Cost Segregation for Short-Term Rentals: How Airbnb Owners Use It

Why short-term rentals are different

Normally, rental real estate is a passive activity. Losses from it, including depreciation, can generally only offset passive income, unless you qualify as a real estate professional, which most people with full-time jobs don't.

Short-term rentals can be treated differently. Under the passive activity regulations, a property where the average customer stay is seven days or less is generally not treated as a "rental activity" for these purposes. If you also materially participate in running it, losses from the property may be non-passive, meaning they can offset wages and business income.

Material participation, in plain English

The IRS has seven tests for material participation. The two most commonly used by short-term rental owners are:

• 500 hours: you participate in the activity for more than 500 hours during the year.
• 100 hours and more than anyone else: you participate for more than 100 hours, and no other individual (including cleaners or a property manager) participates more than you.

Keep a contemporaneous log of your hours: guest communication, cleaning coordination, maintenance, bookkeeping, pricing and furnishing. If the IRS asks, documentation is what counts.

Where cost segregation comes in

A furnished short-term rental is full of short-life assets: furniture, appliances, flooring, fixtures, outdoor amenities, hot tubs, landscaping and site work. A cost segregation study identifies these and reclassifies them into 5-, 7- and 15-year property.

With 100% bonus depreciation now permanent for property acquired after January 19, 2025, those reclassified costs can potentially be deducted in full in the first year. Short-term rentals often see 25% to 35% of the building cost reclassified, sometimes more for heavily amenitized properties.

Illustrative example

Rules and risks to watch

• Average stay: calculate it over the year. Long bookings can push the average above seven days.
• Substantial services: if you provide hotel-like services, different rules and self-employment tax considerations may apply.
• Recapture on sale: accelerated depreciation on personal property can be recaptured as ordinary income when you sell.
• Excess business loss limit: very large losses can be capped for the year and carried forward.
• Year-by-year test: the treatment applies to each tax year, so plan the year you buy carefully.

Timing: act in the year you buy

The biggest benefit usually comes in the year the property is placed in service, when you're also most likely to meet the participation tests while setting it up. A study can be completed after year-end, before you file.

Frequently asked questions

This article is general information, not tax, legal or accounting advice. Tax rules change and outcomes depend on your specific facts; speak with a qualified tax professional before acting.