This tool models the federal and state tax economics of a short-term rental investment over a user-defined hold period, including: § 469 material participation analysis, the § 461(l) excess business loss limitation, § 172 NOL carryforward with the 80% limitation, federal and state-level depreciation (including the OBBBA-restored 100% bonus depreciation under § 168(k) for property acquired and placed in service after January 19, 2025), sale-year recapture and capital gain treatment, and an after-tax internal rate of return.
This tool is informational only. Material participation, eligibility for the § 1.469-1T(e)(3)(ii) short-term rental exception, and the calculation of cost segregation reclassification are fact-specific determinations that depend on the particular facts and circumstances of each matter, the engineering basis for any cost segregation study, and the proper application of multiple loss-limitation rules. The tool produces an estimate based on simplifying assumptions and the inputs provided. Specific facts may produce a different result. Engage qualified counsel before any investment decision.
Under § 469(c)(2), a "rental activity" is per se passive regardless of the taxpayer's participation. The first inquiry is whether the activity falls outside the definition of "rental activity" under one of the six exceptions in Reg. § 1.469-1T(e)(3)(ii), or whether the taxpayer qualifies for Real Estate Professional Status under § 469(c)(7). If either path is satisfied, the activity is analyzed under the general material participation framework in Step 2 rather than as a per se passive rental.
If Step 1 establishes that the activity is not per se passive (one of the six exceptions applies, or REPS is established), the taxpayer must materially participate in the activity to claim losses against non-passive income. Reg. § 1.469-5T provides seven independent tests; satisfying any one is sufficient.
Purchase price and basis allocation. Land is not depreciable; allocate land at acquisition based on assessor records, appraisal, or comparable land values.
Net Operating Income (NOI) from rental operations. NOI grows 3% annually in the model. Choose your input method based on the precision you want for STR vs. LTR economics.
Mortgage parameters. The model assumes a fixed-rate loan with monthly amortization over the term. The cap rate is assumed equal to the mortgage rate (a simplifying assumption that produces NOI = property value × rate, before debt service).
Filing status, tax year, and income profile. Year affects the § 461(l) threshold ($313K/$626K for 2025; ~$256K/~$512K for 2026 due to the OBBBA reset).
Hold period determines when the property is sold and IRR is computed. The model assumes 3% annual escalation on rents, expenses, and property value, and 7% selling costs at exit.
Federal income tax is computed using the actual 2026 IRS tax brackets (Rev. Proc. 2025-32) and the standard deduction for the selected filing status ($16,100 single / $32,200 MFJ / $24,150 HoH). Itemized deductions, exemptions, and credits are not modeled. Tax savings are computed as the difference between baseline tax (no rental loss) and after-rental tax (rental loss applied), subject to § 461(l) and § 172.
The tool implements the § 469 analysis as two distinct inquiries. Step 1 (Per Se Passive Analysis) evaluates whether the activity falls within the definition of a "rental activity" under § 469(c)(2) and Reg. § 1.469-1T(e)(3)(i), or whether one of the six exceptions in Reg. § 1.469-1T(e)(3)(ii) applies: (A) average use ≤ 7 days; (B) average use 8–30 days with significant personal services; (C) extraordinary personal services regardless of period; (D) incidental rental; (E) defined business hours / nonexclusive use; or (F) property used in a non-rental activity of a passthrough entity in which the taxpayer owns an interest. The Real Estate Professional Status path under § 469(c)(7) is a separate route out of per se passive treatment that requires the qualifying spouse to materially participate in the specific rental activity. Step 2 (Material Participation) runs all seven tests of Reg. § 1.469-5T: (1) 500+ hours; (2) substantially all of the participation; (3) 100+ hours and not less than any other individual; (4) significant participation activity with total SPA hours > 500; (5) MP in 5 of prior 10 years; (6) personal service activity (real estate excluded); (7) facts and circumstances with 100-hour floor. Satisfying any one test establishes material participation. The activity is non-passive only if BOTH steps are satisfied: Step 1 escape from per se passive AND Step 2 material participation.
Federal depreciation uses 27.5-year straight-line MACRS for the building shell and 5-year MACRS for the cost segregation reclassification (with half-year convention) and applies the user-selected bonus depreciation rate to the reclass in year 1. State depreciation diverges where states decouple from § 168(k); the tool maintains conformity rules for all 51 jurisdictions (50 states + DC) and applies regular MACRS to states that do not conform to bonus. Where states have specific decoupling schedules (e.g., § 179 caps, additional first-year depreciation rules), those are modeled to the extent practicable.
For 2026, the § 461(l) threshold is $256,000 (single, HoH, MFS) / $512,000 (MFJ) (post-OBBBA reset, indexed). Rental losses in excess of the threshold are disallowed in the current year and converted to a Net Operating Loss carryforward under § 172. The 80% NOL absorption cap is applied to subsequent years; some states decouple from § 172 (e.g., CA NOL suspension through 2026, NJ no individual carryforward, PA 40% cap, MN 70% cap, AR full deduction allowed). The model reflects these state-level variations.
At sale, depreciation is recaptured under § 1245 (personal property and qualified improvements from the cost segregation reclass) and § 1250 (building shell). § 1245 recapture is taxed at the taxpayer's marginal rate using bracket-walking; § 1250 unrecaptured gain is taxed at the maximum 25% rate; long-term capital gain is taxed at 0%, 15%, or 20% based on the combined taxable income.
NIIT is applied at 3.8% on the long-term capital gain portion and the § 1250 unrecaptured portion of the sale. The model does not include a granular AGI threshold test for NIIT (which begins at $200K single / $250K MFJ); for high-income taxpayers utilizing this strategy, the threshold is typically exceeded and NIIT applies in full. NIIT does not apply to operating rental losses where the taxpayer materially participates under § 469 (the activity is non-passive for § 1411 purposes when material participation is established).
State capital gains treatment varies materially. 33 jurisdictions tax LTCG as ordinary income at full state rates; 3 apply a preferential rate (HI 7.25%, MA 5%, MT 3.9%); 6 provide a partial exclusion (AR 50%, NM 40%, ND 40%, SC 44%, VT 40%, WI 30%); WA imposes a 7% tax above $262K/$524K but generally exempts real estate sales under RCW 82.87. 9 states impose no state income tax (AK, FL, NV, NH, SD, TN, TX, WA, WY) and produce no state tax at sale. State conformity reflects information current as of May 2026.
IRR is computed on the levered after-tax cash flows: initial equity outlay (down payment plus closing costs) as the year-zero negative, annual after-tax cash flow (operating cash flow plus federal and state tax savings) for years 1 through hold period, and the final-year net sale proceeds (gross sale price less selling costs, less mortgage payoff, less federal and state sale tax) added to the year-of-sale cash flow. Solver uses bisection with 300 iterations.
Important. This tool produces estimates based on simplified assumptions and the inputs provided. Material participation under § 469, the § 1.469-1T(e)(3)(ii) short-term rental exception, real estate professional status under § 469(c)(7), the § 461(l) excess business loss limitation, the § 172 NOL carryforward rules, the cost segregation reclassification percentages, federal and state depreciation conformity, sale-year recapture under § 1245 and § 1250, the § 1411 net investment income tax, and state-level tax treatment all involve fact-specific determinations that this tool does not and cannot fully model. Specific facts and circumstances may produce a different result. The model assumes annual periodicity (full-year operations and end-of-hold-period sale); actual transactions involve partial-year sale conventions (year-of-sale depreciation under the half-year or mid-month convention, prorated mortgage interest, prorated NOI) that materially affect the sale-year analysis and that the model does not compute. The state conformity table reflects information current as of May 2026 and is updated periodically; users should verify state-specific rules before acting. The cost segregation reclassification percentage entered must be supported by a qualified engineering-and-tax study to be defensible on examination. Reading or using this tool does not create an attorney-client relationship with Donovan Legal PLLC or any of its attorneys. Engage qualified counsel before any acquisition, contribution, or other transaction in reliance on the projections produced by this tool.
The firm represents real estate investors and high-income professionals on the structuring, documentation, and post-acquisition tax compliance for short-term rental and other tax-driven real estate strategies. To discuss your specific facts with the firm, contact us directly.
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