Passive Activity Loss Framework

• Rental activities are generally passive regardless of participation. Passive losses are disallowed against non-passive income and carried forward unless an exception applies IRC § 469.

• Disallowed passive losses are carried to the next year and treated as deductions allocable to the activity IRC § 469(b).

• The IRS summarizes that passive losses exceeding passive income are disallowed in the current year and carried forward; similar rules apply to credits Topic No. 425, Passive Activities—Losses and Credits.

When an STR Is Not a “Rental Activity”
The temporary regulations define when an activity involving the use of tangible property is not treated as a “rental activity” (and thus not passive per se):

• Average customer use of 7 days or less: the activity is not a rental activity Treas. Reg. § 1.469‑1T(e)(3)(ii)(A).

• Average customer use of 30 days or less and significant personal services provided: also not a rental activity. Significant services are determined by all facts and circumstances and exclude certain routine or excluded services Treas. Reg. § 1.469‑1T(e)(3)(ii)(B), (iv).

• Extraordinary personal services: if customers’ use of the property is incidental to their receipt of services (e.g., hotel-like operations), the activity is not a rental activity Treas. Reg. § 1.469‑1T(e)(3)(ii)(C), (v).

If an STR is not treated as a rental activity under these rules, it is evaluated as a trade or business activity. Losses from a trade or business are non-passive if the taxpayer materially participates Treas. Reg. § 1.469‑1T(e)(1).

Material Participation: Converting Losses to Non-Passive
To deduct losses against W‑2 wages, the STR must be a non-rental activity and the taxpayer must materially participate under the regulatory tests, including (among others):

• More than 500 hours of participation during the year.

• Taxpayer’s participation is substantially all of the participation in the activity.

• More than 100 hours and participation exceeds that of any other individual Treas. Reg. § 1.469‑5T(a).

IRS Publication 925 provides detailed guidance on material participation standards and documentation that supports participation claims Publication 925.

Carryforwards and Dispositions

• Disallowed passive losses carry forward until the taxpayer has passive income or disposes of the entire interest in the activity in a fully taxable transaction to an unrelated party, at which point remaining suspended losses are allowed IRC § 469(b), § 469(g).

• The IRS reiterates that disposition of the entire interest may permit deduction of previously disallowed passive activity losses Topic No. 425.

Special $25,000 Allowance (If the Activity Is Passive)
If the STR remains a rental activity (e.g., average stays exceed 30 days without significant services or material participation is not met):

• A special allowance permits up to $25,000 of passive rental real estate losses to offset non-passive income for individuals who actively participate and meet income thresholds IRC § 469(i).

• Active participation is a lower standard than material participation and generally requires involvement in management decisions and at least a 10% ownership interest; the allowance phases out between $100,000 and $150,000 of adjusted gross income IRC § 469(i).

Credits and Publicly Traded Partnerships (PTPs)

• Credits from passive activities are disallowed to the extent they exceed the regular tax allocable to passive income; they carry forward until allowed Instructions for Form 8582‑CR.

• Items attributable to PTPs are applied separately per § 469(k); losses and credits from a PTP generally can only offset income or tax from the same PTP IRC § 469(k); Publication 925.

At-Risk and Excess Business Loss Rules

• Apply at-risk limitations (IRC § 465 IRC § 465) before passive activity rules; Publication 925 provides ordering and coordination Publication 925.

• Non-passive losses from trades or businesses may be limited by the excess business loss rules; Publication 925 highlights that Form 461 may be required and that these limits apply after passive activity rules Publication 925.

Practical Documentation Tips

• Maintain contemporaneous logs of hours and roles to support material participation.

• Track average customer stay to substantiate non-rental treatment under 7/30‑day rules and services provided (significant or extraordinary).

• Retain records reflecting your participation relative to managers, cleaners, and contractors Publication 925.

Reporting Considerations

• Whether the STR is treated as a rental activity or a trade or business is a facts-and-circumstances determination under § 469 and the regulations; classification drives passive/non-passive treatment and the need to complete passive activity forms Treas. Reg. § 1.469‑1T(e); Publication 925.

• Use IRS passive activity worksheets and forms (Forms 8582 series) to compute allowed losses and credits when the activity is passive or when required by the instructions Instructions for Form 8582‑CR.

Summary: Using STR Losses Against W‑2 Income
To deduct STR losses against W‑2 wages:

• Establish that the STR is not a rental activity (average customer use of 7 days or less; or 30 days or less with significant or extraordinary personal services) Treas. Reg. § 1.469‑1T(e)(3)(ii).

• Demonstrate material participation under the § 1.469‑5T tests Treas. Reg. § 1.469‑5T(a).

• Coordinate with at-risk and excess business loss limitations and follow the carryforward and disposition rules Publication 925; IRC § 469(b), (g).

• If the STR remains passive, consider the $25,000 special allowance for rental real estate if you meet active participation and income thresholds IRC § 469(i).