Traditional depreciation spreads your short-term rental’s entire cost basis over 39 years, giving you a small tax deduction each year. What if you could deduct a significant portion of the depreciable value this year by simply commissioning a study that costs just a few grand?
You can indeed make such a massive deduction. The tax tool that allows frontloading a significant portion of the depreciation is called bonus depreciation, while the study that makes it all possible is a cost segregation study.
We are Seneca Cost Segregation, a trusted partner for property investors looking to accelerate depreciation, defer taxes, and increase cash flow. Contact us today to see how much you can save with a cost segregation study and short-term rental bonus depreciation.
What Is Bonus Depreciation for Short-Term Rentals?
The government recognizes that you can allocate capital in your community more efficiently than it can. To encourage you to invest in new assets to stimulate the local economy, Uncle Sam allows you to use bonus depreciation to free up cash for reinvestment.
Also called Additional First Year Depreciation Deduction, bonus depreciation is a tax incentive that allows you to deduct a large percentage of the cost of an eligible asset in the year you “place it in service.” How much you can deduct is determined by various factors, including:
- Value of qualifying property: Assets with a recovery period of 20 years or less qualify for bonus depreciation. In the typical short-term rental, qualifying assets will include furniture, decorations, appliances, electronics, interior renovations, swimming pools, etc.
- The year you put the property in service: The original Tax Cuts and Jobs Act had a phase-out schedule for bonus depreciation. The One Big Beautiful Bill Act reversed the phase-out schedule, though.
- Different treatment of STRs: The IRS generally classifies rental income as passive income. Short-term rentals differ from traditional rental properties because the income can be non-passive.
How STR Bonus Depreciation Differs from Traditional Rental Properties
The core principle of bonus depreciation applies to both traditional rental properties and short-term rentals. However, the application is different because of income passivity rules.
The IRS classifies rental activities as passive, which severely limits the ability of traditional property investors to use losses from claiming a massive deduction in the first year to offset other income, such as business or W-2 income.
The nature of short-term rentals requires active participation. Therefore, an opportunity exists for it to be classified as a trade or business for tax purposes. Such a classification unlocks the full power of short-term rental bonus depreciation, as you can use the paper losses to offset all income.
Current Bonus Depreciation Rates and Phase-Out Schedule
We mentioned earlier that the original Tax Cuts and Jobs Act of 2017 had a phase-out schedule for bonus depreciation. It allowed for 100% bonus depreciation through 2022, and phased it out as follows:
- 2023: 80%
- 2024: 60%
- 2025: 40% (but, see below)
- 2026: 20%
- 2027: 0%
Given the legislation’s success, there was significant interest in cementing its key provisions. The One Big Beautiful Bill Act, signed into law on July 4, 2025, did exactly that. Under the new law, bonus depreciation is back to 100% for qualified properties acquired and placed in service after January 19, 2025.
The Short-Term Rental Tax Loophole Explained
With bonus depreciation back to 100%, you should look for ways to maximize its potential now and in the future. One of the most reliable ways to do this is to get your short-term rental to qualify as a trade or business so you can use any resulting losses to offset all income.
Three key exceptions allow real estate investors to make their real estate income non-passive:
- Short-term rentals (STR): Where guests stay in your STR for an average of seven days or fewer, the IRS can treat the operation as an active business. However, you’ll need to prove that it’s not a passive activity by passing material participation tests.
- Material participation: Where you or your spouse participate materially in the property’s management, your rental income can be non-passive. The common material participation tests are: you do all the work, or you spend 500+ hours total, or you spend 100+ hours total and no one else clocks more than you.
- Real Estate Professional (REP) status: With a REP status, your STR operations will be treated as a trade or business for tax purposes. You achieve REP status by spending 750+ hours in real estate trades or businesses and by spending more than half of your total working time in the trades or businesses.
Knowing these exceptions, you can design your operations to turn any losses you create by claiming a significant bonus depreciation on your STR property into ordinary losses, which you can use to offset all income.
How to Claim Bonus Depreciation on STR Properties
Having bypassed the passive activity loss limitation, you can now maximize the power of short-term rental bonus depreciation. Here’s how the process will unfold:
- Understand qualifying property: The main building structure has a useful life of 27.5 or 39 years and does not qualify. Site improvements and personal property components with a useful life of 20 years or less will be eligible. You’ll need to identify these components.
- Conduct a cost segregation study: The way to identify the qualifying property components is with a cost segregation study for short-term rentals. It’s best to let a professional do the study.
- Claim bonus depreciation on your tax return: With the results of the cost segregation study, you can claim bonus depreciation on IRS Form 4562. You’ll report your rental income on Schedule E and bring over the depreciation amount you calculated on Form 4562 to reduce your taxable income.
Let’s explore how this would play out in real life with the cost segregation study example below.
Maximizing Bonus Depreciation Through Cost Segregation
Usually, you depreciate the entire cost basis of a residential rental property linearly over 27.5 years. For instance, consider a property with the following details:
- Purchase: $1,000,000
- Land value: $150,000
- Improvements made: $50,000
- Cost basis: $900,000 (purchase + improvements – land)
Straight-line depreciation would be $900,000 divided by 27.5 years, giving you a per-year depreciation of $32,727.27. It would be your annual tax deduction.
However, with cost segregation, property gets separated into real property, site improvements, and personal property, each with its own recovery period as follows:
- Real property (the main building structure): 27.5 years
- Site improvements (e.g., fences, driveways, etc): 15 years
- Personal property (e.g., carpeting, appliances, etc): 5 years
Now, assume the property in the example above was placed in service in 2024 and that Seneca Cost Segregation did a study that revealed that 16% of the cost basis is site improvements and 12% is personal property.
- Site improvements = 16% x $900,000 = $144,000
- Personal property = 12% x $900,000 = $108,000
- The remaining 72% is real property = $648,000
Since the property was placed in service in 2024, the site improvements and personal property qualify for 60% bonus depreciation as per the phase-out schedule we discussed earlier.
- Site improvements x bonus depreciation = $144,000 x 60% = $86,400. The remaining 40% comes in over the next 15 years.
- Personal property x bonus depreciation = $108,000 x 60% = $64,800. The remaining 40% comes in over the next 5 years.
- Real property / 27.5 or 39 = $648,000 / 27.5 = $23,563.64 every year until Year 28
The total 1st year deduction = $86,400 + $64,800 + $23,563.64 = $174,763.64
The additional 1st year depreciation = bonus depreciation 1st Year – SL depreciation 1st year = $174,763.64 – $32,727.27 = $142,036.37
You then get a tax deduction of $142,036.37 instead of $32,727.27. At a 37% federal tax rate, this nets you a check from the IRS for $52,553.46.
Considering that a dollar saved or invested today is worth more than a dollar tomorrow, frontloading depreciation in this way can have a significant impact on how fast you grow your real estate portfolio.
Seneca Cost Segregation specializes in helping STR investors like you unlock similar tax savings with cost segregation and bonus depreciation. Contact us today to accelerate depreciation with an IRS-compliant cost segregation study.
Section 179 vs. Bonus Depreciation for STRs
You may be familiar with Section 179 as a way to accelerate tax deductions, and you are probably wondering how it compares to bonus depreciation.
The two can allow you to write off assets quickly, but some differences make bonus depreciation the more practical choice for STR investors. Here’s why:
- Section 179 has a maximum annual deduction limit each year, while bonus depreciation doesn’t.
- While you can use bonus depreciation to create a loss that you can carry forward, you cannot do so with Section 179.
That said, deductions from both Section 179 and bonus depreciation will be subject to depreciation recapture if you sell your STR at a gain.
Depreciation Recapture and Exit Strategies
Cost segregation and bonus depreciation allow you to frontload a significant portion of your property’s depreciation. If you dispose of the property soon after, you will likely sell it at a price higher than the book value. The IRS requires you to “recapture” the tax benefits you received by accelerating depreciation.
While the IRS is justified in wanting to collect the tax that was deferred, there are exit strategies you can employ to minimize or eliminate the tax liability. Here are some of the strategies:
- 1031 Exchange: Also called a like-kind exchange, a 1031 exchange allows you to defer the tax on depreciation recapture when you reinvest the proceeds of the sale in a like-kind property. You must identify the replacement property within 45 days and close on it within 180 days.
- Step-up in Basis at Death: The strategy eliminates the tax liability for your heirs. When you hold the property until death, the property is reset to its fair market value at the time of your passing. When your heirs sell the property, they don’t pay taxes on the gains accruing when you held it, and the depreciation recapture tax is also wiped out.
Frequently Asked Questions (FAQs)
Let’s now answer some of the common questions we get about short-term rentals and bonus depreciation.
Does Bonus Depreciation Apply to Renovations or Remodeling?
Yes, bonus depreciation applies because the renovations and improvements will likely include personal property and site improvements with recovery periods of five or fifteen years.
Is Bonus Depreciation Available for Vacation Homes Used Personally?
If you use a vacation home personally for more than 14 days or for more than 10% of the days it is rented at fair market rates, the IRS considers it a dwelling unit. You are allowed to claim bonus depreciation for qualifying assets in proportion to the percentage considered rental use, but you cannot create a loss.
Does Bonus Depreciation Apply to Land Improvements Like Landscaping?
Yes, land improvements like landscaping, pavings, parking lots, fencing, sidewalks, swimming pools, gazebos, and outdoor lighting qualify for bonus depreciation.
Can I Claim Bonus Depreciation Retroactively on Past Purchases?
Yes, you can claim bonus depreciation retroactively. You’ll apply for a change in accounting method by filing IRS Form 3115.
Conclusion
Short-term rentals offer a wealth of tax advantages to savvy investors. They typically hold substantial personal property and site improvements to enhance guest experience. Many of these assets qualify for bonus depreciation, allowing you to take a massive first-year deduction to create a paper loss.
Further, the opportunity to engineer an active-income scenario means you can use the paper loss to offset all income, including your W-2 and business income.
The first step to capitalizing on these tax advantages is commissioning a cost segregation study. That’s where Seneca Cost Segregation comes in. Talk to our team today to see if your property qualifies for cost segregation.
