As an Airbnb host, you’re likely juggling marketing, cleaning, guest communication, turnover management, and bookkeeping duties. While the responsibilities may seem like a grind, they are the key to maximizing the benefits of Airbnb cost segregation.
The nature of the operation can make the rental income non-passive, allowing you to fully utilize cost segregation and bonus depreciation to offset all income, including your W-2 and business income.
In this post, we’ll explore how cost segregation for Airbnb properties works. We’ll also explore three powerful exceptions you can use to maximize tax savings.
How Cost Segregation Works for Airbnb Hosts
In traditional depreciation, you allocate a property’s cost basis linearly over 27.5 years (residential) or 39 years (commercial).
However, many building components don’t last that long. You can spot this disparity in your Airbnb property, where you’ve likely installed numerous shorter-lived assets to enhance guest experience.
To cure this problem, the IRS permits conducting a cost segregation study, a process that involves separating and reclassifying building components to subject them to depreciation schedules consistent with their actual useful lives.
Here’s how long the IRS expects various building components to last:
- 27.5 or 39 years: The structural components (real property), e.g., structural frame, roof, plumbing systems, built-in fireplaces, HVAC systems, and permanent flooring.
- 15 years: site improvements, e.g., driveways and parking areas, sidewalks, patios, fencing and gates, swimming pools, outdoor kitchens, outdoor lighting, and landscaping features (retaining walls, irrigation systems, etc.).
- 5 years: Personal property, e.g., furniture and decor, appliances, electronics, kitchen equipment, removable floor coverings, outdoor furniture, security and automation, and decorative lighting.
Because the typical Airbnb property features elaborate furnishings and site improvements, it stands to benefit significantly from cost segregation.
Tax Benefits of Airbnb Cost Segregation
The goal of cost segregation is to subject a significant portion of a building’s cost basis to five and fifteen-year depreciation schedules, effectively frontloading your depreciation deductions.
More importantly, when you combine cost segregation and bonus depreciation, you can claim up to 100% of the front-loaded deductions immediately instead of spreading them over five or fifteen years.
Therefore, Airbnb cost segregation affords you the following benefits:
- It helps you qualify for bonus depreciation: Properties with useful lives of 20 years or less qualify for bonus depreciation. You need a cost segregation study to identify and value such property components accurately.
- Tax savings to supercharge growth: Frontloaded deductions help you free up cash to grow your portfolio. You’re effectively getting a loan from Uncle Sam at 0%. Because of the time value of money, the tax savings are worth significantly more now.
Additionally, Airbnb cost segregation and bonus depreciation help you maximize the tax benefits of operating a short-term rental (STR).
The IRS typically treats rental income as passive activity income. With an Airbnb property, however, conditions exist where your income can be non-passive.
It means that if you claim a significant depreciation deduction that results in a paper loss, you can use the loss to offset all income, including your W-2 and business income. To be eligible to make such a tax move, you must qualify for an exemption from passive loss limitations.
Eligibility for Cost Segregation on Airbnb Properties
We believe any rental property with a cost basis exceeding $300,000 (excluding land) will benefit from a cost segregation study.
We also recommend designing your operations to qualify for tax treatment as an STR (short-term rental) with active income.
The eligibility criteria are as follows:
- The seven-day rule: The average guest stay for the year must be seven days or less.
- Material participation: You must demonstrate that your involvement in the running of the STR is regular and substantial by passing material participation tests. The two most common tests are: you spend more than 500 hours in the activity in the tax year, or you spend more than 100 hours, and no one else clocks more than you.
The IRS can also treat your rental losses as non-passive if you achieve Real Estate Professional (REP) status. You attain the REP designation by passing two tests:
- You spend more than 750 hours in a real estate trade or business
- The real estate activities constitute more than half of your total working time
That said, you must also guard against using your Airbnb too much personally. If you stay in your Airbnb for more than 14 days or 10% of the total rental days, the IRS may consider it a personal dwelling, limiting your ability to deduct depreciation.
Key IRS Rules and Compliance Considerations
Doing cost segregation on short-term rentals is a powerful tax strategy.
However, executing an IRS-compliant study requires hiring a specialist because of the following rules:
- Abiding by the IRS Audit Techniques Guide (ATG): The Cost Segregation ATG prescribes the standards a reliable and defensible cost segregation study must meet.
- The need for documentation: You must support your asset classifications and cost allocations with reliable documentation. Relevant documentation includes blueprints, architectural plans, vendor invoices, and interviews with relevant professionals.
- The need to detail study methodology: The cost segregation report must clearly outline the methods used to classify assets and allocate costs. The IRS explicitly states that a study done by someone with an engineering or construction background is more reliable.
At Seneca Cost Segregation, we only do engineering-based cost segregation studies. Our approach yields the best results as it maximizes tax savings while minimizing audit risk.
Moreover, every study we produce is backed by our Seneca AuditDefense Guarantee. We will help defend the study in the unlikely event of an audit.
Contact us today to lower your tax bill with an IRS-compliant cost segregation study. We offer post-study support to help you and your CPA effectively implement our findings.
Cost Segregation Study Process Explained
A high-quality and defensible study should abide by the IRS Cost Segregation Audit Technique Guide and industry best practices. However, processes vary depending on the methodology and the expertise of the professional.
Let’s walk through what a typical engineering-based cost segregation study process undertaken by our team includes:
Consultation and Preliminary Property Review
You can schedule a consult with our team to get a feel of the potential Return on Investment (ROI) available to you.
We will conduct a preliminary review of your property to determine if it is eligible for cost segregation. We want to ensure that your potential tax savings are significantly greater than the cost of the study.
Data Collection and Property Inspection
We will then gather all relevant documentation to ensure our study is accurate and defensible.
You can provide purchase agreements, blueprints, invoices, and other relevant documents as needed. Thorough documentation is essential for an audit-defensible cost segregation study.
Our engineers will then conduct an on-site or virtual inspection of your property.
Engineering Analysis and Report Preparation
Our engineers will analyze your property and its components, classifying assets and allocating costs in accordance with IRS guidelines and industry best practices.
We’ll then prepare a cost segregation report detailing our findings and our methodologies. Your CPA can use the report to prepare your tax filings, and we’ll be available to provide the support you need to implement the findings effectively.
To streamline communication, we’ll assign a dedicated account manager to you. This way, you can have a single point of contact to coordinate with our entire team throughout the process.
Common Mistakes Airbnb Hosts Make
You must avoid the following common pitfalls to maximize the benefits of Airbnb cost segregation:
- Not engineering an active-income scenario: When you fail material participation tests, you cannot use your paper losses to offset all income. It’s an essential point because frontloading depreciation with bonus depreciation will result in depreciation outpacing your rental income (creating a loss).
- Failing the personal dwelling test: A temptation exists to utilize your short-term rental for personal use. If you exceed personal use days, the IRS will treat the property as a personal residence.
- Ignoring the seven-day rule: You must maintain an average stay duration of seven days or less. Otherwise, the IRS will not treat your Airbnb as an STR.
When to Hire a Cost Segregation Specialist
It’s not advisable to do your own cost segregation study due to the audit risk it exposes you to.
With the benefits of Airbnb cost segregation evident, you probably want to hear our opinion on when it makes sense to hire a specialist to lead such a study.
We believe you’d be a great candidate for cost segregation if you meet the following criteria:
- Your Airbnb property has a depreciable basis exceeding $300,000,
- And you or your spouse file as Real Estate Professionals, or are material participants in the STR.
If the above are true, you can unlock enough tax savings with cost segregation and bonus depreciation to justify the cost of the exercise.
Also, if depreciation ends up outpacing your rental income, you can use the loss to offset your W-2 and business income, too.
Frequently Asked Questions (FAQs)
Here are answers to some of the commonly asked questions about cost segregation for Airbnb properties:
What is the Ideal Property Value for Cost Segregation to Be Worth It?
We believe cost segregation will be worthwhile if the cost basis exceeds $ 300,000 (excluding land value).
How Does Cost Segregation Impact 1031 Exchanges for Airbnb Owners?
The typical Airbnb contains significant personal property (furniture, electronics, etc.). Cost segregation allows you to depreciate these assets faster, reducing your property’s book value.
If you dispose of your Airbnb soon after, you’ll likely sell it at a price higher than the book value. The IRS requires you to “recapture” the claimed depreciation deduction as taxable income. You can defer the recapture issue by reinvesting the proceeds in a like-kind STR with similar elaborate furnishings.
However, if you exchange the Airbnb for a shell of a building or an unfurnished building, the difference in value will be treated as a taxable boot.
What Are the Risks of Incorrectly Applying Cost Segregation?
An incorrectly applied cost segregation will likely trigger an audit. If the audit establishes that the study is indeed flawed, the IRS will disallow your accelerated deductions. Additionally, you may incur penalties for underpayment of tax.
If the incorrect applications were due to negligence on your part, the IRS may apply higher penalties.
You can avoid these issues by relying only on experienced cost segregation firms.
How Often Should You Perform a Cost Segregation Study?
If done well, you’ll only need one cost segregation study. However, if you undertake a significant renovation, consider commissioning a second study to capture the new assets.
Conclusion
Cost segregation is one of the most powerful tax strategies you can leverage as an Airbnb investor. It allows you to convert the investments you make to enhance guest experience and the time commitment required to operate the STR into tools for tax planning.
Now’s the time to use cost segregation and bonus depreciation to unlock massive tax savings. At Seneca Cost Segregation, we can help you turn 20 – 40% of your property costs into immediate tax savings.
Contact us today to leverage our experienced engineers for an IRS-compliant study. Our team is deployed across all 50 states and can conduct remote or on-site tours, depending on the property, timing considerations, and individual preferences.
