Ashley Kehr:
What if on tax strategy you think is reserved for big investors only could wipe out a huge chunk of your W2 tax bill on your very first rental?

Tony Robinson:
Or maybe you’re about to hand a stranger the keys to a property you just spent every last dollar on and you have no idea what to actually put on your tenant application.

Ashley Kehr:
And finally, what happens if you fall in love with the idea of flipping houses, but you want to roll every dollar of profit into the next deal without losing a chunk to capital gains? We’re answering all three of those questions and helping you keep more of every deal you do.

Tony Robinson:
This is The Real Estate Rookie Podcast. I’m Tony J. Robinson.

Ashley Kehr:
And I’m Ashley Kerr.

Tony Robinson:
And with that, let’s get into today’s first question. So today’s first question comes from Arenze in the BiggerPockets Forums and this question says, “I need help making a decision on whether to use a cost segregation or not. I’m still a new investor, but I bought a six unit residential property this year in central Massachusetts and I do plan on holding the property for a long time. I have a high W2 plus another side business with six figures. My question is whether using a cost segregation will help in dropping down my taxes. What are the pros and cons and then what are some referral companies that can do this cost segregation study? I think first let’s talk about what a cost segregation study is. It’s basically like an engineering study where instead of taking standard depreciation on a piece of real estate and I believe for a single family home, it’s 27.5 years.
I think for commercial property it’s 39.5. Don’t quote me on those. Somewhere in that ballpark. But instead of taking the depreciation across that standard schedule, you reclassify different components of the property. The roof, the appliances, flooring, whatever it is, and you accelerate that depreciation. Some get bunched into the first year, some get spread out over five years, but there’s a scale there. So it allows you to basically accelerate a lot of that depreciation. So instead of waiting almost three decades, you can get a big portion of that depreciation in year one. Now the cost segregation study can be combined with something called bonus depreciation, which again is where you get all of that. You can take 100% of that in year one. Now I think the trap here where a lot of folks get confused is that if you generate this massive paper loss from your cost sex study, it typically does not offset your W2 income or your other forms of active income unless you qualify for what’s called real estate professional status or you use the short-term rental tax loophole.
Now, again, we should have said this from the beginning. Ash and I are not CPAs, so go talk to a qualified tax professional for your specific situation. But typically reps, real estate professional status or the short-term rental tax loophole are the easiest ways to kind of unlock the benefits of the cost segregation study. If you don’t qualify for either of those, well then all of that paper loss can only be applied against your other forms of passive income from your real estate. So basically the income produced of cash flow from your property, that can be offset by the cost segregation study. Now it is incredibly difficult to qualify for real estate professional status if you’re working a full-time job because you have to prove that you spent more hours in real estate than you did in your full-time job. So if you’re spending 40 hours a week working full-time, well, then you have to prove and show that you’ve spent more than 40 hours per week every single week working in real estate.
And for most people, that’s just unreasonable and not possible. That’s part of the reason why these short-term rental tax loophole is so popular today, because it is significantly easier to apply the short-term rental tax loophole than it is rep status. For the short-term rental tax loophole, there are a few different kind of tests you can meet. One test is the 100-hour rule where you spend at least 100 hours working on your short-term rental. And if you add up all of the other time that other folks have spent, your cleaners, your maintenance folks, whoever may be, they haven’t exceeded the 100 hours. The other approach is the 500-hour rule where regardless of how many other hours other folks have spent, if you spend at least $500 for the whole year, you can qualify for material participation through the short-term rental tax loophole. So that was a lot, but I just wanted to make sure I’ve kind of laid the foundation there for the differences and when you can and can’t apply the benefits of the cost segregation study.

Ashley Kehr:
We actually have a couple resources and I was just trying to look for the links of them, but I’m going to put them in the YouTube description if you’re watching this. We do have a sponsor and I’m going to link their blog posts, but you can get discounts on some of the cost segregations too if you guys are interested in doing that. I did a cost segregation on a property and when it was my first time going through and doing this process, I invested for so long without ever doing one. And it was such a huge regrets of mine that I didn’t know about this sooner. I literally found out about this several years ago and at that point I’d already been investing for like eight years. So I think this is a really beneficial tool. I recently went to Florida and go ahead, put your hate comments on about investing in Florida.
But I wanted to look at property while I’m there. So when I looked at this market as it’s a buyer’s market, there’s not a ton of cash flow. Your biggest opportunity there is renting to a snowbird for six months out of the year. But the real benefit if you were to purchase a property there would be doing a cost sag on the property and getting tax savings. It wouldn’t be cashflow right now. It definitely wouldn’t be appreciation in that market either. So I think that was something that took me a long time to realize are the tax benefits of actually owning a property besides just your regular depreciation that you’re getting off of standard amortization of depreciation.

Tony Robinson:
Now one last piece that I’ll comment on is that even when we do something like a cost segregation study, we get this bonus depreciation, we qualify for material participation or rep status. It’s not like the taxes that are due that they just disappear. We’re basically just kind of getting a loan from the IRS to say, Hey, we’re not paying this today, but the IRS is still keeping track of what you owe them. It never just kind of goes away. And then if you do sell that property in the future, there’s a recapture of those taxes that’ll be applied. But in order to, again, continue to delay those taxes due, you can do what’s called the 1031 exchange where you’re able to defer both the recapture and the capital gains on that sale. So a lot of folks, they’ll use the 1031, it’s called swap to you drop where you basically never actually sell or you’re just recycling that capital into the next deal, or you can just hold the property forever, like just never sell the property and you can do things like a refinance to try and get some of that equity back.
But I just wanted to highlight that because people think that, okay, hey, if I do this and it’s just like free money from the government, when that’s not quite the case, it’s just deferring that tax liability to some point down the road.

Ashley Kehr:
I’ve heard several people that have retired and they said the second best day of their life was when they bought their rental property and the best day of their life was when they sold it. But if you’re going to hold it forever and you’re going to keep that, not have to recapture that depreciation, that’s not going to work. But you could also put it into a trust for a family member, your kids or whatever, just so that when you pass, they get the benefit of the trust or the beneficiaries and they will only pay taxes on what the value of the property is when they inherit it. So instead of paying taxes on what you bought it for 20 years ago compared to what they could sell it today, that can be a huge difference. So you can even continue on the tax benefits until after you have passed away.
Okay. We’re going to take a short break, but coming up, we’ve got one shot to pick the right tenant. So what criteria should you actually set before you list? We’ll break it down right after this quick word from our sponsors. Okay. Welcome back. Our next question comes from the BiggerPockets Forums. “Good morning all. I am set to close on my first investment property tomorrow. This is a two unit multifamily with one unit occupied and the other has been turned over and is ready for rent. What criteria does everyone here set for tenants? Minimum credit score, criminal history, income amount, and so on. I have a good idea of what I want but would love to hear input from some more seasoned investors and anything to look for or to avoid at all cost. “Okay. So to recap, set to close, two unit, multifamily. They don’t need to start screening tenants to look for them.
So it is very important to set your criteria. Easiest thing to do, go into AI, ChatGPT, go into Claude and have them give you a checklist, create a checklist of what is the screening criteria I should have. Okay? Now, I don’t want you to use what it actually says for your screening criteria, but I want you to look at these different things and see if it maybe even gave you more. But you want to set a minimum credit score, you want to set criminal history and you want to set if they have a violent criminal past, you’re not going to accept them. What the income amount is and by this, I usually do it as to how much more income they need than what the rental is. So common is three times what the rent is or three and a half times what the rent is.
This also depends on your class and your neighborhood too that you’re investing in. So these are diferent criteria that you want to set and I would put it right into your listing so it’s very clear what it is when someone fills out the application, I would put it in there so they’re not wasting their time and you’re not wasting your time, but also you don’t want to violate any fair housing laws. So this criteria cannot be no kids allowed or anything like that. And you want to check your state laws as to how specific you can get on what you can deny for criminal history too, but also evictions. In New York State, you cannot deny someone a rental because they have been evicted in the past. It has to be for some other reason. So you can’t say no past evictions if you’re in New York State.
So I would start with that as to kind of setting your criteria for what you want and then set up some property management software that has the screening process. There are companies out there that are just the tenant screening. I really like it integrated with the property management software because you can go ahead and do the full process from start to finish of renting out your unit. So you’re going to set the listing inside. You’re going to hit one button and the property management software is going to push it out to multiple websites. Every time you get a lead, someone clicking that they’re interested, it will go right into the property management software. So even though you’re listed on apartments.com, Facebook Marketplace or realtor.com, Zillow.com, whatever it is, it all comes into one place for you, Craigslist Steven. And so then from there you could send a pre-screen, you could send the application, you can send them a link to schedule a showing for the apartment.
And then from there, when they fill out the application, you can select the screening to be done. So a background check and a credit check. I like to do a verify their income. Some property management software has that integrated where it will do that for you based on their pay stubs. We’ll verify that. If not, you’re going to want to call and verify any documents they give you. So their pay stubs. I’ve had people before submit to me fake pay stubs. I would literally just Google that the address they put on there didn’t even match the company. And then I would call the company and ask and they would have no record of this person at all. Sometimes it’s that easy to catch them, but I would verify as much as you can references, ask them for personal references, ask them for past landlord references.
I also like to … The character references I don’t take much weight in because they can literally put down anybody and they’re usually going to put down people, give them a good recommendation. But the previous landlord, I tried to do a little research and make sure like, okay, this is where they said their last address was. I look up who actually owns that property, see if I can find any correlation to the name they actually gave me, the phone number to coordinate with the address or whatever. And then when I am doing the phone call verifying with the landlord, I try to ask some questions that don’t make me accuse the landlord of being an imposter, but maybe something they would only know about the property if they were the landlord or something like that. You can look up the tax record history or something like that.
But I’m more just trying to compare that they actually own it. It’s not just their friend’s phone number they’re giving me to pretend to be their landlord.

Tony Robinson:
Ash, have you ever actually experienced that where you caught someone red-handed in that kind of situation?

Ashley Kehr:
Not for a landlord, but for an employer reference. I thought I did. I thought I did because it was so sketchy and it was so weird. The email was like a Gmail account, not for a company or anything. And I actually called where it was for a bakery that they said they were starting employment at. They just moved to the area or whatever. But any interaction with the landlord was through a Gmail or a text. It was very, very weird. And I thought I was catching them lying because they didn’t even have a first pay stub yet. They just had a letter written up and then I called the bakery and they actually, I asked to speak to that person and so I got to talk to them there. But the fake pay stubs, I got the fake pay subs before and I didn’t even take it a step further because they were fake.
I wonder if you could run them through AI, like some of this verification and ask, “Do you see anything that stands out that this is fraudulent?” I wonder.

Tony Robinson:
And I was going to say the inverse, I feel like it might be even harder now to catch those things because of AI where someone can make an incredibly easy looking, not only a pay stub, but someone could build out an entire fake website with a few prompts to say like, “Hey, I was the VP of finance at this company.” And there’s a whole digital presence behind it now. But yeah, I was just curious if you’ve ever caught someone red-handed.

Ashley Kehr:
I mean, look at the people that there’s documentaries on where they’ve inserted themself into the wealthy of New York City or whatever and pretend that they are part of that society and everything and people believe it. It goes along with it and all this stuff and it’s like someone can do that. Someone can easily rent an apartment on fraudulent information.

Tony Robinson:
Fake it till you make it at the highest level.

Ashley Kehr:
Unless you’re renting from me, don’t do that. All

Tony Robinson:
Right guys, we’re going to take a quick break before our last question, but while we’re going, be sure that you are subscribed to the Real Estate Ricky YouTube channel. You can find us @realestatericky and we’ll be back with more right after this. All right, let’s jump back in. Our last question today is one that could save you maybe a lot of money in your taxes as well or cost you if you get it wrong. So the question says, “I purchased an off market fix and flip property in New Jersey using hard money and I plan to list it within about two months or a month, eight weeks, give or take after closing. I’m wondering if I can utilize a 1031 exchange when I sell it to defer capital gains taxes from my understanding. 1031 exchanges are typically for investment properties held for rental or business use, but I’m curious if there’s any way my flip could qualify, especially since I haven’t sold it yet.
Would holding it for a short term period automatically disqualify me or are there strategies to structure the sale to make it eligible? Has anyone ever done a 1031 exchange with a flip?” Okay, we talked a litle bit about 1031 exchanges in the first question, this is kind of like a good kind of part B to that. The short answer is no. You cannot leverage a 1031 exchange on a flip property. Flips are inventory, right? They’re commodities. They’re not true investment properties and because of that, they don’t qualify for a 1031 exchange. So again, just to clarify, going back to question one, the benefit of a 1031 exchange is that you can defer any capital gains taxes on the sale of a rental property if you use those proceeds to buy another rental property. When you’re flipping, that’s not quite the case because it was never truly a rental and the IRS looks at intent, not just timing.
So even if you hold it for say 14 months, if your plan was always to sell that property, well, then you could still very quickly get disqualified. We’ve actually done a 1031 before on a property that we held for, I believe it was nine months, but we bought that property with the intention of renting it out and we did rent it out, but the market shifted in our favor where we had a lot of equity during that nine month period. There was another larger set of properties we wanted to purchase and we were able to 1031 the proceeds from that property that we held for nine months into another rental. But we had a lot of proof.This is a short-term rental for us. It was on a bunch of platforms. We had a lot of guests coming in and out, but if anyone ever questioned our intent, it was very clear from the beginning that as soon as we bought it, we immediately put guests into it.
It was never listed for sale. We didn’t even do any renovations on it. So it was very clear what our intent was. So for a flip, there’s basically no way to, I think, to avoid that. Now, if you want to do a delayed flip, that could be an option where say you buy a property, you renovate it, you immediately place a tenant in there and then maybe you hold it for 24 months. Then maybe there’s an opportunity for you to sell that on the backend and still be eligible for a 1031. But again, you want to talk that over with your qualified tax professional to make sure that you’re setting yourself up appropriately, but flipping and 1031 typically don’t go together.

Ashley Kehr:
One thing that I’ve been thinking about doing is, so I doing a live-in flip right now and I’ve already got my next property set up, but it hasn’t been two years yet. So it’s been over a year, so I fulfilled my mortgage requirements by living here for a year, but if I move out right now, I will have to pay capital gains tax when I end up selling the property because it hasn’t hit that two-year mark. So what I think I’m going to do is move out to my new house when it’s done, but rent this property for several years and then I’m going to go ahead and sell it into a 1031 exchange so I’m still avoiding taxes and then investing into another property.
I’m not getting just cash for free. I still have to do the 1031 exchange to put the money into another property, but honestly, I’d probably do that with the proceeds anyways of this property. So there are different ways that you can work to make something work out if you do have to pivot or change your strategy, but I would definitely not risk it with a flip of just doing the rehab, listing it and selling it and then saying I’m doing a 1031 exchange that if you’re audited, it’ll definitely be called out. Okay. Well, thank you guys so much for joining us today on this episode of Rookie Reply. If you have questions, make sure to check out the BiggerPockets forums. I’m Ashley, he’s Tony, and we’ll see you guys on the next episode.