Rental or business? Navigating the Tax Treatment of Short-Term Rentals

11 Dec 2025 Rental or business? Navigating the Tax Treatment of Short-Term Rentals

The short-term rental (STR) landscape has matured. What began as a way for homeowners to offset costs by renting out a spare room or vacation home has evolved into a highly scrutinized area of the tax code. Now, property owners must take a more deliberate approach to tax strategy, classification, and compliance.

Whether you rent out a second home for a few weeks a year or manage a portfolio of short-term units, the tax treatment of your activity depends on how it’s structured and operated. Let’s walk through the key considerations that will shape how your short-term rental income is taxed, and what you can do to optimize outcomes.

Rental vs. business: classification comes first

Short-term rentals are generally defined as properties rented on a transient basis – typically for an average period of seven days or less per guest. This 7-day threshold is important because it helps determine whether the activity is treated as a rental or rises to the level of a trade or business for tax purposes.

By default, all rental activities are considered passive under the tax code. This means losses from those activities can generally only offset other passive income, unless you meet specific exceptions, such as qualifying as a real estate professional.

The key exception hinges on the nature of the services you provide and your level of participation. When a property is rented for short periods, and you provide services such as cleaning during the guest’s stay, concierge assistance, or meals, the IRS may treat the activity as an active trade or business rather than passive rental income.

This classification carries several implications. Business income may be subject to self-employment tax. But it also opens the door to the 20% qualified business income (QBI) deduction, and it allows losses to be deducted against other income if you materially participate in the business. That can be especially advantageous in high-income years or when leveraging cost segregation and depreciation strategies.

If your role is more passive and you don’t provide substantial services, the IRS will likely treat the income as passive rental income. In that case, losses may be limited unless you meet the real estate professional criteria or have sufficient passive income to absorb them.

It’s also worth noting that many hosts fall into a gray area. The IRS hasn’t issued comprehensive guidance for every STR scenario, so how your activity is documented and presented, particularly with respect to guest services and participation, can influence the tax treatment.

The 14-day rule and vacation home exception

Owners of vacation homes or dual-use properties may benefit from one of the simpler provisions in the tax code. If you rent out a personal residence for 14 days or less in a year, and use it personally for more than 14 days or more than 10% of the total rental days, you don’t have to report the rental income at all. The expenses related to those rental days aren’t deductible, but the income itself is entirely excluded.

This is often referred to as the Augusta Rule, named after homeowners in Augusta, Georgia, who began renting out their homes during the Masters golf tournament. The rule, IRC §280A(g), was written with precisely this type of situation in mind.

It’s a valuable provision for high-demand areas during major events, where a few well-timed rentals can result in thousands of dollars in untaxed income. However, once you exceed that 14-day threshold, the income becomes fully reportable, and your expenses must be allocated between personal and rental use. This is where recordkeeping becomes critical. Not only must you track rental dates, but you also need to clearly separate time spent maintaining the property from time spent enjoying it personally. The IRS distinguishes between the two, and so should you.

Income, expenses, and depreciation

Once your STR becomes taxable – whether because you exceeded the 14-day exemption or because it doesn’t qualify as a personal-use property – you must report all rental income, including rents, cleaning fees, and any other amounts paid by guests.

While platforms like Airbnb and VRBO may provide gross receipts through forms like the 1099-K, these figures don’t always align perfectly with what’s taxable, which puts the onus on you to reconcile totals and ensure accuracy.

You’re allowed to deduct many of the ordinary and necessary expenses associated with the rental, including mortgage interest, property taxes, insurance, utilities, cleaning, and repairs. If the property is used for both personal and rental purposes, these expenses must be prorated.

Depreciation is also key: the cost of the structure itself (not the land) is typically depreciated over 27.5 years for residential property, but shorter depreciation lives may apply to certain furnishings or improvements. For higher-value properties, cost segregation studies can accelerate depreciation deductions by separating out components eligible for shorter lives.

Self-employment tax and the risk of “substantial services”

One area that often surprises hosts is self-employment (SE) tax. While traditional rental income is not subject to SE tax, the rules change when you provide substantial services to guests during their stay. This can include meals, daily housekeeping, or entertainment; activities that make the arrangement resemble a hotel or bed-and-breakfast more than a passive rental.

Importantly, the services must be provided by you, your employees, or agents to trigger SE tax. Services provided by independent third parties, such as cleaning companies or platform-facilitated support, do not typically subject you to SE tax. That distinction is crucial.

If your rental activity includes substantial services that you or your staff perform, it could be subject to SE tax and treated as a business, which opens up other tax planning considerations, such as QBI eligibility or entity structuring.

QBI deduction: potential upside with caveats

If your short-term rental activity qualifies as a trade or business, it may also qualify for the 20% qualified business income (QBI) deduction under IRC §199A. This deduction applies to certain non-corporate taxpayers with income from eligible domestic businesses.

To qualify, you must treat the rental as a business and meet specific criteria. The IRS has issued a safe harbor that applies to rental real estate enterprises:

• You must maintain separate books and records for each rental activity.
• You or your agents must perform 250 hours of rental services during the year.
• You must maintain contemporaneous records to substantiate the hours and nature of the services performed.

Even if you qualify as a trade or business, the deduction may still be limited or phased out based on your income level and the amount of wages paid or property held. For 2025, the phase-out begins at $394,600 for joint filers (adjusted annually for inflation). If you’re near or above that threshold, advanced planning is especially important.

State and local considerations

While federal tax rules set the foundation, your obligations don’t stop there. State and local governments have become increasingly aggressive in taxing and regulating short-term rentals. Occupancy taxes, gross receipts taxes, permit requirements, and zoning restrictions all vary by jurisdiction. And noncompliance can result in penalties or denial of deductions.

In some states, such as Virginia and Colorado, localities are now allowed to impose higher lodging taxes on short-term rentals than on traditional hotels. Many jurisdictions also require hosts to register their properties, obtain operating permits, and comply with specific safety, insurance, or usage rules.

Importantly, if you own rental property in a state where you don’t live, you may still owe state income taxes on the income generated there. In other words, you don’t have to physically set foot in the state to be taxed on short-term rental income earned within its borders.

Audit risk and documentation standards

The IRS and state taxing authorities have increased focus on short-term rental activity. Large losses without clear evidence of material participation, mismatches between reported income and 1099-K data, and improperly allocated expenses are among the most common triggers.

To reduce risk, hosts should maintain detailed records: calendars showing guest stays and personal use, receipts and logs for maintenance, property management agreements, depreciation schedules, and platform income summaries. In the event of an audit, the burden of proof falls on you.

Strategic takeaways

The STR sector is stabilizing after years of rapid expansion. Growth has moderated, regulations have tightened, and tax rules have caught up to the realities of the market. For hosts with multiple properties, high rental income, or significant personal use of the property, a cookie-cutter tax approach won’t suffice.

Whether you operate one property or a dozen, understanding how your activity is classified, reported, and documented is essential. The rules are complex, but the payoff for getting them right is significant.

A comprehensive tax review with a qualified advisor can help you identify hidden risks, capture available deductions, and position your portfolio for the year ahead. For more personalized guidance, please contact our office.

Contact The Haynie & Company CPA Firm For Tax Advisor Services