What are the Material Participation Rules For The Short-Term Rental Loophole?

Material Participation is one of the main requirements the IRS has in order for a property owner to qualify for the short-term rental loophole. With the One, Big, Beautiful Bill proposing to bring back 100% bonus depreciation, Airbnb hosts looking to acquire new rentals or renovate their existing ones should know the ins and outs of the Material Participation Rules to qualify for the short-term rental loophole.

Luckily, out of the seven material participation rules, you only need to meet the requirements for one to take advantage of the short-term rental loophole. Here are all of the material participation rules as dictated by the IRS and how you can qualify for them.

Note: The short-term rental loophole is only applicable to property owners in the US.

Test 1: The 500-Hour Rule

This is the most straightforward requirement and requires working more than 500 hours annually on your rental activity. When divided, it translates to roughly 10 hours per week throughout the year.

It’s also worth saying that your spouse’s worked time counts toward this total, even if filing separately or lacking ownership interest. So, if you want to split the hours between you two, then that translates to only about 5 hours a week.

Hosts can accumulate these hours through cleaning, maintenance, guest communication, marketing, and property management tasks. One tip we have is to document everything meticulously. The IRS scrutinizes whether your logged hours align with your other commitments and the property’s actual needs.

Seasonal rentals face particular challenges here. A ski condo or beach house creates uneven workload distribution, making consistent weekly participation difficult. However, rentals that have more consistent year-round demand can easily go past this requirement.

Test 2: Substantially All Participation

This test works best when you handle virtually every aspect of your rental operation. The IRS compares your involvement against all other participants, including employees and contractors.

New property owners can often easily qualify during their first partial year. Let’s say you’re purchasing a rental in October and managing everything through December. You complete the setup, handle bookings, and perform all cleaning duties by yourself. This concentrated effort during a short period can satisfy the substantial participation requirement.

We recommend that you avoid hiring property managers if you are aiming to qualify via this test. Their involvement immediately disqualifies you from claiming substantially all participation.

Test 3: 100 Hours Plus Maximum Individual

This is one of the most popular options. The test requires exceeding 100 hours while working more than any other individual person. The key word here is “individual.” So this means that you don’t compete against combined hours from multiple people.

A smart host can use this rule to their advantage. You can always deploy multiple contractors strategically for the same job. Instead of having one cleaner to handle everything, hire several different people for various tasks. Use different maintenance workers for different projects. This approach prevents any single person from accumulating more hours than you.

Let’s say you get about 26 guest stays requiring 2.5 hours of cleaning after each stay. If you help with the cleaning process, you can reach about 65 hours. Add in the time it takes to market, maintain, and communicate with your guests, and you can quickly surpass 100 hours while maintaining your position as the top individual contributor.

Test 4: Significant Participation Activities

This complex test applies when you participate in multiple business activities. Each activity must involve 100-500 hours of your time without qualifying for other material participation tests. Your combined hours across all significant participation activities must exceed 500.

Most short-term rental owners typically skip this test due to its complexity and limited applicability. It works better for entrepreneurs juggling multiple business ventures rather than those focused on rental operations.

Test 5: Historical Participation

Experience pays off with this test. If you materially participated in your rental activity for any five years during the previous ten years, you automatically qualify. The years don't need to be consecutive.

This provision helps long-term rental owners who previously met other tests but now face changing circumstances. Perhaps you hired more help or reduced your involvement due to other commitments. Your historical participation maintains your material participant status.

Test 6: Personal Service Activities

This test targets professionals in specific fields like healthcare, law, engineering, accounting, and consulting. If you materially participated in a personal service activity for any three prior years, you qualify.

However, rental activities rarely qualify as personal service activities since they're capital-intensive rather than service-focused. Most short-term rental owners cannot use this test.

Test 7: Facts and Circumstances

The catch-all test requires regular, continuous, and substantial participation throughout the year. However, strict additional requirements make this test challenging.

You must participate at least 100 hours annually. No one else can work more hours than you. No one can receive compensation for managing the activity. These restrictions eliminate most property management arrangements and limit employee usage.

Wrapping Things Up

Meeting at least one of these material participation rules can help transform your rental business from a passive investment into an active operation, providing added tax deductions. With the One, Big, Beautiful Bill passing the House, STR hosts are one-step closer to enjoying the benefits of 100% bonus depreciation once again. When combined with the STR loophole, both tax strategies can save you thousands per year.

Disclaimer: This article is for educational purposes only and does not constitute professional tax, legal, or financial advice. Tax laws are complex and frequently changing. The IRS may interpret regulations differently than presented. Tax policies are subject to change, implementation details may vary, and retroactive application is not guaranteed. Always consult with a qualified tax professional regarding your specific situation before making any business or investment decisions. We assume no liability for actions taken based on this content.