The STR Loophole That Burned Dr. E. Mergency
How Material Participation (or Lack of It) Made All the Difference
Dr. E. Mergency was done with the grind.
After years of grueling overnights and weekend shifts—traveling from San Diego to Eureka —he wanted out.
How?
Buy real estate.
Build passive income.
Achieve FIRE (Financial Independence & Retire Early)
That’s when he met a guy calling himself “Short-Term Rental God.”
STR God had a cult following among burned-out ER docs.
His Playbook?
Short-term rental loopholes!
Buy a property.
Cost-segregate and bonus depreciate it.
Keep the average guest stays 7 days or under.
Boom—six-figure paper losses to wipe out your W-2 income.
Rinse and repeat.
It sounded divine to Dr. E. Mergency.
He was all in.
His plan?
One rental a year.
Repeat for 5–6 years, and maybe—just maybe—he could hit that magic number, hang up the ultrasound probe for good...
And never do another rectal exam again.
Palm Spring Condo - Dr. E. Mergency’s First STR
Dr. E. Mergency started his rental venture with the purchase of a Palm Springs condo.
Hello, STR loophole!
Busy with his own ER schedule, he handed the keys to a property manager, ordered a cost segregation study, ran the numbers for bonus depreciation and regular depreciation, and “created” $250k of passive loss. He was pumped for a massive refund, which he planned to use to buy another property - rinse and repeat.
A single guy in California making over $800k, sitting in a nearly 50% blended tax bracket, he expected nothing less than a $120k refund. Use that as a downpayment for another condo. Another STR loophole strategy!
The holy grail of tax hacks for a W-2 earner like him. He felt like a STR God himself.
But then tax season hit.
And his CPA hit him with a reality check that almost gave him a STEMI.
“Sorry, doc. Your short-term rental losses are still passive. You can’t use them to offset your ER income.”
Wait… what?!
“But it’s a short-term rental! Isn’t that non-passive?”
Here’s How Dr. E. Mergency Got Burned!
Dr. E. Mergency did not know this: just because his AirBnb rental had an average guest stay of 7 days or less doesn’t make the loss non-passive.
It is true that, under IRS rules, a rental with an average guest stay of 7 days or less is considered a non-rental activity. But that’s the only the first hurdle to turn the activity non-passive.
There is another one - Dr. E. Mergency still has to materially participate in the STR activity!
For the STR to be non-passive, it has to be classified as a non-rental activity (which can be achieved by keeping the average guest stay at 7 days or less) AND you must materially participate in the activity.
It’s like applying the PERC rule to rule out PE.
You need both:
A low pre-test probability of PE, AND
A score of 0 on the PERC test to rule out PE without a CT scan.
You gotta have both - not only one.
Material Participation 101
Material participation is what the IRS uses to determine whether you are actively running the business. You must pass the material participation test to deduct your STR losses against W-2 or 1099 income, an essential element of the STR loophole strategy.
The IRS lists seven tests (found in IRS Treasury Regulation Section 1.469-5T)—but let’s focus on the three that matter most:
1. The 500-Hour Rule
You spend more than 500 hours conducting day-to-day business activities during the tax year. This is a high bar - it translates to nearly 10 hours of work every week. If you met this, you qualify as materially participating. It is considered the “gold standard”: log 500+ hours in your STR business and you’ve cleared the hurdle.
2. The “Substantially All” Rule
Your participation makes up substantially all the work done in the activity for the year. For example, if you personally handle virtually every task (marketing, guest communication, cleaning, repairs, etc) and other’s involvement is minimal, you may satisfy this test. It is a tough standard because you also have to convince the IRS that you truly do almost everything for the property. The IRS is unlikely to buy it if you also have a high-paying job as a physician. Sniff test: failed!
3. The 100-Hour Rule (and More Than Anyone Else)
This is the test most commonly used for the STR loophole. You spend at least 100 hours—and no other individual spends more time than you (not even your cleaner) during the year. Hitting 100 hours is a lower threshold, but you must also prove that no single person worked more than you on the STR. In other words, you need 100+ hours and you must be the #1 time contributor to the rental’s operations for the year. Many physician-investors target this test, since 500 hours is often unrealistic with a full-time job.
Quick tip: Hire a cleaning company rather than individual cleaners to ensure no one person logs more hours than you. Always ask for a time log from the cleaning company - just in case of an IRS audit.
But heads up… Not All Hours Count
You can’t just sit around reading tax blogs (like this one) and count those hours towards material participation (sadly).
What does count?
Generally, hours spent to perform the day-to-day business activities that a typical owner would handle count - whether it’s management or manual labor.
Examples include:
Messaging guests
Handling check-ins and check-outs
Coordinating cleanings and repairs
Updating Airbnb listings and pricing
Dealing with complaints and special requests
Managing your team (cleaner, handyman, photographer)
Extra tips:
If you are married, you can count both your spouse’s hours towards material participation.
Always keep contemporaneous records of your work on the rental. It does not matter how you document it - as long as it’s detailed and credible, the IRS will respect the log. Courts have rejected “ballpark guesstimates” of time spent.
What doesn’t count?
Hours spent in an investor’s capacity (generally)
Reading about STR tax rules
Doing your bookkeeping
Reconciling bank accounts
Preparing your own tax return
Work not customarily done by owners where one of the primary purposes for performing the work is to earn material participation hours.
Deep-cleaning the gutters or septic tanks.
Travel or commute time (a grey area)
Driving long distances to your rental in another state to pad the hours may not count. Generally, commuting to the property does not count. This is a commonly litigated area, so it is safe not to count these hours.
Where’s the Official List of What Counts?
Melinda Fisher, a senior attorney at the IRS Chief Counsel in Denver office once shared with me.
“If we publish a exact checklist, people will do just enough to game it.
So we don’t publish one.”
Translation: Intent matters.
Are you running a business—or trying to work the STR loophole game?
Dr. E. Mergency’s Redemption Arc
After getting humbled in Year 1, Dr. E. Mergency had an epiphany.
He fired the property manager.
Took over the Airbnb account.
Started tracking his time.
Handled every booking.
Coordinated cleanings and repairs like a pro.
He logged over 100 real hours—and proved that no one else spent more.
This time, the IRS agreed: non-passive!
His six-figure losses finally offset his ER income, and the refund came through.
He bought more rentals and finally hit that magic number.
Boo ya!
He became the “Short Term Rental God” himself. No more rectal exams. He finally hung up his ultrasound probe for good.
Final Thoughts
Short-term rentals can be a tax-saving machine - and a way out of a clinical grind, like Dr. E. Mergency - but only if you run them like a business.
It’s not just about the average days of guest stay—it’s about what you do.
Know the rules. Track your hours. Document everything contemporaneously.
Because in the eyes of the IRS, actual participation with the right intent matters.
Win the STR loophole game.
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