What if you could buy a rental property, claim a massive tax deduction in year one, and avoid the passive loss limitations that apply to most real estate investors?
That’s one of the main benefits of the complex “STR Loophole”: a powerful strategy that allows some short-term rental owners to deduct real estate losses against their active W-2 or business income, potentially saving tens of thousands (or more) in taxes.
Unlike traditional long-term rentals, which come with strict passive activity rules, certain short-term rentals can be treated differently under IRS rules, opening up advanced tax-saving strategies like bonus depreciation and cost segregation to high-income earners without needing real estate professional status.
In this guide, I’ll break down what the STR loophole really is, who qualifies, and how you can use it to turn a short-term rental into a tax-efficient asset.
What Is the STR (Short-Term Rental) Loophole?
STR stands for “Short-Term Rentals,” such as Airbnb or VRBO properties. The term “STR loophole” refers to a tax strategy that some real estate investors can use to:
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Treat income from short-term rentals differently than long-term rentals (active vs. passive)
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Maximize deductions and depreciation
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Possibly qualify for favorable tax treatment, like the Qualified Business Income (QBI) deduction
Why Does This Matter?
Normally, income from rental real estate is considered passive by the IRS. This limits your ability to deduct losses from the property against other types of income, like W-2 wages or business profits.
But short-term rentals are a bit different. If you meet certain criteria, you may be able to:
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Treat the rental activity as a business, not just a passive investment
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Use losses to offset active income, reducing your total tax bill
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Qualify for the 20% QBI deduction
For high-income professionals or full-time investors, this can mean massive potential savings.
How Do You Qualify for the STR Loophole?
There’s no single IRS form that says you qualify, but investors generally rely on a few key rules and activity tests to make their case. Here’s what you should focus on:
1. Short Rental Periods
Your average rental period must be 7 days or fewer, or fewer than 30 days if you provide substantial services like cleaning during the stay, concierge support, or breakfast (although this may open you up to self-employment tax).
2. Material Participation
You must materially participate in the rental activity, meaning you’re not just handing everything off to a property manager. The IRS provides several tests to prove this. You only need to meet one of them:
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You participated for more than 500 hours during the year
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You did substantially all of the work involved with the rental
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You participated for more than 100 hours, and no one else participated more than you
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You had several activities that together exceeded 500 hours, and you materially participated in each
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You participated in the activity for at least 100 hours, and the activity was a significant participation activity (alongside others that meet this standard)
These rules aren’t vague. The IRS expects careful documentation of your time spent, services provided, and level of involvement if you plan on using this strategy.
Cost Segregation: Supercharging the STR Strategy
For high-income investors, one way to maximize the benefits of the STR loophole is by combining it with a cost segregation study.
What is Cost Segregation?
It’s a detailed analysis that we pay a third-party firm to perform. It separates your property’s components into multiple depreciation schedules, typically 5, 7, or 15 years, rather than the default 27.5 years for residential rental property. That means:
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You get larger upfront depreciation deductions
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You can offset high income in the early years
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You improve cash flow today by reducing tax liability
Example: STR + Cost Seg = Big Year-One Savings
Let’s say you buy a short-term rental property for $500,000 (excluding land).
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A cost segregation study identifies $150,000 of components eligible for accelerated depreciation
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You deduct $150,000 in year one using 100% bonus depreciation, which is back due to the recent OBBA tax bill
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If you’re in the 37 percent federal tax bracket, that deduction could reduce your tax bill by $55,500
What Are the Risks?
The STR loophole can be powerful, but like most things, it comes with risks. Here are a few things to watch out for:
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If you fail the material participation tests, your losses may be disallowed or deferred
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The IRS may challenge your classification if your recordkeeping is weak
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STR income can trigger self-employment tax in certain cases if you’re offering hotel-like services, such as daily housekeeping
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Cost segregation studies have upfront costs and require precise documentation
- Depreciation reduces cost basis, but a future 1035 exchange could help you defer any capital gains if the property is sold.
Bottom line: this is not a DIY strategy. You need a qualified professional who understands both advanced real estate and tax law.
What You Should Do Next
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Track your time and involvement throughout the year. Don’t guess, document everything.
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Avoid fully outsourcing property management if you want to claim material participation.
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Consider a cost segregation study if you’re a high-income investor with a newly purchased STR.
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Talk to a tax advisor before tax season, not after. You need to plan proactively with a complex strategy like this.
Frequently Asked Questions
Can I use the STR loophole if I hire a property manager?
It’s difficult. If someone else is doing most of the work, you likely fail the material participation tests. However, it depends on how involved you still are in key decisions and day-to-day tasks.
Does the loophole apply to just one property or all of them?
You can qualify per property, but the IRS does allow grouping of activities in some cases.
Will this always be legal?
The current rules are based on longstanding IRS guidance, but Congress or the IRS could tighten them in the future. The loophole is a legal tax avoidance strategy, but it’s complex and may evolve. The recent OBBA tax bill helped to strengthen the strategy by bringing back 100% bonus depreciation.
Final Thoughts
The STR loophole is one of the most impactful tax strategies available to short-term rental investors, especially when combined with cost segregation for accelerated depreciation. When executed properly, it allows high earners to reduce their tax bill dramatically and boost their after-tax cash flow.
If you currently own short-term rentals or are considering investing in one, reach out. I can help you factor this into your overall plan and work with cost-seg experts who understand how to do this the right way. Again, this is NOT a DIY strategy.
– Clint Kraft
Founder and Financial Advisor, Kraft Capital