You don't need to be a real estate pro to pay zero tax (Week 2 of 3)

YOUR MOVE

Sarah bought a $900,000 rental property in 2020. She took standard depreciation for four years. Never did a cost seg study.

Last spring she called and asked if it was too late.

It was not. We ran a cost seg, identified $225,000 in 5-15 year property, and filed a Form 3115 to pick up $150,000+ of additional depreciation she had been leaving on the table.

One form. $55,000 in tax savings. On a property she already owned.

That is what this week is about. Your exact moves based on where you are today.

If you missed Week 1, go read it first. Everything below builds on that framework.

Three paths. Find yours.

Path 1: You Already Own Property (The Found-Money Play)

If you bought rental property and never did a cost seg, you have money sitting on the table right now.

The IRS allows you to file Form 3115 to change your depreciation method. This creates a Section 481(a) catch-up adjustment. All the depreciation you should have taken but did not gets picked up in a single year.

This is not an amended return. It is a prospective change with a one-time adjustment that sweeps up prior years.

Sarah's $900,000 rental is a clean example. She paid $29,000 a year in standard depreciation. The cost seg study reclassified $225,000 into 5-15 year categories. Because she bought in 2020 when 100% bonus was in effect, the catch-up adjustment captured everything she missed.

One filing. Four years of missed deductions recovered in 2025.

Your action steps:

• Get a cost seg quote on every property you own. The study pays for itself 10x over on most deals above $500,000.
• Ask your CPA about Form 3115. If they do not know what it is, that is a problem.
• Check the bonus depreciation rules for your placed-in-service year. Properties placed in service in 2023 had 80% bonus. 2024 had 60%. Properties placed in service after January 19, 2025 get 100% permanent. The year you bought changes the math on the catch-up.
• Look hard at 2020-2022 properties. Those had 100% bonus and are the biggest opportunities for a 3115 filing.

Path 2: You Are Buying In 2026 (The Day-One Playbook)

If you are looking at deals right now, you have a massive advantage. 100% bonus depreciation is permanent. Factor it into every analysis before you make an offer.

I tell every client the same thing: run the cost seg estimate BEFORE you close, not after. It changes how you evaluate the deal.

A $1.5M multifamily property at 80% financing. $300,000 down. Cost seg identifies 30% in short-lived property. That is $450,000 in bonus depreciation on day one.

At a 37% rate, that is $166,500 in tax savings. More than half your down payment back through the tax code.

Now compare property types. Multifamily buildings reclassify 20-25% on average. Restaurants and medical offices hit 35-40%. A self-storage facility can go higher. The building type changes the size of your deduction.

Evaluate the land ratio before you buy. High land value kills your depreciation. A $2M property on $800,000 of land gives you $1.2M to depreciate. That same $2M on $400,000 of land gives you $1.6M. The difference in tax savings at 37% is $148,000.

Order the cost seg study the day you close. Not next quarter. Not next year. Day one.

Path 3: You Think You Do Not Qualify (Three Workarounds)

The biggest misconception in real estate tax planning: you need RE Pro status to benefit from cost seg and bonus depreciation.

You do not.

Here are three paths that work without it.

Workaround 1: The Short-Term Rental Loophole

If your average guest stay is under 7 days, the IRS does not classify it as a rental activity. It is treated as a business.

That means your losses are not passive. They are active. They offset your W-2 income and your business income without RE Pro status.

You must materially participate. The most common test: log 100+ hours on the property where no one else spends more time than you.

A warning here. If you use a property management company, their hours count against you. You need to be the single largest contributor of time to that property. If the management company's staff collectively logs more hours, you fail the test.

I worked with a couple who bought a $600,000 vacation property in the Hill Country. Average stay: 4 nights. They self-manage through Airbnb. Cost seg generated $150,000 in bonus depreciation. At 37%, that is $55,500 offset against her W-2 income as a physician.

No RE Pro required. They just had to manage the property themselves.

Workaround 2: Buy Your Building

If you are a business owner paying rent, this one is a no-brainer.

Buy the building personally or through a separate LLC. Lease it back to your S-Corp or operating business. Run a cost seg.

Under Treas. Reg. 1.469-2(f)(6), rental income from a self-rental is recharacterized as nonpassive. That means it groups with your active business income on the same return.

A few things to know. Self-rental losses remain passive. You cannot generate net losses from this arrangement and use them against active income unless you have RE Pro status or fall under the $25,000 active participation allowance (which phases out at $150K AGI).

But the cost seg deductions offset the rental income from the lease. That is real tax savings without needing to use losses against outside income.

You get three things: a deductible lease payment out of your S-Corp, cost seg deductions on the building, and an asset that builds equity instead of paying someone else's mortgage.

Workaround 3: The Spouse Strategy

I covered this in Week 1 but it is worth repeating because it is the most common path I see.

Your spouse does not need to work in your business. They need to work in real estate. 750 hours. More than half their total working time.

If your spouse works part-time or has a flexible schedule, this is the easiest test to pass. A spouse working 800 hours in real estate and 700 hours at a part-time job qualifies.

Their status. Your joint return. Every property's losses now offset your active income.

What Is Coming

Week 3 (next week): The endgame.

Five exit strategies that make the tax bill disappear. 1031 exchanges. The refinance play. Installment sales. Step-up in basis at death.

And the one strategy where you never exit at all. The step-up happens while you are still alive.

That issue will change how you think about every deal you do from here forward.

See you next week,

Mitchell Baldridge, CPA, CFP®

P.S. If you own property and your CPA has never mentioned Form 3115, forward them this email. If they still do not know what it is after reading it, call us.

P.P.S. Track every hour you spend on real estate activities. Time logs. Calendar entries. I do not care how you do it. The IRS cares that you did it. This is the single most audited area in real estate tax.

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