When a rental's average stay is 7 days or less and the owner materially participates, the activity is non-passive. The loss offsets ordinary income — no $25K cap, no carryforward wait. Naomi Sato's Maui cottage is the example.
Naomi is a marketing executive earning about $320K. Last year, she bought a 2-bedroom Maui cottage for $1.2M and placed it in service as a short-term rental.
Her CPA didn't just ask, "How big is the deduction?"
The real question was: can the deduction reach Naomi's W-2 income this year?
Six checks in order. Each one moves the activity closer to a non-passive position. Miss any one, and the loss falls back to the §469 passive bucket and the $25K cap.
| Step | What happened | What this unlocks |
|---|---|---|
| 01 | Guests stayed 4.5 nights on average | 7-day test passed |
| 02 | Naomi handled bookings, messages, cleaners, and repairs | 180 hours logged |
| 03 | The property had $900K of depreciable basis | Cost seg was worth running |
| 04 | The study created $267K of year-one deductions | Large tax loss created |
| 05 | Net STR taxable loss was about $220K after income, expenses, and interest | Loss available this year |
| 06 | Both STR gates passed — 7-day average and material participation | W-2 offset unlocked |
Net STR taxable loss: $220,000
Federal tax rate: 35%
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Federal tax saved: $77,000
Carryforward: $0
Short-term rentals carry more interior finish per dollar of basis than long-term residential — heavier appliance loads, decorative finishes, exterior amenities. Reclass ratios run higher, and the 5- and 15-year buckets are 100% bonus-eligible at 2025+ placed-in-service dates.
The cost seg study creates a $267K year-one gross deduction. After rental income, operating expenses, and interest, the net taxable loss is about $220K. Because both STR gates pass, that loss is non-passive — it flows through Schedule E and offsets ordinary W-2 income on the 1040.
5-year bonus at 100%: $162,000 15-year bonus at 100%: $81,000 27.5-year first-year MACRS: $23,891 ───────────────────────────────────── Gross year-one deduction: $266,891 Less rental income + operating expenses + interest (net): ~$47,000 ───────────────────────────────────── Net STR taxable loss: $220,000 Offsets W-2 ordinary income
Adjust the depreciable basis, marginal rate, and whether both STR gates pass. The estimator computes year-one deduction at typical STR reclass ratios. Illustrative only — actual studies depend on engineered analysis and documented hours.
Run the study, show the usable deduction, and give the client a clear savings story with the audit trail behind it.