September 2025 Financial Planning Update

The Short-Term Rental Loophole

Many of our clients have asked about the “short-term rental loophole,” a legitimate, IRS-recognized tax classification that allows investors to purchase a real estate property and offset household W-2 or active taxable income using losses from a short-term rental property.

Under IRS rules, specifically Treasury Regulation §1.469-1T, rental activities are typically considered “passive,” meaning losses can only offset passive income.

But if your property qualifies as a short-term rental, it can be treated as a non-passive trade or business, unlocking the ability to use those losses to offset active income like wages or freelance earnings.

To qualify, your rental must meet two key criteria:

• Short Stay Rule: The average guest stay must be seven days or fewer. This reclassifies the property from a passive rental to an active business.

• Material Participation: You must be actively involved in managing the property. This could mean spending over 100 hours annually on tasks like guest communication, cleaning, and maintenance and doing more than anyone else involved.

When you meet these conditions, you can take advantage of bonus depreciation and cost segregation. These techniques allow you to write off large portions of your property’s value, such as appliances, flooring, and landscaping within the first year. That can result in depreciation losses which can dramatically reduce your taxable income.

Unfortunately, you won’t be able to use the property for vacations as it could disqualify you from claiming losses. So, if you do block off some time to stay at the property, make sure you’re doing some work while you’re there.

Also, hiring a property manager or cleaner who works more hours than you can void your eligibility. Make sure you (or your spouse) operate as the property manager and spend the most time managing. This also saves you the 20-30% a property manager would take from your rental income.

If you’re a high-income earner, this loophole offers a rare chance to reduce your tax liability.

It’s especially powerful in the first year of ownership, when the depreciation benefits are highest.