In our free guide, The Single Best Tax Saving Strategy for High Income Earners we breakdown the exact strategy countless investors use to save hundreds of thousands of dollars each year on their taxes.
The most common approach requires you to qualify as a real estate professional, “REPS”.
To qualify for REPS:
- You, or your spouse, cannot have a full-time job, AND
- That same spouse must have the capacity for 750 hours of work each year.
Unfortunately, that just isn’t an option for most busy, high income households.
Is the entire strategy dead? Absolutely not.
Enter: The Short Term Rental Tax Loophole.
This guide will give you a strong foundation to understand how the loophole works and why it can be so powerful, particularly for busy professionals who are working a full-time job.
How the Short Term Rental Tax Loophole Works
To take advantage of the short term rental tax loophole, you need to accomplish three things:
- Prove that your STR is not a rental activity.
- Establish material participation in your STR.
- Execute The Single Best Tax Saving Strategy for High Income Earners.
Let’s unpack each of those:
Prove that your STR is not a rental activity
The tax code is clear: all income derived from rental activities is considered passive.
Generally, the only way around this limitation is to qualify as a real estate professional.
Since that’s not an option for us, we need to prove that our STR is not a rental activity.
How? The secret is found within the tax code itself.
The code lists six ways to prove your STR is not a rental activity. However, we really only care about one, since it’s by far the easiest.
And that one is the length of stay exclusion.
If your property’s average length of stay is 7 days or less, then your property is not considered a rental activity.
The average is what matters, so a few longer stays would be fine so long as the average stay is 7 days or less.
This is huge. But it’s not enough on its own.
Establish material participation in your STR
We also need to prove that you are materially participating in the operations of your short term rental.
In order for our IRS friends to see that we are materially participating, we will need to meet one of several tests. The easiest test by far is to spend at least 100 hours working on your property AND more than anyone else.
To keep it simple, if you are personally managing your Airbnb (rather than outsourcing to a property manager), you should easily hit 100 hours in a calendar year. You will also very likely spend more time than any other 3rd party vendor, including your cleaners.
Execute The Single Best Tax Saving Strategy for High Income Earners
If you can prove that your short term rental is not a rental activity, and you demonstrate that you are materially participating in your property, then you can take advantage of the The Single Best Tax Saving Strategy for High Income Earners.
The strategy looks something like this:
- Purchase an investment property
- Run a cost segregation study
- Accelerate the depreciation (”Bonus Depreciation”)
- Convert passive losses into active losses that offset your other active income
The short term rental tax loophole is your ticket to accomplishing the 4th step, which is by far the most challenging.
All you need to do now is run a cost segregation study on your short term rental property and consult with an experienced CPA who can help you put all the pieces together.
Congratulations! You’re well on your way to creating loads of passive income and generational wealth.
How is the short term rental tax loophole different from qualifying as a real estate professional?
The key here is understanding that all rental income (or loss) is, by default, treated as passive. And as we know, passive income cannot offset active income on our tax return.
So to take advantage of The Single Best Tax Saving Strategy for High Income Earners we need to convert this rental income from passive to active.
There are two ways to do this:
- Qualify as a real estate professional
- Take advantage of the short term rental tax loophole
The technical differences between why these two strategies work are frankly less important (one is an exclusion to the rule – REPS – the other is a workaround – STR loophole).
What matters more is your personal situation and which of the two strategies is best for you.
What activities will count toward the 100 hour minimum?
There is quite a bit of grey when it comes to hours that count toward the 100 minimum.
The specific language the tax code uses to describe a valid activity is any, “development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, or leasing activity.”
Investor activities — time traveling to and from the property and education or research hours — are generally not counted toward the 750 minimum.
Again, there is a lot of grey here and you should run the specific details by a knowledgeable CPA.
The general litmus test is to ask yourself question: “is this activity something a typical property manager would need to perform if they were operating my property?”
If the answer is yes, then you can count those hours.
Or is this activity just a common investor activity (e.g. scanning Zillow for new listings)? These hours generally will not count.
Can I use the short term rental property for my Airbnb? What about VRBO?
Yes, you can use your Airbnb to take advantage of the short term rental tax loophole so long as your average length of stay is 7 days or less AND you establish material participation.
This strategy can be used for a property with bookings from any platform, including Airbnb, VRBO and Homestay.
Can I use my short term rental for personal use and still use the strategy?
Yes, as long as you do not use the property for personal use for more than 15 days OR for more than 10% of the number of days the property was rented. So for example, if you rented the property for 100 days during the year, you cannot use the property for personal use for more than 10 days, otherwise the STR losses would not qualify as active losses that can offset your active income.
What forms do I need to fill out on my tax return to convert my passive losses into active losses?
You will need to fill out a Schedule E (Form 1040).
I strongly advise you work with an experienced CPA. He or she will know exactly what to do.