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John Malone, JD, CTC
July 2, 2023

Understanding the Short Term Rental Tax Loophole

We are on a mission to educate others on the correct ways to report and strategize for short term rentals from a tax perspective.

The booming short term rental market has opened doors for investors seeking to leverage properties for rapid returns. However, the tax implications are often a maze that requires deciphering.  Properly navigating this maze as part of your tax strategy will help you on the path to achieving tax-free wealth!

This article aims to break down the essentials of what's popularly termed as the "Short Term Rental Loophole" in investor circles. PS - It is not really a loophole, it is just the application of law!

1. Understanding the Place of STRs in Tax Filing

First and foremost, identifying where your Short Term Rental (STR) belongs on your tax return is crucial. You must discuss with your CPA if your STR is providing substantial services like a hotel.

Depending on the services you provide, your STR might fit into Schedule C. However, the vast majority of normal "Airbnb" type properties we see actually fall to Schedule E since the level of activity dos not meet the substantial services definition by the IRS.

2. Deciphering the Depreciation Dilemma

There’s often a debate between a 27.5-year versus a 39-year depreciation timeline for STRs. The key to solving this puzzle lies in the average length of stay. If your guests usually stay for 30 days or less, the IRS considers your STR as transient, similar to a hotel, and it falls under a 39-year depreciation schedule as a commercial property.

However, if the average stay exceeds 30 days, it could be deemed residential and subject to 27.5-year depreciation. If you or your CPA has improperly reported this in the past, you can correct this by using Form 3115.

3. The Rental Property Conundrum: Passive or Nonpassive?

The label “rental property” can be misleading. The tax code sees things differently, and what you consider a rental property may not be treated as such by the IRS. If your property is rented on average for seven days or less, the IRS doesn’t consider it a traditional rental activity. You fall under the exceptions to real estate and thus, this could be considered nonpassive IF you pass one of the 7 material participation tests.

Of the seven tests, the most common we see are:

1) Spend 500 hours on the activity during the year

2) Your participation is substantially ALL of the participation for ALL individuals

3) You spend 100 hours AND more than any other person or entity

It is crucial to understand that by having a nonpassive activity, it does NOT mean that the activity automatically goes on Schedule C! This is where you must test to see if you provided substantial services. Do not get confused by this point as we have met dozens of investors who have made this mistake with an inexperienced short term rental CPA in the past!

Questions? Feel free to reach out via our inquiry link to talk to one of your Short Term Rental Loophole tax specialists today!

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