3 Key Points:
- Rental real estate tax benefits, such as passive income treatment and depreciation, allow investors to shield a significant portion of their cash flow from taxes.
- Short-term rentals (STRs) and long-term rentals (LTRs) are taxed differently, with STRs offering unique “loophole” opportunities to offset active income.
- Qualifying as a Real Estate Professional (REP) or utilizing cost segregation can unlock massive upfront deductions.
Updated January 18, 2026
Interview with Ryan Bakke, CPA
Ryan is the founder of Tax Strategy 365 and has consulted for some of the nation’s largest hedge funds and investment firms. As an active investor himself, he brings a practical perspective to complex tax planning.
1. How does the IRS tax rental income?
Ryan: Rental income is often taxed as passive income, which means it isn’t subject to the 15.3% self-employment (payroll) tax that hits your W-2 or 1099 wages. If you make $12,000 in net profit from a rental, you only pay income tax on that profit, putting you in a lower effective tax rate immediately.
However, the trade-off is that passive losses generally cannot offset your “active” income from your day job. So, if you make $10,000 at your 9-5 and lose $3,000 in your rental real estate, your passive real estate loss could not offset your 9-5 income on your annual income tax return.
Passive rental real estate activity is reported on Schedule E, Supplemental Income and Loss.
Business Income
Rental income is not always passive. If you provide substantial services—such as daily cleaning, meals, or concierge services—the IRS may treat your activity as an active trade or business rather than a passive rental.
In these cases, you report the activity on Schedule C, Profit or Loss From Business instead of Schedule E.
While business income is subject to self-employment tax, it allows you to deduct business expenses like travel and home office costs, and your losses may be able to offset other active income like W-2 wages if you materially participate.
Short Term Rental vs Long Term Rentals
To better understand the additional components of real estate taxation, we must separately identify Short-Term Rental Properties and Long-Term Rental Properties.
- Short Term Rentals (STRs): STRs are defined by the average tenant stay. The IRS says, if the average tenant stays 7 days or less, the property is an STR. Normally, Airbnb and Vrbo properties produce STR income because tenants only stay for a weekend or a few vacation days.
- Long-Term Rentals (LTRs): Generally, a property is treated as a long-term rental if the average guest stay is more than 7 days.
For tax purposes, the main difference between STRs and LTRs are –
- The STR Loophole allows you to use rental losses to offset your W-2 or business income without needing “Real Estate Professional Status,” provided the average stay is 7 days or less and you meet one of the IRS’ Material Participation Tests.
- Depreciation periods differ, with LTRs depreciating over 27.5 years (residential) while STRs are generally treated as non-residential (commercial) and depreciated over 39 years.
The Little CPA Note: Real estate investors with modified adjusted gross income (MAGI) below $100,000 can qualify for an IRS exception that allows small-scale investors to deduct up to $25,000 in rental losses against their active income. These investors must “actively participate” (less stringent than material participation) by making basic management decisions.
2. What is depreciation?
Ryan: The IRS allows you to deduct the value of your building (not the land) over its expected lifespan—27.5 years for long-term rentals and 39 years for short-term rentals. It’s “tax-free cash” because it’s a non-cash expense that reduces your taxable profit without you actually spending money.
Just remember depreciation recapture: when you sell the property, the IRS will want some of that tax benefit back, capped at a 25% rate.
2026 Update: The OBBBA permanently restored 100% bonus depreciation for property placed in service after January 19, 2025. This allows you to immediately write off the full cost of personal property components (like furniture or appliances) in year one.
3. How can someone qualify as a Real Estate Professional?
Ryan: To qualify as a Real Estate Professional (REP), you must spend more than 750 hours a year in real estate trades and more than 50% of your total working time in real estate. The benefit of REP status is massive: as an REP, your STR or LTR rental losses are no longer “passive.” You can use those losses to offset your high-salary W-2 income or other business profits.
2026 Update: High-income earners should note that REP status also helps avoid the 3.8% Net Investment Income Tax (NIIT). For 2026, the NIIT thresholds remain $250,000 for married couples and $200,000 for individuals. Also, under the OBBBA, the Section 199A (Qualified Business Income) deduction has been made permanent. This allows many rental owners with REP status to deduct up to 20% of their net rental income right off the top before calculating their tax bill.
4. Can you recommend software to track hours?
Ryan: TSheets is a great app for logging your time, or you can simply use a Google Spreadsheet! The key is keeping a contemporaneous log to prove your hours to the IRS.
The Little CPA Note: Intuit changed the name of TSheets to Quickbooks Time.
5. In what type of entity should you hold real estate?
Ryan: I typically recommend personal names, Single Member LLCs, or Partnerships. You want the income to “flow through” to your personal return.
Holding real estate in C-Corps or S-Corps often creates headaches, such as taxable events when moving property in or out of the entity and complex “basis” tracking issues.
The Little CPA Note: Discuss structuring with a qualified tax professional and attorney to ensure all legal and tax risks are considered before forming an entity.
Conclusion
For most of us, income tax is our largest lifetime expense. Proper rental real estate tax planning is not just about saving money today; it’s about building a roadmap to wealth. If you plan to incorporate real estate into your strategy, ensure you work with an advisor who specializes in this niche.
About the Expert
Ryan Bakke, CPA is the CEO of Tax Strategy 365. He is a real estate tax strategist, investor, and entrepreneur whose mission is to help families transform their financial future by mastering the tax code.
As a licensed CPA in Illinois, Ryan works with more than 400 real estate investors each year, saving them tens of thousands in taxes by leveraging strategies such as cost segregation, entity structuring, and short-term rental planning.
Having earned over a million dollars in active income by age 25, Ryan has built his career around aligning passion with profit, emphasizing the true value of time, and creating generational wealth.
Beyond his technical expertise, Ryan is a Christian servant leader who values mentorship, relationships, and disciplined living—principles that continue to fuel both his professional success and his commitment to helping others change their family tree
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