The short-term rental tax strategy the IRS actually allows

The short-term rental tax strategy the IRS actually allows

The short-term rental tax loophole is a strategy used to reduce the tax burden for real estate investors. Also known as the Airbnb tax loophole, this strategy allows rental owners to offset their income with real estate losses, significantly reducing their tax bills.

TurboTenant put this guide together to help you understand the benefits of the loophole and the IRS rules for it. This story will also cover documentation best practices and five common errors to avoid so you can make this powerful tax strategy work for your portfolio.

Basis of the STR Loophole: Passive vs. Active Income

The short-term rental tax loophole hinges on classifying your investment property as a business activity rather than a rental activity. The result? Your rental’s income and expenses become active, not passive, activity. Since this tactic depends on the distinction between passive and active income, let’s clarify those terms.

Passive: Income earned with minimal effort, like royalties, interest, dividends, and annuities. According to the IRS, rental income is considered passive income by default.

Active: Ordinary, W-2, nonpassive earnings that require your active involvement.

Why does the difference between active and passive income matter? The IRS doesn’t allow us to offset passive losses against active income. Ordinarily, if you have a 9-to-5 W-2 job and a rental property, you have both active and passive income. When you have a loss from your rental property, you can’t deduct that loss from your W-2 wages.

But if your rental property counts as a source of active income, you can offset your W-2 wages with the rental’s losses. That gives you a way to significantly minimize your tax burden, making this an effective tax strategy for real estate investors.

Did you know? This strategy is considered a loophole because it was initially intended for use by hotels and motels. This was before the rise of hosting platforms such as Airbnb, which significantly changed the hospitality industry. So even though the term loophole may sound shady, this strategy is documented in IRS regulations and publications, and the tax court has upheld it in several cases.

How to Qualify as a Short-Term Rental

Your investment property can qualify as a short-term rental in two ways:

1. The average rental stay is seven days or fewer.
2. You offer substantial services to renters during their stay, and the average stay is 30 days or fewer.

Substantial services go beyond offering garbage collection, internet service, or access to a kayak or paddleboard at a vacation rental. Any of these offerings may count as a substantial service:

• Concierge services
• Daily linen changes
• Meal services
• Transportation
• Vouchers for activities or attractions

IRS Exceptions for Short-Term Rentals

The IRS provides six exceptions that exempt properties from the rental activity designation.

1. The property’s average stay is seven days or fewer.
2. The property’s average stay is 30 days or fewer, and the owner provides services comparable to those of a hotel, including daily cleaning, meals, and transportation.
3. Rental owners offer guests “extraordinary personal services,” including private tours and personal chefs.
4. The rental isn’t the owner’s primary business activity. Let’s say you own a winery with a rental cottage on the property. The rental isn’t your primary source of income or concern.
5. The property isn’t for the exclusive use of any one guest, and it’s available for use during set hours. This rule applies to properties with STRs on the premises plus a gathering space that you may rent out as a venue during business hours.
6. The owner is part of an S-corp, joint venture, or partnership that isn’t involved in rental property, and that company uses the owner’s rental property. For example, you may rent your property to your other business for a corporate retreat or holiday party.

Basics of the Material Participation Test

When a rental property owner is actively engaged in the running of their property and the daily operations of the business, it’s known as material participation. The IRS uses a test to determine whether owners materially participate in their businesses. You must meet one of these seven criteria to qualify for the short-term rental tax loophole:

1. You worked more than 500 hours in the activity.
2. You performed the majority of the substantial work for the business.
3. You worked in the business for more than 100 hours — more than anyone else who worked on the business.
4. You worked for more than 100 hours on a significant participation activity, and you spent more than 500 hours on the combined work from all significant participation activities.
5. You participated in the business for five of the last 10 years.
6. You offered personal services related to the rental property for three prior years.
7. Activities that require advanced skills or education include personal services such as legal, healthcare, engineering, accounting, and construction.
8. You demonstrated consistent, ongoing, and verifiable participation in the business for more than 100 hours.

Material Participation Tests for Rental Property Owners

STR owners typically use the first three material participation tests. If you’re a multiproperty owner, test participation at the property level rather than at the portfolio level. The tests sound intimidating, but you might have met the criteria without realizing it.

Test 1: Work More Than 500 Hours on the Rental

As long as you spend at least an hour and a half per day on your STR, your total participation for the year will exceed 500 hours. If you need to increase your hours, consider offering these services:

• Daily cleaning
• Guided activities
• Laundry services
• Meals
• Tours
• Transportation

Test 2: Perform the Majority of the Substantial Work

If you self-manage a short-term rental, you’re probably doing most of the work.

Material participation is more difficult to satisfy when you use a full-service property manager, co-host, or cleaning service. That reduces your participation in the rental. To meet the criteria and get the tax benefits, STR owners may be better off using a half-service property manager or managing their own properties.

Test 3: Work in the Business for Over 100 Hours — More Than Anyone Else

If your co-host, half-service property manager, or cleaners do less than half the work, you can pass this test. Just spend over 18 minutes per day on the rental to meet the required hours.

How to Prove Rental Property Material Participation

In 2024, the IRS carried out 505,514 audits on tax returns. Even if you’re not part of the 1% of filers who are audited each year, you’re still responsible for having evidence to support your books and tax returns. Here’s how landlords can prove material participation:

• Document your specific tasks, hours, and involvement in a logbook.
• Show how you managed the STR by keeping a daily calendar.
• Keep an appointment book with detailed notes and records of meeting times and durations for guests, staff, and contract workers.
• Use detailed timesheets to document your work on the rental for the year.

By using a combination of these documents, you’ll prove the two key points for material participation: showing consistent engagement in the amount of work performed and providing evidence of regular participation in the type of work carried out.

Avoid These 5 Common Errors with the STR Loophole

Focusing on Travel Time
Are the bulk of your hours for the material participation tests from commuting? Travel time unrelated to property operations doesn’t count toward the required hours. That means commuting hours won’t help you meet the requirements.

Not Tracking Hours for Service Providers
Material participation test #3 states that you work over 100 hours on the property and spend more time working on it than anyone else, including nonowners, like contract workers. If you don’t track the hours your contractors and service providers work on the property, you can’t prove that you passed the test.

You must keep detailed records of the hours worked by you and your service providers, like cleaners, lawn crews, maintenance teams, and property managers.

Not Counting Days for Personal Use
Owners can stay at their rental properties for personal use. However, if an owner stays for more than 14 days or for 10% of the total rental days, the property is considered a personal residence. That means you can’t claim losses on the property.

Keep detailed records of rental and personal-use days, and closely monitor personal-use limits.

Did you know? If you spend time at the rental to work on repairs and maintenance, those days don’t count as personal use — even if other people stay there with you.

Manipulating Leases to Fit the 7-Days Rule
When a tenant signs a lease extension, it counts toward the original period. For example, a guest signs a seven-day lease and then extends their stay by another week. That counts as one 14-day lease, not two seven-day leases. Keep accurate records of tenant stays and aim for true short-term leases instead of manipulating the rule.

Misclassifying Your Property as an STR
The STR loophole is meant for legitimate short-term rentals. The property must meet either of these conditions to qualify:

• An average stay of seven days or fewer for the year.
• An average stay of 30 days or fewer for the year when substantial services are provided.

How to Make the STR Loophole Work for You

The purpose of the STR loophole is to offset active income with rental losses. To maximize this tax strategy, though, you want a paper loss. That’s when your operating costs and noncash expenses are more than the property’s income. In other words, the rental is profitable, but on paper, you have a loss because of your deductions.

So for the STR loophole to be most effective for you, you need to increase the property’s noncash deductions. Depreciation is a key player here.

The Key to Noncash Deductions: Depreciation

Depreciation reflects an asset’s decrease in value — and it’s a deductible, noncash expense. Use these accelerated depreciation strategies to maximize your deductions and set your property up for a paper loss.

Bonus Depreciation
There were significant changes to bonus depreciation this year due to the “One Big, Beautiful Bill” legislation. Instead of phasing out, bonus depreciation has been restored to 100% for qualifying properties purchased and placed in service after Jan. 19, 2025.

For properties acquired and operating before Jan. 19, 2025, the phase-out schedule remains:

• September 2017 to 2022: 100%
• 2023: 80%
• 2024: 60%
• 2025: 40%
• 2026: 20%
• 2027: 0%

Section 179
This part of the tax code allows rental property owners to deduct 100% of qualifying equipment and software in the year they purchased it. And as of 2018, landlords can deduct the cost of personal property items purchased for use inside rental units. So now items like these may qualify:

• Blinds
• Carpets
• Computers
• Drapes
• Kitchen appliance
• Office equipment
• Office furniture
• Outdoor maintenance equipment
• Software
• Vehicles

Note that there are limits to Section 179. Landlords cannot deduct land or improvements like swimming pools, parking lots, or fences.

Reclassification of Assets
A cost segregation study examines a property’s assets and evaluates their values and useful life. Once you have the results of the study, you can reclassify elements of your property and depreciate them over five or 15 years. These assets can make up 20% to 30% of your property’s value, so this strategy can significantly affect your reportable income and position you for a paper loss.

Turn Strategies into Savings with the STR Loophole

The short-term rental tax strategy isn’t a gimmick — it’s a legitimate opportunity hidden in plain sight for landlords who understand the rules and document their work. When structured correctly, an STR can turn depreciation and active participation into powerful tools that reduce your tax burden without sacrificing cash flow. As always, the key is compliance, careful recordkeeping, and working with a tax professional who understands how to apply the strategy to your specific portfolio.

This story was produced by TurboTenant and reviewed and distributed by Stacker.