How to apply for a German Schengen visa, staying in a small hotel with no registration #

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Does it sound legit? Are single-person run hotels in Germany in fact exempt from registration?

Not a lawyer, but: No.
This would be against the basic ideas of all relevant laws, and a quick search turned up no single hint of any (hotel-relevant) exception (but it turned up many confirmations that I'm right).

Basically, all things with the purpose to continously earn money are "Gewerbe" and need to be registered as such. There are some exceptions, but running a Hotel is lightyears away from them. It doesn't matter if the person has employees or not, it doesn't matter if the person has another job, it doesn't matter (much) how much profit this person makes, etc.etc. ... Depending on the type of Gewerbe, there may be additional requirements (Hotel? IT consultant? Gun merchant? All different), and the structure matters too (employees, stocks, ...), but nothing overrides the obligation to register the Gewerbe.

If the hotel really isn't registered:

A likely explanation is tax evasion. (Nonetheless, it could very well be a great place to stay. For tourists, it doesn't imply a high risk of being scammed, robbed or something like that, and it says nothing about room quality etc.).

About your visa, without a register number, this "hotel" obviously won't be usable for an electronic form "leaving you no choice", as you said.

But since we now know that the hotel (apparently) has a (valid?) tax number...

Like chirlu suggested in the comments: Ask again, specifically about the Gewerberegister (ie. the German word). It's possible they misunderstood your first mail, especially because there are other company registers too (where a small/medium hotel doesn't need to register).

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