Short-Term Rental (STR) Loophole

By Jason Watson, CPA
Posted Sunday, May 25, 2025

Everyone loves loopholes, right? The Hummer loophole was recently popular again with 100% bonus depreciation. The older kid on the block is the short-term rental (STR) tax loophole. What is a loophole anyway? Is it a close cousin to donut holes? Yum!

Common convention suggests that a loophole allows you to get around some inherent rule or limitation by finding an escape. According to some historians and BackThenHistory.com,

The word loophole dates to the mid-1500s. It comes from a combination of the word hole and the Middle English word loupe, which refers to the “narrow window” or “slit-opening in a wall” that archers used for protection while shooting. The figurative sense of the word loophole meaning “outlet” or “means of escape” didn’t come into usage until the 1660s.

Today, the word loophole is mostly used in legal applications, and to identify the inconsistency between parents when raising children where a child at the early age of 4 learns how to naturally manipulate. We digress.

With respects to short-term rentals, people in the real estate CPA community consider it a loophole since the tax code was written with hotel operators in mind, and not the average real estate investor operating a single-family home as a hotel. Here is the short-term rental loophole elevator spiel-

• If your average guest stay is 7 days or fewer, and

• You materially participate in the rental activity, then

• Your activity is non-passive, and as such your rental property losses are not limited by passive activity loss limitations (please see our discussion on passive activity losses on page xx).

Short-Term Rental Tax Code

Let’s review where this 7-day rule comes from. Treasury Regulations Section 1.469-1T(e)(3)(ii)(A) reads-

(3) Rental activity—(i) In general. Except as otherwise provided in this paragraph (e)(3), an activity is a rental activity for a taxable year if—

(A) During such taxable year, tangible property held in connection with the activity is used by customers or held for use by customers; and

(B) The gross income attributable to the conduct of the activity during such taxable year represents (or, in the case of an activity in which property is held for use by customers, the expected gross income from the conduct of the activity will represent) amounts paid or to be paid principally for the use of such tangible property (without regard to whether the use of the property by customers is pursuant to a lease or pursuant to a service contract or other arrangement that is not denominated a lease).

(ii) Exceptions. For purposes of this paragraph (e)(3), an activity involving the use of tangible property is not a rental activity for a taxable year if for such taxable year—

(A) The average period of customer use for such property is seven days or less;

(B) The average period of customer use for such property is 30 days or less, and significant personal services (within the meaning of paragraph (e)(3)(iv) of this section) are provided by or on behalf of the owner of the property in connection with making the property available for use by customers;

(C) Extraordinary personal services (within the meaning of paragraph (e)(3)(v) of this section) are provided by or on behalf of the owner of the property in connection with making such property available for use by customers (without regard to the average period of customer use);

(D) The rental of such property is treated as incidental to a nonrental activity of the taxpayer under paragraph (e)(3)(vi) of this section;

(E) The taxpayer customarily makes the property available during defined business hours for nonexclusive use by various customers; or

(F) The provision of the property for use in an activity conducted by a partnership, S corporation, or joint venture in which the taxpayer owns an interest is not a rental activity under paragraph (e)(3)(vii) of this section.

As such, the very first exception is “the average period of customer use for such property is seven days or less.” However, there is a 30-day consideration outside of the second exception as well. Since some readers enter into our book at different places, we repeat ourselves at times. This is one of those times.

30 Day Short-Term Rental

The 30-day thing is a bit nuanced and takes a bit of time to sort through. IRC Section 168(e)(2) reads-

(2) Residential rental or nonresidential real property
(A) Residential rental property
(i) Residential rental property
The term “residential rental property” means any building or structure if 80 percent or more of the gross rental income from such building or structure for the taxable year is rental income from dwelling units.

Ok. What is a dwelling unit? IRC Section 168(e)(2)(a)(ii)(I) reads-

(ii) Definitions. For purposes of clause (i)-
(I) the term “dwelling unit” means a house or apartment used to provide living accommodations in a building or structure, but does not include a unit in a hotel, motel, or other establishment more than one-half of the units in which are used on a transient basis

Great. What is transient basis? In Private Letter Ruling 139827-07, the IRS stated-

“Lodging facility” is defined in section 856(d)(9)(D)(ii) as a (l) hotel, (ll) motel, or (lll) other establishment more than one-half of the dwelling units in which are used on a transient basis. The term “transient” is not defined in section 856 or the regulations thereunder. However, for other purposes of the Code, a renter has generally been treated as “transient” if the rental period is less than 30 days. See section 1.48-1(h)(2)(ii) (which concerned definitions under old section 48 for purposes of the investment credit under former section 38); Shirley v. Commissioner, T.C. Memo 2004-188.

If your rental property has tenants or guests who stay 30 days or less, then they are considered transient. Subsequently, the rental property is nonresidential. However, when people toss around short-term rental or STR, they are commonly referring to the loophole or 7-day version.

Sidebar: As we discussed in our Election 1.469-9(g) section, short-term rentals with an average guest stay of 7 days or less or short-term rentals where you provide hotel-like services are not considered rental activities and cannot be grouped with other rental activities. Yes, STRs can be grouped together just not with other rentals. This is a big deal for material participation testing.

Why did the IRS, Treasury, Congress and everyone define it this way? The original intent was to prevent real estate investors from using 27.5 years of depreciation versus 39.0 years. In other words, by calling a rental property a residential property, they were able to shrink the depreciation schedule (and increase current year depreciation deductions).

As such, if your rental property has tenants who stay 30 days or less, it is considered nonresidential and is depreciated over 39.0 years versus 27.5 years. Many rental property owners are unaware including several tax professionals.

However, we can use this spat to our advantage. How? See our section on qualified improvement property and the additional accelerated depreciation and Section 179 expensing.

30 Day Versus 7 Day Quickie Comparison

We touch on personal services in other sections, but to reiterate- personal services are hotel-like services such as daily housekeeping, meals (bed and breakfast), access to fitness or spa amenities managed by you, concierge services, tours, etc. These are things that most rental property owners or short-term rental hosts generally do not provide.

Here is a summary table-

Average Guest Stay	Personal Services	Tax Treatment	Type	Self Employment Tax
Any	Yes	Business (hotel-like)	Nonresidential	Yes
>30 days	No	Traditional Rental	Residential	Nope
8-30 days	No	Short-term	Nonresidential	Nope
0-7 days	No	Loophole eligible	Nonresidential	Nope

Note that once you are considered providing personal services, the average guest stay doesn’t matter. You are a business, and material participation stuff gets tossed out in favor of basic business thresholds- regular and continuous with profit motive for your loss deduction ability. Activities are reported on Schedule C of your individual tax return (Form 1040) or business entity tax returns such as partnerships and corporations.

We digress…

Forget 30 Days Let’s Talk 7 Days

Many cities and various municipalities are cracking down on 7-day short-term rentals. Sure, people complain about the additional cars, noise, and shenanigans associated with the inherent turnover of guests at a rental property. The hotel industry seems to enjoy this turnover since it typically means higher rents (short rent periods = higher daily rates), but they don’t like competition. As such, they leverage busy body Betty, take her complaints to local governments and influence code changes.

Some kidding aside, the other reason for these ordinance changes is a deemed housing shortage. Some governments believe that a bunch of typical homes are being pulled out of the market as a residence and re-deployed as a short-term rental (a long-term rental can be viewed as a net-zero or neutral within this argument). However, in glamorous cities such a New York City and San Francisco, short-term rentals help long-term renters with high rent costs by augmenting their household income with sporadic rental income. For example, a NYC long-term renter might sublet his Manhattan pad when they travel overseas for 10 days. Not anymore.

There is a gotcha for real estate professionals and the 750 hours rule who have short-term rentals with an average guest stay of 7 days or less. Temporary Treasury Regulations 1.469-1T(e)(3) reads-

(3) Rental activity—(i) In general. Except as otherwise provided in this paragraph (e)(3), an activity is a rental activity for a taxable year if

(A) During such taxable year, tangible property held in connection with the activity is used by customers or held for use by customers; and

(B) The gross income attributable to the conduct of the activity during such taxable year represents… amounts paid or to be paid principally for the use of such tangible property.

(ii) Exceptions. For purposes of this paragraph (e)(3), an activity involving the use of tangible property is not a rental activity for a taxable year if for such taxable year-

(A) The average period of customer use for such property is seven days or less;

Read those last two sentences again. Are we telling you that a short-term rental with an average guest stay of 7 days or less is not considered a rental activity? Not even a real property trade or business? No, but the regulations are.

Oh, and so are the courts.

In Bailey v. Commissioner, Tax Court Memo. 2001-296, and again in Bailey v. Commissioner, Tax Court Summary Opinion 2011-22, which are different people with different facts but the same problem- the court used a literal interpretation of “the average period of customer use for such property is seven days or less” and stated that the activity was not a rental activity, and therefore those hours did not count as material participation.

If you cannot get enough, here is a contradicting blurb from Chief Counsel Advice 201427016–

whether a taxpayer is a qualifying taxpayer within the meaning of section 469(c)(7)(B) and Treas. Reg. § 1.469-9(b)(6) depends upon the rules for determining a taxpayer’s real property trades or businesses under Treas. Reg. § 1.469-9(d), and is not affected by an election under Treas. Reg. § 1.469-9(g). Instead, the election under Treas. Reg. § 1.469-9(g) is relevant only after the determination of whether the taxpayer is a qualifying taxpayer.

Let’s break this down. IRC Section 469(c)(7)(B) refers to the 750 hours requirement which is a consideration for real estate professional status (REPS). The Treasury Regulations 1.469-9(g) refer to the formal election to group all your rental activities together as a single activity for material participation testing. The IRS’s chief counsel is disagreeing with the Bailey decisions. Nice!

Why do you care? If you want to qualify as a real estate professional as defined by the IRS, there are two hurdles related to hours. The first is the 750 hours test which some call REPS hours. You cannot use the time spent on your short-term rentals where the average guest stay is 7 days or less for the REPS hours hurdle. That’s why you might care.