Case Study - How an STR Creates Income and Saves You Money on Taxes

Blog Post Series: Maximizing Wealth Through Short-Term Rentals

Part 5: Case Study - How an STR Creates Income and Saves You Money on Taxes

Welcome to the final installment of our five-part series on short-term rentals (STRs) and their financial benefits for physicians. So far, we’ve explored why STRs are a powerful asset for building wealth, how they provide a blend of income and appreciation, and the critical role of tax efficiency. In this concluding post, we’ll dive into a detailed case study to illustrate how owning an STR can optimize your financial situation and reduce your tax liabilities.

Summary of the Previous Parts

1. Part 1: The Benefits of STRs for Doctors We discussed how STRs serve as both income-producing assets and personal getaways, while also offering tax benefits through Real Estate Professional Status (REP Status) and cost segregation studies.

2. Part 2: Income and Appreciation We examined how STRs translate income into passive revenue and appreciate in value over time, making them an attractive asset class for physicians.

3. Part 3: LLC Ownership for Liability and Tax Efficiency We highlighted why placing your STR in an LLC can offer both liability protection and tax efficiency, focusing on personal use restrictions and operational management.

4. Part 4: Tax Efficiency Strategies We detailed the tax advantages of STRs, including REP Status, the STR REP loophole, and cost segregation studies, and demonstrated how these strategies can benefit high-income professionals.

Case Study: Dr. Michael Jensen's STR in South Haven, MI

To illustrate the financial benefits of STRs, let’s delve deeper into our case study of Dr. Michael Jensen from our previous post, a physician with an annual W-2 income of $400,000. Dr. Jensen owns a short-term rental property in South Haven, MI, and has structured his investment through an LLC. We’ll examine three scenarios: owning the STR without cost segregation, owning it with cost segregation, and owning it with both cost segregation and REP Status.

Scenario Assumptions

• Purchase Price of STR: $500,000

• Allocation to Building (Depreciable): $400,000

• Allocation to Land (Non-Depreciable): $100,000

• Annual Rental Income: $50,000

• Annual Expenses (Excluding Depreciation): $30,000

• Mortgage Interest: $15,000

• Property Taxes: $5,000

• Insurance: $2,000

• Maintenance and Utilities: $3,000

• Property Management Fees: $5,000

• Depreciation Period for Building: 27.5 years

• Cost Segregation Results: $50,000 (5-year property), $30,000 (7-year property), $20,000 (15-year property), $300,000 (27.5-year property)

• W-2 Income: $400,000

• Tax Rate: 35% (for simplicity)

Scenario 1: Owning the STR in an LLC Without Cost Segregation

Depreciation:

• Annual Depreciation: $400,000 / 27.5 = $14,545

Net Rental Income Calculation:

• Gross Rental Income: $50,000

• Total Expenses: $30,000

• Net Rental Income: $20,000

Taxable Income Calculation:

• Net Rental Income: $20,000

• Less Depreciation: $14,545

• Taxable Rental Income: $5,455

Taxes Paid:

• W-2 Income: $400,000

• Taxable Rental Income: $5,455

• Total Taxable Income: $405,455

• Taxes Paid on W-2 Income: $400,000 * 35% = $140,000

• Taxes Paid on Rental Income: $5,455 * 35% = $1,909

• Total Taxes Paid: $140,000 + $1,909 = $141,909

Cash Flow:

• Net Rental Income: $20,000

• Less Taxes on Rental Income: $1,909

• Net Cash Flow: $18,091

Scenario 2: Owning the STR in an LLC With Cost Segregation Study

Depreciation:

• 5-Year Property: $50,000 / 5 = $10,000

• 7-Year Property: $30,000 / 7 = $4,286

• 15-Year Property: $20,000 / 15 = $1,333

• 27.5-Year Property: $300,000 / 27.5 = $10,909

• Total Annual Depreciation: $26,528

Net Rental Income Calculation:

• Gross Rental Income: $50,000

• Total Expenses: $30,000

• Net Rental Income: $20,000

Taxable Income Calculation:

• Net Rental Income: $20,000

• Less Depreciation: $26,528

• Taxable Rental Income: $0

• Depreciation Carried Forward: $26,528 - $20,000 = $6,528

Taxes Paid:

• W-2 Income: $400,000

• Total Taxable Income: $400,000

• Taxes Paid on W-2 Income: $400,000 * 35% = $140,000

Cash Flow:

• Net Rental Income: $20,000

• Less Taxes on Rental Income: $0

• Net Cash Flow: $20,000

Scenario 3: Owning the STR in an LLC With Cost Segregation Study and Claiming REPS

Depreciation:

• 5-Year Property: $50,000 / 5 = $10,000

• 7-Year Property: $30,000 / 7 = $4,286

• 15-Year Property: $20,000 / 15 = $1,333

• 27.5-Year Property: $300,000 / 27.5 = $10,909

• Total Annual Depreciation: $26,528

Net Rental Income Calculation:

• Gross Rental Income: $50,000

• Total Expenses: $30,000

• Net Rental Income: $20,000

Taxable Income Calculation:

• Net Rental Income: $20,000

• Less Depreciation: $26,528

• Taxable Rental Income: $0

• Depreciation Used to Offset W-2 Income: $26,528 - $20,000 = $6,528

• Adjusted W-2 Income: $400,000 - $6,528 = $393,472

Taxes Paid:

• Adjusted W-2 Income: $393,472

• Total Taxable Income: $393,472

• Taxes Paid on Adjusted W-2 Income: $393,472 * 35% = $137,715

Cash Flow:

• Net Rental Income: $20,000

• Less Taxes on Rental Income: $0

• Net Cash Flow: $20,000

Summary Comparison

Analysis:

1. LLC without Cost Segregation: Higher taxes and lower net cash flow due to limited depreciation benefits.

2. LLC with Cost Segregation: Slightly reduced taxes and increased net cash flow due to higher depreciation deductions.

3. LLC with Cost Segregation and REPS: Significantly reduced taxes and maximized net cash flow. By using REPS, Dr. Jensen can offset W-2 income with the remaining depreciation, resulting in substantial tax savings.

Conclusion

Owning a short-term rental can be a powerful strategy for both generating income and optimizing your tax situation. By leveraging cost segregation studies and REP Status, you can enhance your financial benefits and reduce your tax liabilities. This case study demonstrates how strategic management of your STR investment can lead to significant savings and improved cash flow. This has been my exact experience with my STR Simpli SoHa.

Unlock the full potential of short-term rentals to boost your income and enhance your tax efficiency. If you’re interested in experiencing the charm of South Haven, MI, book a stay at my Simpli SoHa STR rental for your next vacation.

Call to Action

If you’re a physician interested in maximizing the potential of short-term rentals and other real estate investments, consider enrolling in The Semiretired Doctor's "Accelerating Wealth Course." This program provides valuable insights and strategies for leveraging real estate to build and sustain wealth. Sign up now to gain expert knowledge and start enhancing your financial future.

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