The 7-Day Average Stay Rule:

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This is where short-term rentals become dramatically more tax-advantaged than long-term rentals.

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The core concept: If your average guest stay is 7 days or less (or 30 days or less with substantial services), your rental is classified as a "non-passive" business activity — not a rental activity - subject to material participation rules discussed later. This 7-day average is calculated on an annual, not a per-booking, basis.

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Why this matters: Rental losses are usually "passive losses" that can only offset passive income. But when your short-term rental is non-passive, those losses may offset your W-2 income, consulting income, or any other ordinary income, if certain conditions are satisfied.

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The calculation:

• Total nights rented: 180 nights
• Total reservations: 45 bookings
• Average stay: 4 days (180 ÷ 45)
• Result: Qualifies as non-passive

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What counts as "substantial services":

• Daily housekeeping during the stay
• Concierge services
• Meals 
• Arranged tours or activities

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What usually doesn't count:

• Regular cleaning between guests
• Providing linens and basic amenities
• Maintenance and repairs
• Trash removal

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Real-world impact:

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Jennifer has a beach condo she rents short-term. After depreciation and expenses, she has a $25,000 loss on paper (even though cash flow is positive). Because her average stay is 5 days:

• She can deduct that entire $25,000 loss against her $150,000 W-2 salary
• At a 32% federal + state rate, that's $8,000 in tax savings
• If it were a long-term rental (passive), she couldn't use any of that loss.

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Material Participation: The 7 Tests You Need to Know

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To use short-term rental losses against ordinary income, you need to "materially participate" in the business. You must meet one of these seven tests:

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Test 1: The 500-hour rule

• Work more than 500 hours per year in the rental activity
• This is roughly 10 hours per week
• Includes: guest communication, cleaning, maintenance, marketing, bookkeeping, property checks
  
  • Note: the IRS often challenges STR classification in scenarios where the taxpayer outsources cleaning and automates systems. Contemporaneous logs are critical, and recreated logs are often rejected.

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Test 2: Substantially all the work

• You do substantially all the work (no one else does more)
• Common for solo hosts without property managers

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Test 3: The 100-hour rule

• 100+ hours per year, and no one else works more than you
• Feasible for most active hosts

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Test 4: Significant participation activities

• Less common for single-property hosts
• Relevant if you have multiple rental properties

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Test 5: Material participation in 5 of the last 10 years

• Builds up over time
• Useful for long-term hosts

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Test 6: Personal service activity

• You materially participated in 3 previous years
• Activity is a personal service activity
• Rare for rentals

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Test 7: Facts and circumstances

• 100+ hours per year
• Work regularly, continuously, and substantially
• IRS is skeptical of this test alone

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How to document material participation:

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Keep a contemporaneous log showing:

• Date and time of each activity
• Description of work performed
• Hours spent

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Use a simple spreadsheet or time-tracking app. Update it weekly, not at year-end.

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Deductions That Add Up

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Beyond standard rental deductions, short-term rentals have unique deductible expenses:

Platform-Specific Costs

Service fees:

• Airbnb host service fees (typically 3%)
• Vrbo subscription or per-booking fees
• Direct booking website platforms (Lodgify, Guesty)
• Channel managers that sync calendars

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Example: $60,000 in annual bookings at 3% Airbnb fees = $1,800 deduction

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Guest Amenities and Consumables

What short-term rentals provide that long-term don't:

• Coffee, tea, snacks for guests
• Toiletries (shampoo, conditioner, soap, lotion)
• Kitchen basics (salt, pepper, olive oil, spices)
• Paper products (toilet paper, paper towels, tissues)
• Cleaning supplies (dish soap, sponges, trash bags)
• Laundry detergent and dryer sheets

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Real numbers: These consumables can easily run $100-200 per month ($1,200-2,400 per year) for an active rental.

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Linens and Furnishings Turnover

The short-term rental reality: Your sheets, towels, and furnishings wear out much faster than in a long-term rental.

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Deductible replacements:

• Sheets and duvet covers (replaced 1-2 times per year)
• Towels and bath mats (high turnover)
• Dishes and glassware (breakage happens)
• Small appliances (coffee makers, blenders)
• Furniture that wears out

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Accounting treatment:

• Items under $2,500: immediately deductible (de minimis safe harbor)
• Items over $2,500: depreciate over time

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Depreciation: The Key That Creates Paper Losses

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This is where short-term rentals become incredibly powerful tax-savings tools.

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The basics:

• Residential real estate depreciates over 27.5 years
• If you bought a property for $400,000 (with $100,000 land, $300,000 building), annual depreciation is roughly $10,900
• This is a paper expense — no cash leaves your pocket, but you get a tax deduction

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The bonus depreciation opportunity:

Through 2026, certain personal property inside your rental may qualify for bonus depreciation, letting you deduct immediately.

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What qualifies:

• Furniture and appliances
• Carpeting and removable fixtures
• Decorative items
• Some landscaping

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Cost segregation studies:

For higher-value properties ($500,000+), a cost segregation study can identify components that depreciate faster than the building:

• 5-year property: appliances, carpeting, furniture
• 15-year property: landscaping, fencing, paving
• 27.5-year property: the building structure

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‍The strategy: Take the large first-year deduction, which might create a loss that offsets other income (if you materially participate).

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Case Study

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Let’s examine a hypothetical but reasonable example. Note that this example is simplified and assumes no additional federal or state limitations apply.

Purchase price: $450,000 Down payment: $90,000 Mortgage: $360,000

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Year 1 results:

• Gross rental income: $72,000
• Occupancy: 165 nights, 42 bookings
• Average stay: 3.9 days (qualifies as non-passive)
• Material participation hours logged: 520 hours

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Expenses:

• Mortgage interest: $18,000
• Property taxes: $5,500
• Insurance: $2,400
• Utilities: $3,600
• Cleaning (outsourced): $6,300
• Platform fees: $2,160
• Supplies and amenities: $1,800
• Maintenance and repairs: $4,200
• Property management software: $720
• Total cash expenses: $44,680

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Cash flow: $27,320

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Tax calculation:

Gross income: $72,000; Cash expenses: $44,680; Depreciation (standard): $14,545; Net taxable income: $12,775

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But with cost segregation: Accelerated depreciation (year 1): $42,000; Net taxable income: -$14,000 (loss)

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Tax impact: W-2 income: $185,000; Without rental: Taxable income = $185,000; With rental loss: Taxable income $171,000

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Tax savings at 32% bracket: $4,480

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The complete picture:

• Cash in pocket: $27,320
• Tax savings from loss: $4,480
• Total first-year benefit: $31,800

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And you paid taxes on zero rental income (actually reduced overall taxes).

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The Long Game: Watch Out For Depreciation Recapture, Excess Business Losses, Personal Use, and Local Regulations

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When you eventually sell the property, you'll owe depreciation recapture tax on all the depreciation you claimed — taxed at up to 25%.

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The math:

You claimed $150,000 in depreciation over 10 years. You sell the property. You owe approximately $37,500 in recapture tax (25% rate).

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But consider:

• You saved taxes every year at your marginal rate (potentially 32-37%)
• You defer the tax until sale (time value of money)
• You might 1031 exchange into another property and defer indefinitely (note, however, that STRs with “hotel-like services,” significant personal use, or short holding periods can jeopardize investment-property treatment for exchange purposes)

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The strategy: For most people, the current-year tax benefits far outweigh the future recapture cost, especially considering the time value of money.

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Excess business loss limitations might apply to higher-income W-2 taxpayers. Losses are limited to $512,000, indexed annually (if married filing jointly). In an extreme example, where married taxpayers realize $1mil of income and a paper loss of $800k on an STR, that loss would be limited.

The IRS uses a strict threshold to determine if your property is a business or a residence. If your personal use exceeds the greater of 14 days in a year, or 10% of the total days rented at fair market value (i.e. not discounted for friends/family), this short-term rental treatment no longer applies.

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The Bottom Line

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Short-term rentals offer one of the most tax-advantaged ways to earn income because:

1. They can generate rental income that's treated as active for loss limitation purposes (letting you use losses against W-2 income)
2. Depreciation creates paper losses while you have positive cash flow
3. Every expense is deductible when properly documented
4. STR income is excluded from self-employment tax (with the exception of properties where a taxpayer provides “hotel-like services” - daily housekeeping or on-demand concierge services)

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But the benefits only work if:

• You understand the material participation rules
• You properly document everything
• You classify the rental correctly (7-day average stay rule)
• You work with a tax advisor who knows these rules

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Already running a short-term rental and wondering if you're maximizing these benefits? Or considering buying a property and want to understand the tax implications before you commit? Fifteenth specializes in helping short-term rental hosts optimize their tax situation. Let's review your specific numbers and build a strategy that works.

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