In the realm of real estate investments, the short-term rental loophole offers a unique opportunity, subject, however, to certain rules and regulations. According to passive activity loss rules, every business is obligated to adhere to specific criteria, especially when it comes to short-term rentals. One crucial stipulation is that the property must be rented for 7 days or less on average. 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 capped for single individuals at $250,000 and for married individuals at $500,000, with any surplus being suspended and carried forward. Notably, short-term rentals are categorized 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 for improvements can be utilized, with the latter, however, capped at zero to prevent negative losses. Determining whether the venture falls under a service or rental business hinges on the provision of substantial services; for instance, if a bed and breakfast service is offered, it must be reported on Schedule C, triggering a 15.3% self-employment tax.
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. The involvement of onsite management, often seen as a potential red flag, can lead to the property failing crucial qualification tests. Understanding these rules is essential for investors seeking to capitalize on the short-term rental loophole while maintaining compliance with tax regulations.
