Short Term Rental Tax Question - Schedule C versus Schedule E

[Theresa McGallicher]

I have researched this topic extensively on Bigger Pockets and elsewhere and I am still struggling to understand the tax code. 

I have a STR property that went into service in Jan 2022. I met the Material Participation requirements that year, and took our taxes to our preparer with the expectation of a refund. She filed our STR on Schedule E, and we owed $7000 to the IRS, because the rental income was added to our W-2 income, which was over $150,000. We were told that none of our real estate losses could be deducted.

After we paid, I reached out to another STR owner who recommend her tax preparer. The new CPA amended our 2022 taxes and filed our STR on Schedule C, so we recieved a refund of $6000.

Now we are preparing to file for 2023, and I was told by some STR gurus, and also read on here, that we should not be using Schedule C since we are not providing daily hospitality services. However, I don't see how filing with Schedule E can be benficial due to the Passive Activity Loss Rules.

What am I missing here?

[Theresa McGallicher]

I found the answer to my question!

If it's a short term rental with an average stay of 7 days or less, and you materially participate, it is non-passive income, but it still goes on Schedule E. The difference is that it isn't limited by the passive activity rules on form 8582. Most tax software has an option to specify that rental income is non-passive, and that's how you do it. It goes on Schedule C only if you provide "substantial services", which means services during guests' stays, such as daily cleanings during their stay like a hotel (not just between guests), or meals. But that's rare. Normal Airbnb rentals that are cleaned between stays always go on Schedule E. References for this include IRS Tax Topic No. 414 which details when to use Schedule C for rentals, and IRS Letter Ruling 202151005 which details when self-employment tax is applicable to rentals (which is equivalent to choosing Schedule C vs. Schedule E).

So, the STR rental still goes on Schedule E (not C), but the checkbox they're referring to is not on Schedule E because the difference in how STRs with material participation (the "STR loophole") is not on Schedule E, it's a difference in how it's handled on FORM 8582, which is where the passive activity loss rules are applied. Professional tax software has a "non-passive" checkbox option, but it's not a checkbox on Schedule E itself. Some versions of consumer software like TurboTax also have that option, but I think it's only in forms mode.