Podcast Summary: Tax Smart Real Estate Investors Podcast

Episode 360 – "Why Short-Term Rentals Are Still the #1 Tax Strategy for 2026 (+ New Tax Court Case)"

Host: Hall CPA
Date: January 5, 2026
Length: ~26 minutes

Episode Overview

In this solo episode, Hall CPA outlines why short-term rentals remain the top tax-saving strategy for high-income earners through 2026 and beyond, particularly given newly permanent 100% bonus depreciation rules and a recent tax court case. The host thoroughly explains how the strategy works, addresses legitimacy concerns, and compares it with other popular options like real estate professional status (REPS), oil and gas investments, and tax credit strategies. A breakout of a fresh 2025 tax court case is covered to emphasize documentation best practices, with a continued focus on practical, compliance-oriented advice for investors.

Key Discussion Points & Insights

1. Why Short-Term Rentals Remain #1 for 2026

• No Legislative Threats:
  • "At the federal level…there's no indication whatsoever that they're looking to change these rules at the core of the short-term rental strategy." (04:38)
• Permanent 100% Bonus Depreciation:
  • "100% bonus depreciation was just made permanent in the one big beautiful bill that was passed in July 2025." (04:55)
• Significant Tax Savings:
  • Real examples were cited:
    • "One client save[d] $130,000 with one short-term rental…another client…save[d] over $300,000 in taxes over several years." (02:12)

2. Short-Term Rental Strategy Recap

(06:30 – 09:40)

• Key Steps:
  • Buy a rental property and maintain an average period of customer use of 7 days or less (or 30 days or less if providing “substantial hotel-like services”).
  • Material Participation — You must be actively involved, passing one of the IRS ‘material participation’ tests (most commonly: more than 100 hours and more than anyone else).
  • Cost Segregation Study: Accelerates depreciation by categorizing property components for immediate deduction using 100% bonus depreciation.

Notable Quote – On the Basics:

"We have to take it from a rental property into a business. And we do that by meeting one of those two tests right there." (06:49)

3. Legitimacy & Legal Foundation

(09:45 – 15:45)

• IRS & Regulations Cited:
  • Reg. Section 1.469-1T(e)(3)(ii)(A)
  • IRS Publication 925 – "Passive Activity and At-Risk Rules"
• Supporting Case Law:
  • Lucero v. Commissioner (2020): Lost due to poor documentation of material participation.
  • James v. Judith M. Patterson v. Commissioner (2002): Emphasizes precise calculation of average stay.
  • Moreno v. USA: Shows IRS scrutinizes decimal points in average stay calculation.
  • Rogerson v. Commissioner (2022): No rentals = can’t prove average period.

Emphasis on Documentation:

"Had they been able to make that proof, perhaps they would have won that case, which is why documenting your time is so important when you are using this strategy." (11:32)

On Audit Risks:

"Audit rates are extremely low…less than 1% across the board. Even at our firm…it's less than 2%." (14:25)
"Bad bookkeeping is probably a bigger audit risk than using the short-term rental strategy, assuming you document your position correctly…" (15:22)

4. Why It’s Still Called a “Loophole”

(15:47 – 20:10)

• Passive Activity Rules (Section 469):
  • Originally designed to block high-income earners from offsetting W2 income with rental losses.
  • Real Estate Professional Status (REPS) (since 1994) allows exceptions only for full-time real estate professionals.
• Short-Term Rental Exception:
  • The rules were intended for hotels/motels, not for ordinary investors renting out homes on Airbnb, etc.
  • The strategy is “a loophole” only by accident of history—technology and platforms like Airbnb made widespread usage feasible.

On Regulator Intent:

"The framers of this law…I have to presume, did not…imagine someone's going to eventually put this stuff on the Internet and be able to circumvent what we're kind of putting in place here." (19:15)

5. Breakdown of New Tax Court Case: Merck v. Commissioner (2025)

(20:13 – 23:22)

• Facts:
  • Both taxpayers were attorneys; one was a CPA.
  • Attempted to deduct losses as both real estate professionals and under short-term rental rules.
  • Problems:
    • Their time logs were based on ballpark estimates, including inflated on-call and cleaning hours.
    • Claimed personal cleaning hours while also deducting cleaning fees (contradictory!).
    • On-call time disallowed as participation.
  • Decision:
    • Court found their logs not credible (“ballpark guesstimate”).
    • Failed material participation tests (did not reach 100 hours credibly).
    • Deduction denied.
• Lesson:
  • Meticulous, credible documentation is mandatory—only actual time, not estimates or “on call,” counts.

Notable Quote – On Documentation:

"If you do ever make it to tax court…you are guilty until proven innocent…You need to support your position for these strategies that you are using." (23:05)

6. Comparison With Other Strategies

(23:22 – 25:15)

• Real Estate Professional Status (REPS):
  • Valid for mid-/long-term rentals
  • Harder for dual-income couples: “750 hours and more than 50% of your total working time.”
• Oil and Gas Investments:
  • “Completely valid…don’t have to materially participate…But at the end of the day you are investing in oil and gas.”
• Tax Credits & Charitable Giving:
  • Often less desirable for those still accumulating wealth (less interest in giving away principal).
• Business Acquisition:
  • Can depreciate assets but involves running (and risk of) a traditional business.

Why STRs Are Superior for Most:

• Airbnb/VRBO make executing the strategy much easier and more accessible.
• 100-hour participation threshold is much lower than 750 hours for REPS.
• Can leverage property appreciation, significant cash flow, and tax savings simultaneously.

Notable Quote:

"If you operate these properties correctly, you might be looking at property appreciation. You might also be looking at significant cash flow as a result…in addition to the significant tax benefits." (24:40)

7. Practical Planning & The Role of a Tax Advisor

(25:15 – End)

• Customization is Key:
  • Each tax situation is unique; strategies must be tailored to lifestyle, income, other assets, and personal goals.
• Value of Proactive Advisory:
  • Preparers merely file; advisors help you plan and implement.
  • "[If] you’re only working with a tax preparer, chances are you’re leaving money on the table." (25:43)
• Annual Call to Action:
  • Start planning early in the year to maximize benefits.

Closing Case Studies:

• "[We] help[ed] them save roughly $130,000 with one short-term rental and [an]other client saves significantly more…over $300,000…over the course of a few years thanks to net operating losses." (26:10)

Memorable Quotes with Timestamps

• On Documentation:
  "Documenting your time is so important when you are using this strategy." – (11:32)
• On Loophole Origins:
  "The framers of this law…I have to presume, did not…imagine someone’s going to eventually put this stuff on the Internet and be able to circumvent what we’re kind of putting in place here." – (19:15)
• On Audit Risk:
  "Bad bookkeeping is probably a bigger audit risk than using the short-term rental strategy, assuming you document your position correctly…" – (15:22)
• On Planning:
  "Where tax strategy and planning comes into play is how do we look at the complex tax landscape and your individual situation and piece together all of these strategies…in a way that ensures you’re compliant." – (25:21)

Timestamps for Key Segments

| Segment | Timestamp | |--------------------------------------------------------------|-----------| | Introduction & Overview | 00:32 | | STR Strategy Recap | 06:30 | | Legitimacy – Citing Regs & Cases | 09:45 | | Documentation Best Practices & Audit Rates | 14:25 | | Why It’s a “Loophole” | 15:47 | | New Tax Court Case Breakdown (Merck v. Commissioner, 2025) | 20:13 | | Comparison w/ Other Tax Strategies | 23:22 | | Planning & Advisor Importance, Case Studies | 25:15 | | Closing Thoughts | 26:10 |

Summary Takeaways

• Short-term rentals remain the most powerful and accessible tax-saving tool for high-income earners, thanks to precise regulations, permanent bonus depreciation, and proven case law.
• Meticulous time tracking and operational records are essential—cases are lost on poor documentation, not on the legitimacy of the strategy.
• Other strategies exist (REPS, oil & gas, credits, business acquisition), but STRs often combine ease of access, substantial savings, and investment upside in ways others cannot.
• Proactive, individualized planning is crucial—work with advisors, not just preparers, and keep excellent records for audit defense.

For further information, visit: www.TheRealEstateCPA.com/Podcast