Short-term rental taxes aren’t as simple as they seem. The IRS classifies most short-term rental income as passive, restricting deductions. Here’s how to qualify your income as non-passive and avoid costly surprises.

Is Short Term Rental Income Passive? Know Before You File

Most short-term rental income is passive unless you meet the material participation tests to qualify as non-passive.

Your tax classification affects how much you can deduct. Classifying as non-passive allows for greater tax deductions.

If you don’t meet material participation tests, you may still deduct up to $25,000 in losses—but only if your income is under $150,000.

Can you deduct your short-term rental losses against your income? Many hosts assume the answer is yes—until tax time, when they realize the IRS doesn’t treat all rentals the same. If your rental is classified as passive, your losses are limited and may be stuck until you have passive income to offset them or sell the property.

Most rentals are automatically passive, but short-term rentals follow different rules. If you’re actively involved and meet certain IRS tests, you may qualify as non-passive, meaning bigger deductions and immediate tax savings.

So, where does your short-term rental fall? Let’s break it down so you don’t leave money on the table—or get caught off guard at tax time.

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Why Most Rental Income Is Passive—and Why It Matters

Under Sec. 469 rules, rental income is automatically passive unless you meet an exception. The IRS sees rental properties as investments, not businesses, since most landlords collect rent without managing the property full-time.

Years ago, high-income taxpayers took advantage of rental losses—claiming big paper deductions for depreciation and expenses to wipe out taxes on their salary or business income, even if they barely managed the property. To stop this, the IRS introduced passive activity loss limitations to restrict when and how rental losses can be used.

If your STR is passive, losses can only offset other passive income, like profits from another rental. If you don’t have passive income, losses carry forward until you sell the property.

If your STR is non-passive, you can deduct losses immediately against your regular income, lowering your tax bill now.

This is why passive vs. non-passive status matters—it decides whether you get immediate tax savings or have to wait years to use your losses.

If you’re trying to figure out whether your short-term rental income is passive or active, here’s the first thing to know—the IRS doesn’t actually use the word “active” in this context. Instead, rental income falls into one of three categories:

Passive – The default classification. Losses can’t offset wages or business income—only other passive income (like profits from another rental).

Non-Passive – If you meet material participation rules, your STR is non-passive, meaning losses can be fully deducted against any income.

Active Participation – A separate rule that applies to some passive rentals. It allows up to $25,000 in deductions, but doesn’t remove passive classification like material participation does.

These terms get mixed up a lot, but they determine what deductions you qualify for and how losses impact your taxes. Now, let’s break down where short-term rentals fit into these rules.

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Is Short-Term Rental Income Passive or Non-Passive? 

Most rental properties are automatically classified as passive. However, short-term rentals follow different rules because they often operate more like a business than a traditional long-term rental.

Unlike long-term rentals, which are always passive unless the owner qualifies for real estate professional status, short-term rentals can sometimes be classified as non-passive—without needing to be a real estate professional. The key factors that determine this include how long guests stay and how involved you are in managing the rental.

Here’s when a short-term rental may qualify as non-passive, allowing for more tax benefits and unlimited deductions: 

The average guest stay is seven days or fewer – The IRS does not consider properties with very short rental periods to be traditional real estate investments. Instead, they may be classified as a trade or business.

The average guest stay is between 8 and 30 days, and you provide significant services – If guests stay more than seven days but less than 30, your rental may still be non-passive if you provide substantial services beyond basic maintenance. This includes things like:

You materially participate – You can still override the per se passive rule by proving that you actively manage the property. This requires meeting one of the IRS’s material participation tests, which we’ll cover shortly.

If your short-term rental is non-passive, you can access tax benefits not available to passive rentals:

Immediate tax deductions – Losses from expenses like mortgage interest, maintenance, and depreciation can be deducted in the same year, reducing taxable income.

Offsetting other income – Unlike passive losses, non-passive losses can be deducted against wages, business income, or other earnings.

No passive activity loss limits – Passive losses are normally trapped unless you have passive income to offset them, but non-passive STR losses are fully deductible.

Possible lower self-employment tax – STR income may avoid self-employment tax, depending on the level of services provided.

Additional tax breaks – A non-passive STR may qualify for business deductions, including the Qualified Business Income (QBI) deduction, reducing taxable income by up to 20%. You can also access faster depreciation for certain property improvements.

You must prove material participation to unlock these benefits, which we’ll cover next.

Material Participation Tests for Short-Term Rentals

If you want your short-term rental to be fully classified as non-passive, the IRS requires you to meet at least one of seven material participation tests, outlined in Temp. Regs. Sec. 1.469-5T(a). These tests measure how involved you are in managing the rental and determine whether you can treat it as a trade or business instead of a passive activity.

You must meet one of the following criteria to be considered non-passive:

You spend more than 500 hours on rental activities during the year.

Your participation is substantially all the work done for the rental property (meaning you don’t rely on a property manager).

You spend more than 100 hours managing the rental, and no one else spends more time than you.

You participated in the rental business for five of the last ten years.

You participated in a personal service activity (like real estate or property management) for at least three years.

You spend more than 100 hours on the rental, and it’s part of a group of rental properties you actively manage.

You regularly and continuously participate in significant rental activities.

For most short-term rental hosts, test #1 (500-hour rule) or test #3 (100-hour rule + more than anyone else) are the most common ways to prove material participation.

How STR hosts prove material participation

Hosts must track and document their involvement in managing the property to pass IRS material participation tests and classify their short-term rental as non-passive. The IRS requires proof that you play a significant role in operations, especially if you want to classify your rental as non-passive and deduct losses against other income.

Guest communication – Answering inquiries, handling bookings, and resolving guest issues.

Managing listings and pricing – Adjusting rates, updating descriptions, and responding to market trends.

Overseeing cleanings and maintenance – Coordinating with cleaners, performing inspections, and handling repairs.

Marketing the property – Promoting through social media, direct booking platforms, or email marketing.

Reviewing financials and optimizing revenue – Analyzing expenses, adjusting pricing strategies, and managing cash flow.

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If I use a property manager, does that make my short-term rental passive? 

Not automatically, but it makes it harder to qualify as non-passive. The IRS looks at who is doing most of the work—so if your property manager handles most tasks, your rental will likely be passive, meaning you can’t deduct losses against your salary or business income. Instead, losses can only be used to reduce other passive income, such as profits from another rental property or investments.

Many business owners use professional property management for their vacation rentals, but still want non-passive status. If you actively manage key decisions—like pricing, guest communication, and maintenance—you may still qualify, but you must track your hours and meet material participation rules. Otherwise, any losses you can’t use now will be carried forward until you have passive income or sell the property.

The Active Participation Deduction: A Limited Option If You Don’t Qualify as Non-Passive

If you don’t meet the material participation tests needed to classify your short-term rental as non-passive, you may still be able to deduct up to $25,000 in rental losses—as long as you qualify for the active participation deduction.

This deduction isn’t as powerful as fully removing passive status, but the active participation deduction can still help reduce your tax bill if your income is below a certain threshold.

Who qualifies for the $25,000 active participation deduction? 

To claim this deduction for your active participation in rental real estate, you must:

Make key management decisions — this includes tasks like setting rental terms, approving guests, and overseeing maintenance (but you don’t have to be involved full-time) 

Have a modified adjusted gross income (MAGI) below $100,000. MAGI is just your total income with a few adjustments. It’s usually slightly higher than your adjusted gross income (AGI) because some tax-free earnings get added back in. If your MAGI is under $100,000, you qualify for the full $25,000 deduction.

Other Factors That Can Impact Your Rental’s Tax Status

While material participation is the main way short-term rental owners can classify their income as non-passive, a few other tax rules may also come into play. These won’t apply to every host, but they’re useful to know if you own multiple properties or have a more complex rental setup.

Most short-term rental owners don’t need to worry about real estate professional status, but it’s another way to make rental income non-passive. This applies mainly to people who work full-time in real estate, like agents, brokers, or property developers. To qualify, you must spend at least 750 hours per year in real estate and more time in real estate than any other job.

For STR owners who have other jobs or don’t work in real estate full-time, material participation is the better path to non-passive status.

Aggregation election for rental activities

If you own multiple short-term rentals, you may be able to combine them for tax purposes using an aggregation election. This means you count all your rentals together when applying material participation tests, making it easier to qualify as non-passive.

However, this choice is permanent while you own the properties. Some states don’t follow federal rules, so it may not always be beneficial. If you’re considering this, talk to a tax professional to make sure it’s the right move.

If you rent your property to a business you own, the IRS may treat the income differently. If you actively participate in the business that rents from you, the IRS may classify the rental income as non-passive—even if the rental itself wouldn’t normally qualify. However, if the rental loses money, those losses remain passive and can’t be deducted against other income.

For most STR hosts, this rule doesn’t apply since they rent to travelers, not their own businesses.

Selling Your Rental to Unlock Passive Losses

If your rental losses have been stuck as passive for years, one way to finally deduct them is by selling the property in a fully taxable sale. When you sell outright, any previously unused passive losses can be deducted that year.

However, not all sales count. If you do a 1031 exchange (which allows you to defer taxes by reinvesting in another property) or gift the property to someone else, those losses stay locked because the IRS doesn’t see it as a taxable event.

Want a complete overview of all the tax responsibilities that come with running a short-term rental? Check out this guide to STR tax obligations.

The Bottom Line on Tax Classification for Short-Term Rentals 

For most short-term rental owners, qualifying as non-passive through material participation is the best way to maximize tax benefits. It allows for unlimited loss deductions and avoids the limitations placed on passive income. However, if you don’t meet material participation rules, you may still qualify for limited deductions under active participation—if your income is below the threshold.

If you own multiple properties, provide guest services, or rely on a property manager, your tax situation may be more complex. That’s why it’s important to consult a tax professional who specializes in short-term rentals. They can help you determine your rental’s classification, ensure compliance, and find the best tax-saving strategies for your situation.

No matter how your rental is classified, you’ll still need to report your Airbnb income properly to stay compliant with the IRS.

Most rental income is passive by default, meaning losses can only be deducted against other passive income—not wages or business earnings. However, short-term rentals follow different rules. If your average guest stay is seven days or fewer, your rental isn’t automatically passive. But to fully remove passive status, you must prove that you actively manage the property by meeting material participation tests.

What makes a short-term rental non-passive?

Your short-term rental is non-passive if:

Guests stay an average of seven days or fewer, and

You meet one of the IRS’s material participation tests—meaning you spend enough time actively managing the rental.

If you meet these requirements, you can deduct rental losses against other types of income, like wages or business profits.

What happens if I don’t meet material participation rules?

If you don’t meet the participation tests, your short-term rental remains passive. This means:

You can’t deduct rental losses against your salary or business income.

Losses can only be used to offset passive income from other rentals or investments.

If you don’t have passive income, losses carry forward until you do—or until you sell the property.

What is active participation, and how is it different from material participation?

Active participation is a separate IRS rule that applies to long-term rentals or STR owners who don’t meet material participation. If you make key management decisions and earn under $150,000, you may be able to deduct up to $25,000 in rental losses—but this doesn’t remove passive status.

Material participation is the stronger option because it fully removes passive classification, allowing unlimited loss deductions against all income.

If I hire a property manager, can I still be non-passive?

Yes, but only if you meet one of the material participation tests. The most relevant test for many STR owners is spending at least 100 hours on the rental and more time than anyone else.

If a property manager does most of the work, it may be difficult to prove you’re the most involved person, making it harder to qualify as non-passive. However, if you’re still actively managing aspects like pricing, guest communication, maintenance oversight, and marketing, you may still meet a material participation test and qualify for non-passive status.

The key factor is your level of involvement—the IRS looks at whether you are truly running the rental as a business, even if you get some outside help.

What’s the best tax classification for short-term rentals?

The best option for most hosts is qualifying as non-passive by meeting material participation rules. This lets you deduct all rental losses without limits.

If you don’t qualify as non-passive, you might still be able to deduct up to $25,000 in losses under the active participation rule—but only if your income is below $150,000. If your income is higher, or you don’t meet either rule, your rental stays passive, and losses can only offset passive income.

Think you can deduct short-term rental losses? Maybe—but only if the IRS classifies your income as non-passive. Learn how to navigate STR tax rules and maximize your deductions.

Is Short Term Rental Income Passive? Know Before You File

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