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If you decide to stay in Key West, I would recommend staying away from the larger hotels and select a Bed & Breakfast instead. There are a number of great old properties that have been converted.
Two that I have stayed at and recommend are the "Curry Mansion", and the "Island City House".
If you want to stay further up in the keys, a rental house is also an option in lieu of a hotel. Try VRBO to get you started. Islamorada is a good compromise between all out Key West and the quiet areas like Big Pine Key.
Everyone should visit the keys at least once!
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