When you have a rental that has an average stay of 7 days or less, and you also put in enough hours for material participation (100 hours/year on it if no one else spends more time on it than you do, or 500 hours/year if anyone spends more time on it than you do), then it qualifies to be treated as non-passive, and that's when it can offset your W-2 income. This is what is sometimes called the STR loophole or the STR tax strategy. Unfortunately, TurboTax still doesn't handle this situation. There's a way to do it in TurboTax Desktop if you go to Forms mode, but there isn't a way to do it at all with TurboTax Online, unfortunately.
This isn't called "active participation", that's something different in the tax code, which is related to how you qualify for the $25,000 loss allowance if your total gross income is under $150,000 for the year (it phases out starting at $100,000). But if your income is under $150,000, then that's a different way you may qualify to offset some or all of your rental losses.
If you reported as a Schedule C business in TurboTax instead, that should actually let your losses offset your W-2 income, as long as you select the option to specify that you materially participated. The problem with doing it that way is it's not technically correct since a rental property shouldn't go on Schedule C unless you provide what is called "substantial services," which means things like daily cleanings during guest stays or providing entertainment or meals to guests during their stay. So if you reported on Schedule C and you don't provide those kinds of services, then they could disallow your loss if you are audited.
You mentioned that you are doing rental arbitrage. Yes, you can use these same strategies with rental arbitrage, and the same rules about material participation and the Schedule E, etc., all still apply. The only difference is you can't claim depreciation when you don't own the property, but you can claim the rent you pay on the property as an expense.
David O
