In the realm of real estate investments, the short-term rental tax loophole offers a unique opportunity, subject, however, to certain rules and regulations. Under passive activity loss rules, every business must follow specific criteria, especially for short-term rentals. One key requirement is that the property be rented for an average of 7 days or less. While this may exempt it from being classified as a rental activity, active participation remains a requirement, necessitating compliance with three tests: spending 500 hours on the property, dedicating at least 100 hours (and more than any other participant), and performing all the necessary work needed.
Additionally, long-term viability and consideration of depreciation recapture are important concerns. Excess business losses are limited to $250,000 for singles and $500,000 for married couples. Any excess is suspended and carried forward. Short-term rentals are classified as non-residential properties. If over 50% of guests stay on a transient basis, the property is subject to depreciation over 39 years. Bonus depreciation and Section 179 allowances can be used for improvements. However, Section 179 is capped at zero to prevent negative losses. Whether the venture is a service or rental business depends on the services provided. For example, offering a bed and breakfast must be reported on Schedule C. This triggers a 15.3% self-employment tax.
Personal Use & Compliance
Moreover, personal use plays a crucial role in the classification of the property. If used for 15 days or more or 10% of the rental days at fair market value, it becomes a residence, subject to specific regulations. The REPS-9 election prohibits grouping short-term and long-term rentals, emphasizing the need for careful strategic planning. Notably, personal visits for maintenance purposes do not contribute to personal use calculations. Onsite management is often seen as a potential red flag. It can cause the property to fail crucial qualification tests. Understanding these rules is essential for investors. This knowledge helps them use the short-term rental loophole while staying compliant with tax regulations.
