How The Short-Term Rental Loophole & Cost Segregation Can Benefit Passive Investors

Unlocking the Short-Term Rental Loophole

Tax regulations generally classify all rental income as passive income by default, meaning losses from depreciation can’t be used to offset active income like wages or business earnings. However, short-term rentals can be classified as an active trade or business for tax purposes if they meet specific IRS criteria and material participation requirements.

This is because short-term rentals fall into the same category as hotels and motels, which have a different set of rules. Taxpayers are required to depreciate STRs over 39 years, but the flip side is that it’s much easier to meet the “material participation” rules that move those deductions from “passive” to “non-passive” deductions. Taxpayers only need to meet 1 of the 7 criteria below:

Key Qualification Factors Include:

• • 7-Day Rule – The average rental period must be days or less per booking.
  • Material Participation – Owners must actively be involved in managing the property (e.g., direct booking, maintenance oversight, guest interactions).
    1. Perform all of the activities for the short-term rental business
    2. Spend more than 100 hours on short-term rental business, and no other person spends more than the owner
    3. Spend more than 500 hours on the short-term rental business
    4. Significant participation activities exceeding 100 hours and the owner’s total participation exceeds 500 hours
    5. Participating in the short-term rental business on the property for 5 of the previous 10 years
    6. Providing personal service or non-income producing activities for 3 of the previous years
    7. If owners do not qualify based on the first 6 tests, regularly participating on a continuous basis during the year for at least 100 hours a year may also qualify

By meeting these requirements, investors can use deductions from depreciation to reduce their overall taxable income, leading to significant savings.