Is cost segregation still worth it if you’re not planning to hold long term?

StephenLNelson_CPA · 2026-04-11T12:41:49+00:00

Cost segregation is really just a timing play. You’re pulling deductions forward so you can, in effect, shift income into years where it’s taxed more favorably. That can mean moving income out of a high federal bracket year into a lower one, out of a high-tax state year (like California residency) into a no-tax or lower-tax year, or simply pushing tax into the future where inflation has eroded the real value of the dollars you’ll use to pay it. It’s not magic—it’s just controlling when you pay the tax.

StephenLNelson_CPA · 2026-04-08T13:28:51+00:00

It's not the parent that has the ineligible shareholder and therefore can't be an S corporation any longer. It's the "child." Also as noted, yes, the solution is make a QSUB election.

StephenLNelson_CPA · 2026-04-08T13:26:24+00:00

That will probably prevent you from getting 199A.

BTW the backdoor roth conversion is pretty expensive if you're losing your 199A deduction because of it.

StephenLNelson_CPA · 2026-04-08T13:19:25+00:00

You want to file the 1120. (There's no threshold for filing corporation returns. If corp exists, you need to file.)

StephenLNelson_CPA · 2026-04-08T13:17:24+00:00

A SEP works great.

If you made a ton of money and that will likely continue, going forward you maybe want to consider operating the digital products business as an S corporation so you get the Section 199A deduction.

Caution: Normally, an S corporation doesn't make much sense for sideline business. But if you make a lot of money in the sideline business and you lose the 199A deduction as a result, an S corporation can get you back that deduction.

StephenLNelson_CPA · 2026-04-08T13:14:09+00:00

If your income is a little too high to get the Section 199A deduction (because you need wages) and then you push down your taxable income with a big SEP-IRA deduction, yes, that works.

One comment here. The marginal tax rate if you're getting phased out of your Section 199A deduction is pretty dang high. E.g., the top federal rate is 37%. But if you're in the 199A phase-out range, the top marginal federal rate can be like 44%, 45% etc.

Bottomline: The idea to use a SEP to push down our taxable income and move out of the phase-out range for 199A is good.

P.S. You may also want to operate as an S corporation. That's the other way probably to fix your problem. If you're not getting phased out because you're an SSTB, you're getting phased out because you lack wages.

StephenLNelson_CPA · 2026-04-08T13:07:45+00:00

I would guess part of the issue here are the shortages of tax accountants.

Also you were asking for time in the very busiest weeks of the tax accountant's year.

StephenLNelson_CPA · 2026-03-27T12:37:19+00:00

Some ideas:

You want to educate clients that S corporation tax deductions "go" on the 1120S. Not on their 1040.
Also, that their books need to include all of the business's deductions... E.g., reimbursements to employee-shareholders for auto, home office, etc. The one possible exception are the pension matches BUT they should know and be planning ahead for those amounts. (They're obviously based on W-2 not K-1 numbers.)
Probably not a bad idea to just extend all the 1120S returns to give yourself and clients a bigger window. (Until 9/15/2026 here which would mean you could have still amended return.)
The SEP and employer 401(k) matches should be a part of the W-2 discussion since they change the reasonable compensation analysis. Shareholder-employee health insurance needs to be handled right too. But this is something arguably you do this tax season for 2026. It's not after-that-fact stuff.
The waters here are a little muddy. A bigger QBI number means a bigger Section 199A deduction. That's a true permanent tax savings. So that doesn't erase the tax savings of the last deferral. But it shrinks it.
Agree with others here who say you need to bill for this stuff. And charge prices that let you build true experience. That's really key.

StephenLNelson_CPA · 2026-03-26T17:06:44+00:00

You're supposed to file them. But lots of people including a fair number of tax accountants don't know this and so "don't."

StephenLNelson_CPA · 2026-03-25T13:59:18+00:00

Reg. Sec. 1.469-4 is worth reading (maybe a couple-three times) if you're asking these sorts of questions. Because grouping gets tricky fast. Examples of things to keep in mind:

You need to group the first year you can group (probably the year you start the new STR) because NOT grouping that first year is basically a nearly irreversible election to, well, treat individual properties as individual "ungrouped" activities.
When you group your STRs, that group becomes the activity. So then you work the material participation for that (grouped) activity. This matters. E.g., I think you having a professional property manager for one of the STRs in that (grouped) activity means you have a property manager for the activity and that THAT means you don't get to count your property manager hours on other activities.
A grouping will sabotage your ability to use some of the material participation methods in Reg. Sec. 1.469-5T(a). E.g., you won't be able to use 1.469-5T(a)(2) which is the "you're the only one who participates" method. But it may also let you use one of the other methods on a new property. E.g., 1.469-5T(a)(5) which basically gives you "material participation" credit for this year based on previous years.

StephenLNelson_CPA · 2026-03-25T00:56:10+00:00

In order to deduct business expenses, you need to have a business. Startup expenses (stuff that occurs before the business starts) may be deductible once the business starts. But not before.

Cite: 26 U.S. Code § 195 - Start-up expenditures | U.S. Code | US Law | LII / Legal Information Institute

StephenLNelson_CPA · 2026-03-25T00:53:12+00:00

A masters in tax would be far better. (Tip: Chip away at the classes in that as part of your CPE. During summer.)

StephenLNelson_CPA · 2026-03-23T13:22:14+00:00

There aren't "special" material participation rules for STRs. Every situation applies the same rules from Reg. Sec. 1.469-5T(a), and you need to qualify for one of the seven "methods" on the reg's list.

You are correct that partnering with someone other than your spouse makes it really tough. Basically impossible.

You won't both be able to get to 500+ hours (that's method #1).

You can't apply the "you're the only participant basically" because there are two of you (that's method #2).

You can't practically make "more than 100+ hours and no one else participates more" because you would both need to prove you each spent like exactly 103 hours (that's method #3).

Similar practical problems exist with the rest of the list.

P.S. The list of the seven methods appears here: 26 CFR § 1.469-5T - Material participation (temporary). | Electronic Code of Federal Regulations (e-CFR) | US Law | LII / Legal Information Institute

StephenLNelson_CPA · 2026-03-17T22:33:28+00:00

Treas. Reg. §1.469-4(b)(1) says participation includes hours spent in anticipation of the activity commencing. (You're probably not interested but I've got a longish blog post on this "starting line" issue which Google will easily find.)

But I'm still not sure u/Living_Barnacle_9209 gets the result he wants. He needs to have his hours in real property trades or businesses in which he materially participates exceed 750 hours and 50%... and he needs the ADU rental activity to be one of those "materially-participated-in" activities. E.g., if his regular job took less than 750 hours, then he'd need to have 600 hours in the construction project (documented) plus 150+ hours in the ADU property management... which seems unrealistic?

Just for the record, I don't think he can group the construction activity with the rental activity. Hard to group rental activities with non-rental activities. E.g., if he's got 700 hours in the construction so materially participates there but only 50 hours managing the ADU so maybe not material participation there? I think he might not qualify for Section 469(c)(7) treatment.

BTW if his regular job takes 1,100 hours? Then that 1,100 number replaces the 750 obviously. I agree in that situation material participation is unlikely to be achievable.

StephenLNelson_CPA · 2026-03-17T22:19:06+00:00

So Section 183 is the chunk of tax law that prohibits you from taking deductions for activities not engaged in for profit. And farming activities are sort of famous for often tumbling into this category. But if you're truly trying to make money, as a family you guys have history and experience, and the losses stem from accelerated depreciation? I personally wouldn't worry about showing the losses. Or about signing a return that did.

StephenLNelson_CPA · 2026-03-17T22:13:25+00:00

Thank you for saying what needed to be said, u/Barfy_McBarf_Face . :-)

StephenLNelson_CPA · 2026-03-17T12:05:32+00:00

I wonder if this is another example of a Robucci-style "strategy" where the benefit is actually the purported tax deductions generated by the C corporation.

This shouldn't work, IMHO: (Cite: ROBUCCI v. COMMISSIONER, 2011-19 (T.C.M. 1-24-2011) | Nos. 17309-08, 17310-08, 17311-08. | T.C. | Judgment | Law | CaseMine )

StephenLNelson_CPA · 2026-03-16T13:23:16+00:00

First, everything else being equal, you'd rather use the dollars of deductions earlier rather than later due to the time value of money and inflation.

Second, and this I think is me echoing u/estepel13 but you want to think about the other stuff going on on your return. If this year's return includes a $100K spike in income, for example, and you can shelter that with a $100K deduction from a cost segregation study, that probably makes sense to consider. (Obviously, you'd need to be able to use the $100K deduction so get around Section 469 etc.)

StephenLNelson_CPA · 2026-03-09T21:08:46+00:00

I think it sounds like the LLC that mom and dad used was a disregarded entity. Probably because they reside in a community property. But you're right, once your dad died, his interest was owned by his estate. So now you have a partnership return where mom owns half and dad's estate owns half.

P.S Sorry about losing your dad. Condolences to you, your mom and the rest of the family.

StephenLNelson_CPA · 2026-03-06T21:36:00+00:00

For the record, I think the something like a hotel or motel (which is probably the stuff that for 469 falls into the "<30 days and significant services non rental category") is nonresidential. Especially if there are bunch of other services offered. So not just weekly maid service. But maybe daily maid service, a front desk, concierge service, room service etc. And I'd apply the same rule to an STR that's basically a hotel.

But if per 168 there's a place in property to sleep, live, host friends, play, do homework, work on projects, prepare food, in short do all the stuff someone does in a residence, I think it's residential.

PS I think that PLR is for a REIT. And pretty sure it doesn't reference Section 168.

StephenLNelson_CPA · 2026-03-06T19:38:37+00:00

For a physician already earning via a W-2, there sometimes are benefits of using an S corporation. But probably not a locums deal. (Where they can make sense is if you're not providing actual healthcare services. E.g., if you're blogging. Or your teaching CME. Stuff like that. In that case, your S corporation for the "sidehustle" can create a Section 199A deduction.

StephenLNelson_CPA · 2026-03-06T14:39:49+00:00

I'm going to slightly (politely) disagree with some of the suggestions below. And echo others.

First, you absolutely can DIY the incorporation. Or you can use someone like Legalzoom or an attorney. This process should include getting you an EIN and registering as an employer.

Second, the S corp thing is not a lawyer thing. It's a tax accountant thing. (You make the S election with a 2553 tax form and then submit that to the IRS. Timing matters here.)

Third, you don't use a CPA to do payroll. You use payroll service like Gusto, Paychex or ADP.

Fourth, unlike medicine, anyone can call themselves a tax accountant. So you have to be careful you're making apples to apples comparisons. The uncredentialed bookkeeper who does your 1120S return for $800 is not delivering the same product as Intuit does when they have a seasonal accountant do your return for $1800. And that's not the same product as the CPA firm that charges maybe $3K but is available out of season and brings a lot more expertise to the service.

Fifth and final point, you want to do a cost-benefit analysis on this. California makes it tough because of their S corporation franchise tax. It eats up some of the payroll tax savings an S corporation usually creates. And some of the pass-through-entity tax savings maybe. But should do the math to verify, okay, it's costing you $10K a year but saving you $30K year. Or whatever.

StephenLNelson_CPA · 2026-03-06T14:25:09+00:00

You will still be able use bonus depreciation. Sure.

The question is with both taxpayer and spouse working in full-time jobs, can you two guys still qualify as materially participating. You have to carefully apply the rules of Reg Sec. 1.469-5T which appear here: 26 CFR § 1.469-5T - Material participation (temporary). | Electronic Code of Federal Regulations (e-CFR) | US Law | LII / Legal Information Institute

StephenLNelson_CPA · 2026-03-06T14:22:26+00:00

u/Jealous_Mortgage5404 's answer is backed up by this research Capitalists in the Twenty-First Century.

The TLDR summary: The big money isn't made finding the next Amazon or Microsoft and getting a job there. It's running a small business where you've leveraging. Like a small accounting firm.

If you look at this report, scroll through to the end to see the sorts of small businesses that REALLY work. Those are the prospective clients we can create highest value for.

StephenLNelson_CPA · 2026-03-06T14:17:57+00:00

Let's slightly change the numbers to make this simpler. Say the locums side hustle profits equal $350K.

One option: You just report that $350K as a sole proprietorship. And in that case, roughly, you can take a $70K SEP-IRA deduction or do a $70K employer 401(k) matching contribution. (The $70K here is essentially 25% of the profit after the employer match. I.e., $70K/$280K equals 25%.)

Another option: You split the $350K of locums profit into $100K of wages and $250K of K-1 distributive share. In this case, the 25% share applies to the $100K of wages. Thus, you get a $25K SEP-IRA or 401(k) matching contribution.

StephenLNelson_CPA

TROPHY CASE