Short-Term Rentals: What I Tell Every Client Before They Start

Short-term rentals can be an incredible wealth-building tool, but they can also become a very expensive mistake if you jump in for the wrong reasons. Over the last few years, I've had a lot of clients come to me excited about Airbnb, VRBO, and short-term rental strategies, and the conversation almost always starts the same way. They've heard about the tax benefits, they've seen someone online talking about big write-offs, and they're ready to go buy a property tomorrow. And sometimes that works, but oftentimes it doesn't because there's landmines they don't see coming. Now, my name is Mark J. Kohler, CPA. Attorney, small business advocate, and fellow short-term rental owner. My wife and I own 5 short-term rental properties, and today I'm going to walk you through what I tell every client before they start a short-term rental. The good, the bad, the ugly, what actually matters. And if you want the strategy to work for you in the long term, you got to know the strategies that go with it. Let's break it down. Now, first, short-term rentals can be a great investment, but they're not automatic wins. And as I referred to earlier, my wife and I were on our 5th short-term rental that we're going to bring online this year in 2026. But each one has presented different challenges along the way, and we've learned a lot. So here's the good. They can generate strong cash flow and significant depreciation. That's the tax benefit. And in the right circumstances, potential appreciation. And in fact, Patty and I have even found some other unexpected benefits I'll talk about later. But none of those are guaranteed. And one of the biggest mistakes I see people assuming is that if it's an Airbnb, it's going to be a great deal. I don't know where they get that. This is not how it works because here's the bad. Cash flow can fluctuate, be cyclical, unexpected, because a lot of times a good Airbnb is going to be in some type of vacation area that you're going to get strong renters coming, but it may not be 365 days a year. Number 2, you've got to furnish the place. You've got to not only buy the property, you've got to make sure it's rent ready. Third, you've got to learn how to manage those cleaners and the handyman and the repairs that are inevitably going to come. You probably stayed in an Airbnb yourself. You know what I'm talking about. And then finally, you've got to learn the algorithm, how to play the numbers game, making sure you price it properly, making minor adjustments. I think of it like a video game almost, and I enjoy the, the gameology, if you will. But you've got to know that it's not just a set it, forget it situation. So with all that said, the first thing I ask clients is forget the tax benefits. Does this investment make sense? So first, make sure you're doing a good profit and loss analysis. Look at the cash flow, look at the return on investment. How much are you investing? And make sure that you look at it from a best case scenario to a worst case scenario. Now, if after all of that, we can start talking about the other benefits and learning how to manage the other risks. Now, the tax benefits are real but can be highly misunderstood. So let me just define what is this short-term rental loophole? What is this tax benefit everybody wants? Well, If your property qualifies as an STR, which we'll talk about, and you show enough material participation in the first year, which is typically the strategy when you buy it, let's hit this loophole in year 1, then in year 2, 3, or 4, you could turn it into a midterm rental or long-term rental. But we got to hit that material participation in year 1. If you can meet those 2 tests, then you would do a cost segregation or depreciation study on the property that would then allow you to rip out a bunch of depreciation and take that write-off against your day job, the W-2 or other business income. Under the one big beautiful bill, this 100% bonus depreciation can be unlocked with a short-term rental when you materially participate. That's the big loophole. So investors want to get those two boxes checked and then get that loophole and take those losses against their other income. Now, with a long-term rental, you can't do that. Unless you qualify as a real estate professional. That's not a requirement here. You could be a dentist, a lawyer, be a restaurant owner and do a little short-term rental on the side. That's fine. You can still unlock those losses. But we've got to meet those two tests of qualified short-term rental and your material participation. So let's first talk about how to qualify as a short-term rental. Now, under this, there's two tests as well, and we have to check the box on both of them. The first one is the average stay of your guest. It has to be less than 7 days. Let's do some math. Here on this average stay. Let's say you rented the property for 10 total weeks last year and you had 5 tenants. Well, we're going to have a problem. 10 weeks divided by 5 means your average stay was 2 weeks. But if you rented it for those same 10 weeks but had 20 tenants during that same time period, that would be an average of about 3.5 days, which is very common with Airbnbs. You might have people stay for 2 nights or 4 nights or somewhere in between. So you take your total rental days divided by the number of patrons, and there gives you your average stay. It's got to be under 7. Now the second rule is that you cannot provide substantial services. You can't treat it like a bed and breakfast or a hotel. You're not there every morning in the kitchen cooking up bacon and eggs. You're not providing turndown service with a little mint on their pillow. You're not cleaning the place every day. You're not providing concierge services or massages in the garage. You can't do any of that. That's what you would get at a hotel or a bed and breakfast. It's a short-term rental. You're going to clean it when they leave and that's it. Now, this is difficult because a lot of times these Airbnb owners are tempted to provide additional services so they can charge more and rent the place more, which I get. Now, in year 2 or 3, you might want to do that. But remember, I want the loophole. So in year 1, I've got to stick to the rules. No substantial services. I'm going to be like every other Airbnb, provide the normal blah, blah, blah. People come stay and they stay less than 7 days on average. Now we've checked the box that we have qualified as a short-term rental. So now let's talk about material participation, which really revolves around this 100-hour rule, and it catches a lot of people off guard. One of the biggest surprises that new investors in the short-term market have when they're going after this write-off is that they have to have material participation and it has to be very well documented. That's probably the biggest surprising point. They think, oh yeah, I could just say I did it or, you know, make a note in my phone and blah, blah, blah. Nope. Under case law, and we've seen more and more cases on this and the IRS going hard at these people claiming the write-off, that they need to see logs and lists and proper recordkeeping on this material participation. Now, what does that mean? There's actually 7 tests or 7 ways you can qualify for material participation. The easiest is test number 3, and it's this 100-hour rule, which says as long as you put in 100 hours and more than anyone else on the property, typically again in the first year, then you have qualified with material participation. Let's break it down further. And what's cool is that if you're married, both you and your spouse's time counts for that 100 hours. So you're going to keep a good list of all the things you're doing to get to the 100 hours, and you're going to keep track of anybody else that helps with the property. Cleaners, once you go online, handymen, contractors, anyone else that shows up at the property, you're going to write it down and say, oh, so-and-so the landscaper came in and put in 2 hours, or so-and-so put in 4 hours, or the hot tub people came, whatever. You're going to keep a record of the people that come to the property and your time. See, that's a mistake a lot of people make because remember, you got to show you put in 100 hours and more than any other one person. Then you check that box. Now, what are some of the things that qualify? Shopping for the property, making the offer on the property, going through all the documentation and paperwork, the loan closing, then showing up at the property, inspecting it, buying furniture, painting, repairs, cleaning, fixing. Can I just say the easiest rule of thumb? Manual labor. Shopping online doesn't count. Going to a workshop doesn't count. Doing the bookkeeping doesn't count. They want to see 100 hours of physical labor on the property. Good record keeping of your time and everybody else's. Many clients assume they can just buy the property, hire a manager, and still get the aggressive tax treatment. Nope, that does not work. You have to put in meaningful time, be materially involved. Again, that documentation. If you're completely passive from one day to the next, the math is not going to work out the way you expect. And regrettably, I see people online talking about this incredible strategy, like it's a magic switch you just flip. It's not. You have to be deliberate and intentional for it to work properly. Now we've hit the big issues for sure, and there's other pitfalls I want to warn you about. But I also want to tell you about one of the other benefits. A couple of things that we really loved about this Airbnb asset class is that Patty and I, my amazing wife, have really grown closer together through this experience. We have had a lot of fun. Now you really need to look inward and ask yourself, what's fun? But for Patty and I, we love on a Friday night going to Home Depot and buying a bunch of stuff on a Saturday, turning on a football game, some music and working on the property, jamming music and, and just being together at the property doing something productive. Now, I know that's like fingernails on a chalkboard for some of you. And if that doesn't sound like fun, you're looking at the wrong investment. We've really enjoyed it. In fact, one of the funnest experiences was Halloween. We were at the Airbnb working dressed up in our Chip and Joanna Fix and Flipper outfits, whatever, wearing a tool belt, answering the door, handing out candy. I'll never forget that. It was a lot of fun. But also there was another hidden benefit. Our family. Our kids are all over age 20 and some in college, some out there with careers, some married, some not. But I swear every one of our kids got involved with this rental property to some degree, and it was special. Some would come over in the evenings and work with us. Others would go work on it on the weekends together. We were blending family and it was really an incredible experience. And what was cool was our kids seeing us work on the property as well, seeing that we would freaking roll up our sleeves and we're just sitting in front of Netflix every night for hours on end. I think that's one of the beauties here is that you're building wealth, saving taxes, and showing your family how to live their American dream as well. Now, a few other pitfalls to be aware of. Most investors don't realize that their losses could get actually bottled up. Now they'll get them someday, but it'll be delayed gratification, not a big write-off they can take against their income. So it's not the end of the world. Remember, our number one rule was, does this investment make sense before the tax write-off? So you've got to be aware that if you don't meet those tests of a qualified short-term rental and material participation, those losses are going to go into a carry-forward bucket. And most rental losses are passive by default, and thus Taxpayers can't take those losses against their W-2 or other business income. Even if you become a real estate professional later, you can't unlock those losses. They are locked down until you sell the property. But this is also why the short-term rental rules became so popular, because there was this way to get at the losses if the investor was willing to put in the time in the year of acquisition. So again, the strategy only works when the details are done correctly. Now, another major pitfall: local regulations can kill the deal. This is the part social media almost never talks about unless it's a dramatic problem. Cities and counties have gotten actually more aggressive about regulating short-term rentals. If you didn't know this, the hotel industry really doesn't like the short-term rental market and homeowners associations, communities that don't want a bunch of renters coming in on the weekend and partying. So I've seen clients run into permit limits, HOA restrictions, zoning issues, occupancy caps, special taxes and fees. And oftentimes they find this out after they've already bought the property. So if you're an investor and you're out shopping for a short-term rental, that's great. Make sure you're talking to the realtor you're working with, or if you're doing all the legwork yourself, that you're checking all of those regulations where that property is located. For example, I think it was our fourth Airbnb Patty and I were looking for. Our realtor was very savvy. We love him, Clint. He was awesome. We went into a neighborhood to look for some property that we knew would be a great area for a short-term rental, and it was literally split down the middle. There was an HOA on one side of the road and no HOA on the other. And what was interesting, the properties on the HOA side were actually more expensive because some people like to have that big brother making sure everybody's lawns are manicured and there's no trailers on the street, whatever. The side without the HOA, those properties were a little cheaper. Well, that's exactly what we wanted. There was no HOA, no restrictions on the Airbnb rules. But before closing, we still called the city and said, is there a city concern here? Is there a city permit required for Airbnbs in that area? Clint already knew there were, but we made the call ourselves, got our application in right before closing, and got it approved as a short-term rental before we even closed. Were there extra taxes? No, we just had to pay a filing fee of like $50 or whatever to get the application reviewed by the fire department and the whatever, someone in the city that just had to have a job stamping something. But we went through those steps to make sure that that property was going to work for us. And it goes without saying, this could be a painful and expensive lesson. So before buying any short-term rental, you need to understand the local rules. And this is a good opportunity to go back to the investment test. Remember the first rule? It's got to make sense financially. Well, what's your fallback? You always got to have a fallback in any deal. Now, I know Tony Robbins would say burn the boats. You only have Plan A and that's it. Well, that's not how I operate. I want to have a Plan B just in case. The Plan B is a long-term rental. Long-term rentals oftentimes circumvent any HOA rules or most of them and city licensing rules. So I want to make sure this property is going to cash flow even as a long-term rental. Now, it may not cash flow as much, but it's not going to be a disaster. And that's what we're worried about. When you're looking at these regulations, you can be looking at the fallback options if the property doesn't work out as a short-term rental. Now, before we finish this video, I'd be remiss if I did not give you an example of what the tax benefits could look like in a basic example. Let's go through it because the tax benefits can be extremely powerful. Let's say a client buys a short-term rental for $500,000 and puts down $100,000 as a down payment, 20%. Now, to properly furnish it and place it into service, let's estimate on another $40,000. So we're into this thing $540,000. We also have our plan of attack for the average stay. We're going to get our account set up on Airbnb and we've got enough work to do to get our material participation in. We're going to put in a fence, we're going to furnish the place. We're also going to paint some rooms, maybe put some shelving in here or there. We've got to put in a hot tub. Whatever it is, you got enough hours to make sure you hit your material participation. And let's assume in year 1, not under your best case analysis, but in kind of the moderate case analysis, you're going to have enough cash flow to cover the mortgage payment and the utility bills and any other incidentals. So what's the write-off going to look like? Now, remember, we bought this property for $500,000. We have to take the land out. Now, most accounts will allocate 20% of the purchase price to land. So ironically, This matches our down payment. Don't worry about that. It just happens to be in this example that's the case. So we've got $100,000 allocated to the land and $400,000 allocated to the building. Now, normally we'd have to write this off over 39 years because it's a commercial property. So the depreciation time period is longer. Short-term rentals are considered commercial. So now we go do a cost segregation analysis. This is going to run you around $3,000 to $4,000. To get a good one, and it's going to give you a report of all of the 3, 5, 7, and 15-year property that you can depreciate faster under the one big beautiful bill, bonus depreciation. So instead of writing off everything over 39 years, these sorts of things I can write off faster. They're considered chattels, like the fence, the blinds, the carpet, the appliances, a variety of things, the water heater, all sorts of things that aren't going to last 39 years. A cost segregation analysis typically going to allocate around 40% to this type of property that can be written off in one fell swoop. So 40% of $400,000, remember, that's the amount we've allocated to the building, is $160,000. Oh, but we're not done yet. Remember, we've spent $40,000 on furnishings, repairs, and some other things, and we even had a cost segregation analysis. So we might be in another $50 grand. So I've just chalked up over a $200,000 write-off. It could be $210,000 in that example, but I only put down $100,000. Wow. Now, why am I allowed to do that? Because it qualified as a short-term rental. I materially participated and I had basis, something we didn't talk a lot about. But you're signing on that mortgage loan, so that increases your basis and allows you to take that write-off. So I'm going to get over $160 grand in depreciation. $50,000 in furnishings and other expenses in that first year, a $210,000 write-off, and the property still cash flowed, still maybe went up in value. And I had the experience of building a future, my American dream investment property. And remember, this is not automatic and it is definitely not something you want to wing without proper planning. Our tax lawyers at our office meet with clients every day on a variety of tax strategies. And all of them are trained in the short-term rental strategy to make sure our clients succeed. Getting a consultation like that would be a must if you're going to go down this path. So in summary, what do I tell clients before they start? If you're thinking about getting into short-term rentals, here's my quick checklist. First, make sure this is something you're going to enjoy. Ask yourself some hard questions. Do you like going to Home Depot on a Friday night? Do you like putting on a tool belt? Is doing a little manual labor on a rental property for the next 6 weeks on the weekends and evenings, something you would enjoy? Number 2, are you willing to stay involved moving forward, learning how the Airbnb algorithm works, working with a property manager or managing it yourself, knowing that you're going to have to be involved on an ongoing basis after you put this thing online? This is not, again, a set it and forget it. And third, not only understanding the participation requirements, it's making sure that property will give you enough hours for participation. You may say, yeah, I'm good with 100 hours, and you buy one of these turnkey properties that just needs the window washing. That's not going to work. You got to have something you can add value to. Fourth, when you're shopping, you're going to always verify local regulations and make sure you're not buying a poison pill that's going to flop the minute you close. Fifth, do your projections and model conservative Occupancy and pricing. You're not going to get the same price every night, every day of the year. In fact, Patty and I are shooting for about 60 to 70% occupancy with our average model. And sometimes we do better. Sometimes we don't. But we want to guesstimate an average occupancy of over 70% and a moderate pricing level. And may I say, get it out there, stay in some Airbnbs in the area, really know what you're up against and who your competition is. How available are the Airbnbs at an in that area. If there's always something available, that market may be a little saturated. So shop around. Sixth, build a team to help support the project. Not only is that cleaners and handymen and maybe a property manager, it's your tax team, making sure that we're on the inside with you, setting up the proper LLC, helping guide you through the tax rules so that you don't miss anything. Remember, an ounce of prevention is worth a pound of cure. Now I know there's other things that we could be talking about, but if you can do these, I know you will dramatically improve your odds of success. So in summary, short-term rentals can be an incredible wealth-building tool, but only when they're approached with the right expectations and the right structure. The biggest mistakes I see aren't because the strategy doesn't work. They happen because people rush in chasing tax hype instead of building a solid investment plan first. So if you're thinking about jumping into short-term rentals or you already have one and just want to Make sure you're actually getting the tax treatment you're expecting. This is exactly where good planning matters. My team at KQS Lawyers works with real estate investors all over the country. We're a boutique law firm where you're just one Zoom call away with talking with a real small business tax lawyer. We'll help you structure it properly for asset protection, privacy, and the tax strategy, avoiding the common traps. When you go to book your call, I would recommend the comprehensive tax and business consultation. Where we'll build your trifecta and analyze all of the tax issues for your investment strategy. Make sure you click the link below and get that call set up as soon as possible. And if this video was helpful, make sure to hit the like button, subscribe to the channel, and turn on notifications so you don't miss future videos. I'm Mark J. Kohler. Thanks for watching. See you in the next video.