The Short-Term Rental Loophole (Reg. § 1.469-1T(e)(3)(ii))

The short-term rental strategy lets a taxpayer deduct STR losses against active income without REPS, transformative for high-income W-2 earners who cannot meet the § 469(c)(7) tests.

Why STRs escape the per se passive rule

The key is the definition of "rental activity." § 469(c)(2) makes rental activities per se passive, but Treas. Reg. § 1.469-1T(e)(3)(ii) provides that an activity is not a rental activity if the average period of customer use is seven days or less. At that point it is a trade or business, the per se passive rule does not apply, and the taxpayer need only materially participate, no real estate professional status required.

The material participation requirement

Because the STR is a non-rental trade or business, losses unlock by materially participating under any of the seven tests of Treas. Reg. § 1.469-5T. The most accessible is usually test 3, the 100-hour test: more than 100 hours and more than anyone else, including cleaners, co-hosts, and managers.

Pairing with cost segregation

The strategy is frequently combined with a cost segregation study to reclassify components into shorter-lived classes, accelerating depreciation and generating a large first-year loss that, with material participation, flows against active income.

The pitfalls

• The "more than anyone else" trap. A manager or cleaning crew logging more hours than the owner defeats test 3, self-management is often essential.
• The average-stay calculation. The seven-day average is computed across all stays; a few long stays can blow it.
• Substantial personal services. Even at seven days or less, providing substantial services can trigger different rules.
• Documentation. Contemporaneous time logs, as always.