The short-term rental (STR) tax loophole is a strategy real estate investors use to reduce their tax burdens by offsetting rental income with real estate losses.
Also known as the Airbnb tax loophole, this strategy classifies the activity as a business rather than a rental activity, so all income and expenses related to the property are considered active, not passive. The qualification requirements are less stringent compared to the real estate professional status—you just need to pass the material participation test.
Today, we’ll cover key terms and points related to the short-term rental loophole, including ways to maximize your noncash deductions and avoid common tax mistakes for STRs.
Key Definitions for the STR Loophole
What is passive and active income?
The effectiveness of the STR loophole hinges on whether your rental’s income counts as passive or active, so let’s get clear on those terms first:
- Passive income is income you earn with minimal effort, providing financial freedom. By default, the IRS considers rental income as passive income.
- Active income is any W-2, ordinary, nonpassive income that requires your active involvement to earn it.
This distinction is important because, according to IRS regulations, you cannot offset passive losses against active income. So let’s say you have a W-2 job and a rental property. If your rental has a loss for the year, you can’t offset your W-2 income with that loss. You can only apply passive losses against passive income.
That’s why getting your rental losses to count as active is essential—you can minimize your tax liability.
What counts as a short-term rental?
Short term can be subjective, but in this case, your property can qualify as an STR in two ways:
- The average rental stay is seven days or less.
- The property has an average stay of 30 days or less, and you offer substantial services to guests during their stay.
What’s a substantial service? Think daily cleaning or linen changes, meal services, transportation, concierge services, vouchers for activities or local attractions, etc. Offering basic services, like garbage collection or internet service, doesn’t count.
What are the IRS exceptions for short-term rentals?
IRS section 469 defines six exceptions to what counts as rental activity.
- The average stay lasts seven days or less.
- The average stay is 30 days or less, and the owner provides services equivalent to those offered by a hotel, such as daily housekeeping, meal services, and transportation.
- Owners provide “extraordinary personal services” to renters. Think luxury rentals that include a personal chef or private tours.
- The rental property is not the primary business concern. For example, your operational farm has a small guesthouse on the business premises. Occasionally, you rent out the guesthouse, but the rental is not the primary business activity.
- The property is available for use during defined business hours, and the use isn’t exclusive to any one guest. For example, you have a property with a designated gathering space that you can rent out as a venue during regular business hours, plus you have STRs elsewhere on the property.
- The owner takes part in a partnership, S-corp, or joint venture that isn’t a rental activity, and that company uses the rental property. So, if you are a partner in another business, you could rent your property to the business for company retreats or team-building sessions.
What is material participation?
Material participation refers to an owner’s level of involvement in the daily operations of a business. The IRS has a test to determine whether you, the property owner, are actively engaged in running your STR. You must meet one of the seven material participation criteria to qualify for the tax loophole:
- You must spend over 500 hours on the business.
- You do substantially everything for the business.
- You spend over 100 hours on the business, and no one else’s time commitment surpasses yours.
- You engage in a significant participation activity for over 100 hours, and your combined activity in all significant participation activities is over 500 hours.
- You took part in the business for five of the previous 10 taxable years.
- You provided personal services connected with the rental property for three of the previous taxable years.
- Personal services are activities that require advanced skills or education, such as legal, healthcare, engineering, accounting, construction, or other professional services.
- You show regular, continuous, and provable participation in the business for over 100 hours.
The first three criteria are the most common for STR owners. Once you’ve met the criteria and your STR activity is considered active, you can deduct your rental losses from your active income.
Pro tip: If you have multiple properties, test your participation for each rental separately, not your overall participation for your entire portfolio.
Material Participation for Landlords
The material participation criteria may sound daunting at first, but you may qualify already and not realize it.
- Spend 500 hours on the business
Do you spend over 1.5 hours per day (on average) on managing your STR? Your total participation will add up to over 500 hours per year. Need to increase your hours? Start providing cleaning and laundry services, meals, organized tours, or transportation.
- Do substantially everything for the business.
For Airbnb or VRBO hosts, you may need to manage your own property or use a half-service manager. Working with a full-service manager reduces your involvement in the business, likely disqualifying you from material participation.
Are you a DIY host for a short-term rental? If you don’t have a co-host, property manager, or housekeeping service, you’re already doing most of the work.
- Spend over 100 hours on the business, without anyone else’s time commitment surpassing yours.
Do you have a co-host or half-service property manager who does less than half the work? As long as you spend 18 minutes or more per day on the business, you’ll meet the time requirement.
How Landlords Can Prove Material Participation
If tax authorities audit you, you’ll need to prove two points that support your claim of material participation:
- The amount of work done, showing consistent engagement
- The type of work performed, proving regular participation
This is where your recordkeeping and supporting documentation come in.
Use work logs to document specific involvement, tasks, and hours. Keep a calendar to prove how you managed the STR during the year. Take notes in a logbook during appointments, showing the time and duration of the meetings with renters, staff, and service providers. Maintain detailed timesheets that break down all your work on the property for the year.
Pro tip: Use time-tracking software to manage the documentation process. You can download your work logs to save with your tax records each year.
Impact of the STR Loophole for Landlords
Landlords and real estate investors typically use the Schedule E to report their passive rental income. If your STR income becomes active, though, your tax situation changes.
Since your rental counts as a business (not a passive concern), you become subject to self-employment taxes. You’ll also use the Schedule C to report income; partnerships will use Form 8825.
Note: We recommend consulting with a real estate lawyer or CPA about your specific situation before changing your portfolio or tax strategies.
How to Get a Paper Loss for Short-Term Rentals
The beauty of the STR loophole is that you can offset active income with your rental losses; however, not all losses are the same. An operating loss occurs when your operational costs are more than your gross profit.
A paper loss, though, occurs when your operational costs plus your noncash expenses surpass your income. You’re operating at a profit, but on paper, your deductions give you a loss.
The key to making the STR loophole work for you is to increase your non-cash deductions to surpass your income. And that’s why depreciation is so crucial to real estate investors.
Depreciation is a non-cash, deductible expense that reflects the decrease in an asset’s value. To make the STR loophole most effective, you need to maximize your property’s depreciation.
Maximizing Deductions with Accelerated Depreciation
Typically, depreciation for rental properties spreads out over 39 years. However, you have options to speed up depreciation for your STR that will reduce your taxable income and may improve cash flow during the early years of operation.
Unlock Bonus Depreciation
Once you qualify for material participation, you also qualify for bonus depreciation. This tax incentive allows you to immediately deduct a large amount of depreciation instead of writing it off over the asset’s lifetime.
This means you can deduct short-lived improvements, such as replacing an HVAC system.
The bonus depreciation option is phasing out. In 2025, the bonus amount is 40%. In 2026, it’s 20%, and in 2027, the option will be gone, unless the provisions are updated.
Increase Deductions with Section 179
With Section 179, landlords can write off the total price of qualifying equipment and software acquired during the tax year.
Reclassify Assets
Another option is a cost segregation study, which examines the assets associated with a property and determines their values and useful life. This practice enables you to reclassify elements of your property and depreciate them over five or 15 years.
Since these components usually comprise 20% to 30% of a property’s purchase price, this has a significant effect on your reportable income and sets you up for a paper loss.
Common Mistakes with the STR Loophole
Misunderstanding the Seven-Days Rule
The problem comes up when one tenant signs consecutive short leases—the lease extensions don’t count as one stay.
Accurately track each tenant’s use periods, and don’t manipulate leases to fit the rule. Focus on bookings that meet the criteria instead.
Ignoring Personal Use Days
When owners use the STR for more than 14 days or 10% of the total rental days, the property counts as a personal residence. You can’t claim losses associated with your personal residence, so this affects the tax strategy.
Keep detailed records of your personal use days versus rental days, and don’t use your STR personal visits beyond the limits.
Pro tip: Be strategic with your visits. Days spent on repairs and maintenance don’t count as personal use days, even if other people are staying there with you.
Failing to Track Contractor Hours
One way to pass the material participation test is to work over 100 hours on the property and spend more time on it than anyone else, including contract workers like maintenance crews and cleaners. Failing to track contractor hours undermines your claim of material participation if the IRS audits you.
Keep detailed logs of your hours and hours for any contractors who work on the property. Using property management software can help track and document hours.
Relying on Travel Time
Travel time that doesn’t directly relate to property operations or that’s excessive for the task doesn’t count toward participation hours. In a 2020 court case, commuting time between a personal residence and an STR was excluded.
Ensure that your participation hours are reasonable and directly related to the STR.
REI Hub: Simplified Accounting for Short-Term Rental Owners
Managing short-term rentals means juggling bookings, expenses, and multiple platforms, and REI Hub helps you keep it all organized. Built for property investors, our software streamlines bookkeeping so you can focus on guest experiences, not spreadsheets.
Our default setup aligns with the Schedule E, so you’re ready to track income and expenses from day one—no customization needed. Use built-in templates to record cleaning fees, rents, or security deposits with ease.
Automatically import transactions from linked bank accounts, and save time with smart rules and recurring entries. Monitor each property’s performance with detailed reports on cash flow, ROI, and occupancy metrics—all available by unit, property, or portfolio.
Prepare for tax time with depreciation tracking, digital receipt storage, and a CPA-ready export packet.
Plus, REI Hub integrates seamlessly with TurboTenant and RentRedi, and our US-based support team and knowledge base are here whenever you need help.
Streamline your STR’s finances and stay tax-ready with REI Hub.
Start your free 14-day trial today, no commitment or credit card required.
