Cost segregation for short-term rentals

Rental activities are generally passive. Losses from them usually can only offset passive income. But under Treas. Reg. 1.469-1T(e)(3)(ii)(A), an activity is not a rental activity if the average period of customer use is seven days or less. A separate exception covers average stays of 30 days or less when significant personal services are provided.

When the exception applies, the property is treated like other businesses under the passive loss rules. Losses are nonpassive if you materially participate. The regulations list seven tests. Common ones for owners are:

• More than 500 hours of participation in the year.
• Your participation is substantially all of the participation by anyone.
• More than 100 hours, and not less than any other individual, including cleaners and managers.

Keep a contemporaneous log of your hours and what you did.

A building is depreciated over a long recovery period. A cost segregation study separates out components with shorter recovery periods, such as certain furnishings, fixtures and land improvements. Federally, qualified property acquired after January 19, 2025 is eligible for a permanent 100% first-year deduction under the 2025 tax law (P.L. 119-21). Lower percentages apply to property acquired before that date.

The IRS's Cost Segregation Audit Techniques Guide describes several study methods and calls the detailed engineering approach from actual cost records the most methodical and accurate. Studies are typically prepared by engineers or specialists, and quality studies document their methods and the records used.

State decoupling: DC, Virginia and Maryland do not follow federal bonus depreciation. Your state deduction can be much smaller than your federal one. See 2025 tax law changes for businesses.

If a property has been depreciated as a whole building for at least two tax years, correcting it is generally an automatic accounting method change filed on Form 3115, designated change number 7 under Rev. Proc. 2025-23. The depreciation you missed is captured in a section 481(a) adjustment in the year of change, without amending prior returns. Different rules can apply if the property was placed in service only last year.

• Average stays are longer than seven days and the losses would be passive with nothing to offset.
• You can't meet a material participation test.
• The property's value is low enough that the study cost outweighs the tax benefit.
• You plan to sell soon. Depreciation reduces basis and can be recaptured when you sell.

Best for: owners of short-term rentals with significant purchase or renovation costs, who are involved in running the property.

1. On a free 30-minute call, we review average stay length, your hours, the purchase date and your other income.
2. We model federal and state results with and without a study, so you can decide whether to order one.
3. If you proceed, you engage a qualified cost segregation provider. We review the study for tax use.
4. We prepare the return, the depreciation schedules (federal and state) and Form 3115 if needed.

We don't promise a savings figure. Fees are transparent and fair, quoted upfront, in writing.