 Did you know you don't need to be a real estate professional to unlock major tax savings on your short-term rental property? Discover the secrets of the short-term rental tax loophole and learn how to significantly reduce your taxable income and boost your profits.

How to Leverage the Short-Term Rental Tax Loophole to Reduce Your Tax Burden

The short-term rental tax loophole allows non-professional property owners to reduce their taxable income by reclassifying rental income and offsetting it with depreciation and deductible expenses.

Property owners must meet one of the six IRS exclusions or pass the material participation test to qualify.

The loophole should be combined with other tax strategies, such as cost segregation analyses, to maximize savings.

Short-term rental investments can be incredibly profitable, but the tax side of things can be daunting. As a property owner, you're probably on the lookout for ways to lighten your tax load and boost your earnings.

That's where the short-term rental tax loophole comes in. This powerful provision in the tax code could let you classify your rental income a little differently, enabling you to offset it with other active income sources. 

Let’s break down the short-term rental tax loophole, how you can qualify for it, and why it's a game-changer for property owners like you. 

AirDNA’s powerful yet easy-to-use tools make hosting and investing a breeze. This means having every insight you need, all in one place, always up-to-date.

What Is the Short-Term Rental Tax Loophole?

The short-term rental tax loophole is a special provision in the tax code that helps owners of short-term rental (STR) properties save on taxes. It allows STR owners to reduce their taxable income significantly, even if they aren't professional real estate investors.

Typically, only real estate professionals (REPs) can offset their rental income with losses from other active income sources like wages or business profits. However, this STR tax loophole permits non-professional property owners with short-term rentals to qualify for similar benefits if they meet certain criteria.

Here's why the loophole is valuable: It allows rental income to be classified as non-passive, meaning it can be offset by other active income. 

This reclassification leads to substantial tax savings by enabling deductions for various expenses associated with managing rental properties. Deductible expenses that feed into your net operating income might include:

Additionally, vacation rental owners can benefit from depreciation, spreading the cost of the property over several years to further reduce taxable income. 

For more information on how rental income is taxed when you have a mortgage, check out our guide. 

How to Qualify for the Short-Term Rental Tax Loophole

Property owners need to meet specific criteria that demonstrate active participation to reclassify their rental income as non-passive. Reclassifying rental income in this way allows property owners to offset vacation rental income with other active income sources, resulting in substantial tax savings. 

There are two main pathways to qualify: meeting any of the six IRS exclusions or passing the material participation test.

According to the tax code, here are six scenarios where rental property income can be excluded from the passive category:

The average duration of guest stays is seven days or less.

The average guest stay is 30 days or less, and substantial personal services, similar to those provided by a hotel, are offered by or on behalf of the property owner. Personal services could include daily housekeeping, meal services, access to a vehicle, or vouchers for local attractions. 

If you provide exceptional personal services in connection with making the property available for use, regardless of the average duration of guest stays, the rental income can be considered non-passive. A good example might be a luxury Airbnb that offers a private chef and private tours.

The rental of the property is secondary to a non-rental activity conducted by the taxpayer.

Suppose you own a winery that offers wine tasting and tours. Occasionally, you rent out a small guesthouse on the property to visitors. Since the primary business is the winery operations, and the guesthouse rental is secondary or incidental to this primary activity, the income from the rental can be considered non-passive

The property is typically available for nonexclusive use by various customers during defined business hours.

 Imagine you own a property that has a designated gathering space that can be rented out as a venue during regular business hours. Even if you have short-term renters occupying the other parts of your property, you could still qualify for the short-term rental tax loophole under this scenario because your property isn’t exclusively used by one entity.  

The property is used in activities carried out by a partnership, S corporation, or joint venture in which the taxpayer has an ownership interest, and these activities are not classified as rental activities.

Suppose you are a partner in a tech startup that occasionally uses a property you own for company retreats and team-building activities. Since the property use is integral to the business operations of the startup (a non-rental activity), the income can be considered non-passive.

If your rental activity does not fit any of the above exclusions, you can still qualify for the short-term rental tax loophole by passing the material participation test.

Material participation refers to the active involvement of a taxpayer in a real estate business or rental activity. 

The IRS has established specific criteria to determine whether a taxpayer meets the material participation standard:

500-Hour Rule: You spend more than 500 hours working on your short-term rental business during the tax year.

Substantially All Participation: Your involvement in the rental activity is almost all the work done for the business, including by non-owners.

100-Hour Rule: You participate in the rental activity for more than 100 hours during the tax year, and no one else participates more than you do.

Significant Participation Activities: This criterion looks at your participation across multiple business activities, not just the rental property. You must spend more than 500 hours in total on all significant business activities you are involved in, including but not limited to the rental property.

Previous Material Participation: You materially participated in your short-term rental business for any five of the last ten tax years.

Personal Service Activity: You provided personal services in connection with the rental property, and you did so for at least three of the previous taxable years. Personal services are activities that require advanced skills or education. Examples include legal, health, engineering, accounting, construction, or other professional services.

Facts and Circumstances: Based on all the facts and circumstances, you participate in the activity on a regular, continuous, and substantial basis.

You only need to meet one of the seven criteria to pass the material participation test for the short-term rental tax loophole. If you pass, you can classify your rental income as non-passive. This classification is essential for leveraging the STR tax loophole and benefiting from significant tax savings.

Understand the investment potential of any address in the world.

Depreciation is a crucial tax strategy that allows property owners to deduct the cost of their property over time, reflecting its gradual loss of value due to wear and tear. For short-term rental (STR) property owners, leveraging depreciation can significantly reduce taxable income, making it a valuable component of the short-term rental tax loophole strategy.

Once rental income is reclassified as non-passive, STR property owners can leverage accelerated depreciation methods, such as:

Bonus Depreciation: This allows for an immediate deduction of a large percentage of the purchase cost of eligible assets.

Section 179 Expensing: This enables property owners to deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year.

A word of warning: the rules on depreciation are changing. 

New bonus depreciation rules now apply to property acquired and placed in service after September 27, 2017, and before January 1, 2023. In January 2023, the current provision expired, but the phase-out schedule extends to 2026. Here’s the timeline for the phase-out:

Imagine you make a real-estate investment in an STR property for $250,000 in 2022. Under the 100% bonus depreciation rule, you could deduct the entire $250,000 in that year. However, if you purchased the same property in 2024, you would only be able to deduct $150,000 under the 60% bonus depreciation rate.

While it’s possible that future legislative changes could alter this schedule, this is the current trajectory as outlined by the Tax Reform Act. It’s important to note that the short-term rental tax loophole itself is not at risk; rather, it’s the 100% bonus depreciation that is phasing out. 

Components of property rentals, such as furniture, appliances, or landscaping improvements, can often be depreciated over shorter periods. A 5-year or 15-year depreciation schedule continues to offer substantial tax savings compared to the standard 39-year depreciation timeline for a rental property.

Other Tax Strategies for Short-Term Rental Properties

A cost segregation study allows property owners to accelerate the depreciation of certain parts of their short-term rentals. This means you can take bigger tax deductions sooner by identifying and reclassifying personal property assets to shorter depreciation periods like 5, 7, or 15 years instead of the usual 39 years.

This involves a detailed cost segregation report, which breaks down the property into individual components like plumbing, electrical fixtures, and landscaping. Utilizing this strategy can lead to substantial upfront tax savings.

Accelerated depreciation methods, such as bonus depreciation and Section 179 expensing, enable property owners to quickly write off the cost of qualifying assets. Improvements to land, property, and tangible personal property can be depreciated over shorter periods, providing immediate tax benefits. 

For example, Section 179 allows you to deduct the full cost of new furniture in the year you buy it instead of spreading the deduction over several years. This immediate deduction reduces your taxable income for that year.

Accelerated depreciation is especially useful for short-term rental owners who invest in property improvements and furnishings. This tax strategy helps reduce taxable income and improve cash flow early in the ownership period.

Maximizing tax deductions and credits is essential for lowering your tax burden. Key deductions include mortgage interest, property management fees, maintenance costs, insurance premiums, and utilities. You can also claim significant tax deductions for major repairs and improvements, leading to substantial savings.

Track Expenses: Keep detailed records of all expenses to ensure you capture every eligible deduction.

Energy-Efficient Improvements: Take advantage of tax credits for energy-efficient improvements, which can offset costs associated with making your property more energy-efficient.

Qualified Business Income (QBI) Deduction: If your rental activity qualifies as a trade or business, you may be eligible for the QBI deduction, allowing you to deduct up to 20% of your qualified business income.

Understanding the nuances of these tax rules can help you optimize your tax strategy and maximize the return on your STR. For anyone with short-term rentals, combining these strategies with the STR tax loophole can reduce your taxable real estate income and improve your overall financial performance.

AirDNA’s vacation rental pricing tool uses data-driven recommendations to propose the best daily rates.

What is the short-term rental tax loophole?

The short-term rental tax loophole is a provision in the tax code that allows owners of short-term rental properties to classify their rental income as non-passive if they meet certain criteria. This reclassification allows them to offset rental income with depreciation and deductible expenses.

What are the criteria to qualify for the short-term rental tax loophole?

Property owners must meet specific criteria, whether that’s one of the 6 qualifying scenarios related to guest length of stay or extent of services provided OR through material participation. The latter involves actively managing the property and meeting one of the IRS’s material participation tests, such as spending more than 500 hours a year on the rental activity.

How does the phase-out of bonus depreciation affect the short-term rental tax loophole?

The phase-out of bonus depreciation means that the percentage of the property cost that can be deducted in the first year is decreasing annually until it phases out entirely by 2027. While this reduces the immediate tax benefits of bonus depreciation, property owners can still utilize other forms of accelerated depreciation and the short-term rental tax loophole to maximize their tax savings.

How can I maximize tax savings using the short-term rental tax loophole?

Make sure that you meet the material participation criteria to classify your rental income as non-passive. Conduct a cost segregation study to accelerate depreciation, take advantage of any remaining bonus depreciation, and keep detailed track of all deductible expenses related to your rental property. Consulting with a tax professional who specializes in real estate can also help you navigate the complexities of taxation and choose the best tax strategy.

Learn how the short-term rental tax loophole can maximize your STR profits and what you need to qualify for this tax-reducing trick.

Key Takeaways
The short-term rental tax loophole allows non-professional property owners to reduce their taxable income by reclassifying rental income and offsetting it with depreciation and deductible expenses.
Property owners must meet one of the six IRS exclusions or pass the material participation test to qualify.
The loophole should be combined with other tax strategies, such as cost segregation analyses, to maximize savings.

Short-term rental investments can be incredibly profitable, but the tax side of things can be daunting. As a property owner, you're probably on the lookout for ways to lighten your tax load and boost your earnings.

That's where the short-term rental tax loophole comes in. This powerful provision in the tax code could let you classify your rental income a little differently, enabling you to offset it with other active income sources. 

Let’s break down the short-term rental tax loophole, how you can qualify for it, and why it's a game-changer for property owners like you. 

Smart investments happen here

AirDNA’s powerful yet easy-to-use tools make hosting and investing a breeze. This means having every insight you need, all in one place, always up-to-date.

Start exploring for free
What Is the Short-Term Rental Tax Loophole?

The short-term rental tax loophole is a special provision in the tax code that helps owners of short-term rental (STR) properties save on taxes. It allows STR owners to reduce their taxable income significantly, even if they aren't professional real estate investors.

Typically, only real estate professionals (REPs) can offset their rental income with losses from other active income sources like wages or business profits. However, this STR tax loophole permits non-professional property owners with short-term rentals to qualify for similar benefits if they meet certain criteria.

Here's why the loophole is valuable: It allows rental income to be classified as non-passive, meaning it can be offset by other active income. 

This reclassification leads to substantial tax savings by enabling deductions for various expenses associated with managing rental properties. Deductible expenses that feed into your net operating income might include:

Mortgage interest
Property management fees
Maintenance and repairs
Utilities
Insurance premiums
Advertising and marketing costs
Supplies and furnishings

Additionally, vacation rental owners can benefit from depreciation, spreading the cost of the property over several years to further reduce taxable income. 

For more information on how rental income is taxed when you have a mortgage, check out our guide. 

Learn about short-term rental data

How to Qualify for the Short-Term Rental Tax Loophole

Property owners need to meet specific criteria that demonstrate active participation to reclassify their rental income as non-passive. Reclassifying rental income in this way allows property owners to offset vacation rental income with other active income sources, resulting in substantial tax savings. 

There are two main pathways to qualify: meeting any of the six IRS exclusions or passing the material participation test.

IRS Exclusions for Non-Passive Income

According to the tax code, here are six scenarios where rental property income can be excluded from the passive category:

1. Short Stays

The average duration of guest stays is seven days or less.

2. Shorter Stays with Services

The average guest stay is 30 days or less, and substantial personal services, similar to those provided by a hotel, are offered by or on behalf of the property owner. Personal services could include daily housekeeping, meal services, access to a vehicle, or vouchers for local attractions. 

3. Extraordinary Personal Services

If you provide exceptional personal services in connection with making the property available for use, regardless of the average duration of guest stays, the rental income can be considered non-passive. A good example might be a luxury Airbnb that offers a private chef and private tours.

4. Incidental Rentals

The rental of the property is secondary to a non-rental activity conducted by the taxpayer.

Suppose you own a winery that offers wine tasting and tours. Occasionally, you rent out a small guesthouse on the property to visitors. Since the primary business is the winery operations, and the guesthouse rental is secondary or incidental to this primary activity, the income from the rental can be considered non-passive

5. Business Hours

The property is typically available for nonexclusive use by various customers during defined business hours.

 Imagine you own a property that has a designated gathering space that can be rented out as a venue during regular business hours. Even if you have short-term renters occupying the other parts of your property, you could still qualify for the short-term rental tax loophole under this scenario because your property isn’t exclusively used by one entity.  

6. Partnership or S Corporation

The property is used in activities carried out by a partnership, S corporation, or joint venture in which the taxpayer has an ownership interest, and these activities are not classified as rental activities.

Suppose you are a partner in a tech startup that occasionally uses a property you own for company retreats and team-building activities. Since the property use is integral to the business operations of the startup (a non-rental activity), the income can be considered non-passive.

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The Material Participation Test 

If your rental activity does not fit any of the above exclusions, you can still qualify for the short-term rental tax loophole by passing the material participation test.

Material participation refers to the active involvement of a taxpayer in a real estate business or rental activity. 

The IRS has established specific criteria to determine whether a taxpayer meets the material participation standard:

500-Hour Rule: You spend more than 500 hours working on your short-term rental business during the tax year.
Substantially All Participation: Your involvement in the rental activity is almost all the work done for the business, including by non-owners.
100-Hour Rule: You participate in the rental activity for more than 100 hours during the tax year, and no one else participates more than you do.
Significant Participation Activities: This criterion looks at your participation across multiple business activities, not just the rental property. You must spend more than 500 hours in total on all significant business activities you are involved in, including but not limited to the rental property.
Previous Material Participation: You materially participated in your short-term rental business for any five of the last ten tax years.
Personal Service Activity: You provided personal services in connection with the rental property, and you did so for at least three of the previous taxable years. Personal services are activities that require advanced skills or education. Examples include legal, health, engineering, accounting, construction, or other professional services.
Facts and Circumstances: Based on all the facts and circumstances, you participate in the activity on a regular, continuous, and substantial basis.

You only need to meet one of the seven criteria to pass the material participation test for the short-term rental tax loophole. If you pass, you can classify your rental income as non-passive. This classification is essential for leveraging the STR tax loophole and benefiting from significant tax savings.

Calculate potential earnings

Understand the investment potential of any address in the world.

See your STR revenue potential
Depreciation and the Airbnb Tax Loophole

Depreciation is a crucial tax strategy that allows property owners to deduct the cost of their property over time, reflecting its gradual loss of value due to wear and tear. For short-term rental (STR) property owners, leveraging depreciation can significantly reduce taxable income, making it a valuable component of the short-term rental tax loophole strategy.

Once rental income is reclassified as non-passive, STR property owners can leverage accelerated depreciation methods, such as:

Bonus Depreciation: This allows for an immediate deduction of a large percentage of the purchase cost of eligible assets.
Section 179 Expensing: This enables property owners to deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year.
The Phase-Out of Bonus Depreciation 

A word of warning: the rules on depreciation are changing. 

New bonus depreciation rules now apply to property acquired and placed in service after September 27, 2017, and before January 1, 2023. In January 2023, the current provision expired, but the phase-out schedule extends to 2026. Here’s the timeline for the phase-out:

Imagine you make a real-estate investment in an STR property for $250,000 in 2022. Under the 100% bonus depreciation rule, you could deduct the entire $250,000 in that year. However, if you purchased the same property in 2024, you would only be able to deduct $150,000 under the 60% bonus depreciation rate.

While it’s possible that future legislative changes could alter this schedule, this is the current trajectory as outlined by the Tax Reform Act. It’s important to note that the short-term rental tax loophole itself is not at risk; rather, it’s the 100% bonus depreciation that is phasing out. 

Components of property rentals, such as furniture, appliances, or landscaping improvements, can often be depreciated over shorter periods. A 5-year or 15-year depreciation schedule continues to offer substantial tax savings compared to the standard 39-year depreciation timeline for a rental property.

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Other Tax Strategies for Short-Term Rental Properties
Cost Segregation

A cost segregation study allows property owners to accelerate the depreciation of certain parts of their short-term rentals. This means you can take bigger tax deductions sooner by identifying and reclassifying personal property assets to shorter depreciation periods like 5, 7, or 15 years instead of the usual 39 years.

This involves a detailed cost segregation report, which breaks down the property into individual components like plumbing, electrical fixtures, and landscaping. Utilizing this strategy can lead to substantial upfront tax savings.

Accelerated Depreciation

Accelerated depreciation methods, such as bonus depreciation and Section 179 expensing, enable property owners to quickly write off the cost of qualifying assets. Improvements to land, property, and tangible personal property can be depreciated over shorter periods, providing immediate tax benefits. 

For example, Section 179 allows you to deduct the full cost of new furniture in the year you buy it instead of spreading the deduction over several years. This immediate deduction reduces your taxable income for that year.

Accelerated depreciation is especially useful for short-term rental owners who invest in property improvements and furnishings. This tax strategy helps reduce taxable income and improve cash flow early in the ownership period.

Tax Deductions and Credits

Maximizing tax deductions and credits is essential for lowering your tax burden. Key deductions include mortgage interest, property management fees, maintenance costs, insurance premiums, and utilities. You can also claim significant tax deductions for major repairs and improvements, leading to substantial savings.

Tips for Maximizing Deductions:
Track Expenses: Keep detailed records of all expenses to ensure you capture every eligible deduction.
Energy-Efficient Improvements: Take advantage of tax credits for energy-efficient improvements, which can offset costs associated with making your property more energy-efficient.
Qualified Business Income (QBI) Deduction: If your rental activity qualifies as a trade or business, you may be eligible for the QBI deduction, allowing you to deduct up to 20% of your qualified business income.

Understanding the nuances of these tax rules can help you optimize your tax strategy and maximize the return on your STR. For anyone with short-term rentals, combining these strategies with the STR tax loophole can reduce your taxable real estate income and improve your overall financial performance.

Boost Your Rental Revenue

AirDNA’s vacation rental pricing tool uses data-driven recommendations to propose the best daily rates.

Start for free
Frequently Asked Questions 
What is the short-term rental tax loophole?

The short-term rental tax loophole is a provision in the tax code that allows owners of short-term rental properties to classify their rental income as non-passive if they meet certain criteria. This reclassification allows them to offset rental income with depreciation and deductible expenses.

What are the criteria to qualify for the short-term rental tax loophole?

Property owners must meet specific criteria, whether that’s one of the 6 qualifying scenarios related to guest length of stay or extent of services provided OR through material participation. The latter involves actively managing the property and meeting one of the IRS’s material participation tests, such as spending more than 500 hours a year on the rental activity.

How does the phase-out of bonus depreciation affect the short-term rental tax loophole?

The phase-out of bonus depreciation means that the percentage of the property cost that can be deducted in the first year is decreasing annually until it phases out entirely by 2027. While this reduces the immediate tax benefits of bonus depreciation, property owners can still utilize other forms of accelerated depreciation and the short-term rental tax loophole to maximize their tax savings.

How can I maximize tax savings using the short-term rental tax loophole?

Make sure that you meet the material participation criteria to classify your rental income as non-passive. Conduct a cost segregation study to accelerate depreciation, take advantage of any remaining bonus depreciation, and keep detailed track of all deductible expenses related to your rental property. Consulting with a tax professional who specializes in real estate can also help you navigate the complexities of taxation and choose the best tax strategy.

How to Leverage the Short-Term Rental Tax Loophole to Reduce Your Tax Burden

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