet another wrinkle: Any day you rent to a family member counts as a personal except when you rent at a fair market rate to a family member for use as primary residence.

Finally, a last giant wrinkle to know about. Personal use of a principal residence doesn’t count as personal use days when those days fall before or after a qualified rental period.

And what the heck is a “qualified rental period?” Quoting from the law, it’s a “consecutive period of 12 months or more” for which the property is “rented or held for rental at fair market value.” Or it’s a “consecutive period less than 12 months” for which the property is “rented or held for rental” and “at the end of which such dwelling unit is sold or exchanged.”

The takeaway here: If you rent your former principal residence for at least twelve months to someone? Or you rent your former personal residence to someone (like maybe the buyer?) who occupies your home after the point you move and before you sell it? Your occupancy doesn’t count as personal days. Which means you don’t get entangled in Section 280A.

And the big planning point: You want to minimize your personal days. (Ideally, you want to so minimize your personal days that you don’t see your deductions limited to your rental income.) And if you can, you want to jack up the rental use percentage by having lots of rented days. That way you write off more of your expenses.

Other Vacation Home Rental Tax Resources

The Internal Revenue Service provides a very useful publication you want to read if you own and may rent a second home: Renting Residential and Vacation Property Note that you use some special accounting rules to pick which expenses get deducted when you report your vacation home rental income and deductions. The publication describes these.

We’ve got another copy of blog posts that talk about how to work the short-term rental tax planning opportunity: Tax Strategy Tuesday: Vacation Rental Property and Surviving Short-term Rental Audits.

The post Vacation Home Rental Tax Traps appeared first on Evergreen Small Business.