The short-term rental tax strategy, also known as the STR loophole, allows Airbnb hosts to classify their rental losses as active business losses as opposed to passive, provided the average guest stay is under 7 days, and the owner spends over 100 hours managing the property.
For many Airbnb and VRBO owners, the appeal of short-term rentals starts with the property itself.
A stylish desert retreat, a modern mountain cabin or an artfully restored historic bungalow can attract premium nightly rates and loyal guests.
However, beyond beautiful interiors and eye-catching architecture, hosts are also discovering ways to make those design investments work harder at tax time.
That’s where the short-term rental (STR) tax strategy, often called the short-term rental tax loophole, has started trending. For hosts trying to estimate the potential impact, the depreciation calculator for real estate investors provides a quick way to estimate potential first-year depreciation savings based on purchase price and property type.
This resource is an invaluable tool for real estate investors, as well as Airbnb and VRBO property owners, that can aid them in making the most of this highly-effective strategy that has the potential to result in five or six-figure tax savings within a single year for high-earning professionals.
Why Airbnb Hosts Are Increasingly Implementing the Short-Term Rental Loophole
The STR loophole refers to a unique exception in the tax code that allows some short-term rental owners to avoid the limitations of passive activity loss that normally apply to real estate rentals.
Since rental losses are normally considered to be passive, they usually can’t be used to offset active income in the form of:
- W-2 wages
- Business income
- Consulting income
- Earnings from self-employment
However, short-term rentals can be treated differently on condition that the average guest stay is 7 days or less and the owner materially participates in the operations.
Under these circumstances, the activity is no longer classified as a passive rental activity according to the IRS rules.
As a result, this means that your depreciation losses could potentially offset your active income.
How Depreciation Can Be a Money-Saving Opportunity
Most short-term rental owners are already quite well-versed when it comes to standard deductions in the form of:
- Mortgage interest
- Repairs
- Utilities
- Cleaning costs
However, the real opportunity lies in depreciation because it enables you to deduct the wear and tear of your property over time.
Normally, your residential property depreciates over the course of 27.5 years, but with an STR cost segregation study, many components of your property can be reclassified into shorter schedules, which accelerates deductions into early years.
When paired with cost segregation and bonus depreciation, this strategy may allow hosts to turn renovation costs, upgraded finishes, and design-focused property improvements into substantial first-year tax deductions.
What Cost Segregation Looks Like For Short-Term Rental Owners
An Airbnb cost segregation study can help you to identify portions of a property that might qualify for shorter depreciation timelines.
This can include things like:
- Flooring
- Cabinets
- Appliances
- Fixtures
- Landscaping
- Outdoor improvements
- Certain electrical and plumbing systems
By implementing this, some components can be depreciated over 5, 7 or 15 years as opposed to depreciating everything over 27.5 years. This accelerated depreciation will create large upfront deductions.
Where Bonus Depreciation Fits Into The Equation
Bonus depreciation allows your qualifying assets with shorter useful lives to be deducted much faster.
When operating under 100% bonus depreciation rules, investors will be able to immediately deduct the full value of their qualifying reclassified assets in the first year as opposed to spreading those deductions over multiple years.
Despite the fact that bonus depreciation percentages have started phasing down, this strategy is still incredibly valuable for many investors, depending on their timing and tax circumstances.
In fact, bonus depreciation has become one of the most widely used real estate tax planning tools when it comes to accelerating deductions.
Bonus Depreciation in Action
To better understand the value of this strategy, a practical example can be useful.
So, imagine an investor purchases a short-term rental property to the value of $40,000.
Assuming the following:
- Land value: $80,000
- Depreciable building basis: $320,000
- Average guest stay: 4 nights
- Owner materially participates
- Property qualifies for cost segregation
- 25% of the building is reclassified into short-life assets
The standard depreciation of this property, without cost segregation, would be approximately $11,636 annually. While this is useful, it’s still relatively modest.
However, assuming the cost segregation study identitfies $80,000 wirth of 5-, 7-, and 15-year qualifying property assets, then under 100% bonus depreciation rules, the owner may deduct that $80,000 immediately in the first year.
The remaining building basis continues to depreciate normally.
How Material Participation Is Measured
Many property owners overlook the requirement of material participation, but it’s important for you to remember that simply owning a short-term rental property isn’t enough.
You need to materially participate in the operations as well.
This can include things like:
- Managing bookings
- Communicating with guests
- Coordinating cleaners
- Handling maintenance
- Managing pricing
- Doing administrative work
One of the most commonly implemented benchmarks requires you to participate in more than 500 hours a year or for your participation to exceed that of anyone else involved.
The IRS Publication 925 can also provide you with more in-depth and detailed guidance regarding the rules of material participation and passive activity.
Unlocking The Real Tax-Saving Potential of Your Property
The STR loophole has been a core pillar of many real estate investment and property owners’ tax-saving initiatives, and it’s not hard to understand why.
However, it’s important to read the fine print and ensure that you’re adhering to all of the rules and requirements to qualify for these deductions, which means taking material participation into account to ensure that you’re not eliminated based on a minor technicality.
With the real estate market currently under immense pressure, finding ways to save on costs like taxes is an invaluable asset.
This money can then be used to increase the value of your Airbnb through custom renovations and unique architectural features.
The STR loophole is one of those open secrets that exist within the real estate world that celebrities and moguls have been capitalizing on for years to help them maintain their impressive real estate portfolios.
