Cost Segregation on a Short-Term Rental: A $600,000 Vacation Home Example

Short-term rentals get attention from cost segregation investors for two reasons. They are often furnished, so more of the purchase price lands in short-life categories. And the tax rules for short-term rentals can let the losses offset other income. Both points have conditions. This example shows the math and then the conditions.

The numbers are illustrations, not a forecast. Your CPA should confirm how the rules apply to you. For the full background, see the complete guide to cost segregation.

The property

• Purchase price: $600,000 for a vacation home rented by the night
• Land allocation: $120,000 (20%)
• Depreciable basis: $480,000
• Acquired after January 19, 2025, so the permanent 100% bonus depreciation rule applies to qualifying property (see the IRS announcement)

Without a study

Assume the house is depreciated as residential rental property over 27.5 years:

$480,000 / 27.5 = about $17,500 per year

One caution: some tax professionals take the position that a property rented on a transient basis is not "residential rental property" for depreciation and should use 39 years. Ask your CPA which recovery period applies to your property before you rely on any estimate. This example uses 27.5 years.

With a study

Assume a study moves 25% of the depreciable basis, or $120,000, into 5, 7 and 15-year property. Published ranges for short-term rentals are wide, so 25% is an assumption. The article on reclassification percentages lists the sources.

• Bonus depreciation on the $120,000: $120,000 in year one
• Straight-line on the remaining $360,000: about $13,100
• Year-one depreciation: about $133,100

That is about $115,600 more than the $17,500 baseline.

These figures ignore the mid-month convention and state tax. The total depreciation over the life of the property does not change. You are moving deductions earlier.

If you buy furniture and equipment separately, those items are usually 5 or 7-year property by themselves. A study mainly adds value by identifying parts of the building and site that also qualify.

Can you use the loss?

This is where short-term rentals differ from long-term rentals.

The 7-day rule. Under the passive activity regulations, an activity is not treated as a rental activity if the average period of customer use is 7 days or less. When that applies, the usual rule that rental losses are passive does not apply, and the question becomes whether you materially participate. There is a separate exception when the average stay is 30 days or less and you provide significant personal services. Material participation. The IRS has seven tests. Two common ones are more than 500 hours in the activity during the year, or more than 100 hours and more than any other person, including any property manager or cleaner. Hours must be documented. A hands-off owner who uses a full-service manager often cannot meet these tests. Why it matters. If the activity is non-passive and you materially participate, the depreciation loss can offset other income, subject to other limits. If you do not materially participate, the loss is generally passive and offsets passive income only. Losses you cannot use carry forward. Audit attention. Short-term rental losses used against wages draw attention. Keep a contemporaneous log of your hours and the average stay for each year. The log, more than the study, is what protects the position.

What happens when you sell

Gain on the 5, 7 and 15-year property is generally recaptured as ordinary income, up to the depreciation claimed. Gain from straight-line depreciation on the building is taxed at up to 25% federal. See depreciation recapture on rental property. A long hold or a 1031 exchange may change the outcome.

Already own the property?

If you bought it in a prior year, you can generally still claim missed depreciation without amending returns by filing Form 3115. See how to file Form 3115 for a cost segregation study.

Next steps

Track your average stay and your hours from day one.

Ask your CPA about the recovery period and your participation status.

Run a quick estimate in the calculator.

Order the study if the numbers and the participation facts support it. See pricing.

For more on this topic, read cost segregation for short-term rentals.