Cost Seg and Short Term Rentals
A concise, practical explanation of how cost segregation delivers tax benefits to STR owners
TLDR: Short term rentals and cost segregation studies can be a highly effective strategy to lower taxes on your active W-2 salary income
Short Term Rentals
Over the past decade, short term rentals (or "STRs") have grown dramatically with the rise of Airbnb, VRBO, etc. and are projected to continue to grow quickly. STRs are an attractive way to monetize real estate assets, because of their ability to access global demand, unique locations, and uncommon footprints.
Background On Depreciation
To explain cost seg, we first need to explain the concept of depreciation. Depreciation is the accounting method to reduce the value of an asset over time as it ages. Section 167 of the tax code allows the taxpayer to deduct depreciation for the “exhaustion, wear and tear (including a reasonable allowance for obsolescence)” for property used in its business or for property held for the production of income.
The tax code (and the IRS) allows property owners to use depreciation deductions to offset income, lowering taxable income and the taxes you pay each year.
Typically, taxpayers depreciate their entire property (excluding land, which is not depreciable), over 27.5 years for residential properties (excluding short-term rentals), or 39 years for commercial properties, and using the straight-line method. However, this assumes all components have the same useful life — which is rarely true.
The Role Of Cost Segregation
Bundling all of the components of a property into a 27.5 year or 39 year bucket is overly simplistic and does not reflect reality.
The IRS recognizes that different components of a property have different useful lives. For example, components such as carpet, cabinetry, specialty electrical, and land improvements (sidewalks, fencing) typically require more frequent repair or replacement, and so have shorter useful lives (e.g., 5, 7, or 15 years). Structural components of a building, such as walls and roofs, have longer useful lives (e.g., 27.5 or 39 years).
A cost segregation study is a detailed engineering analysis that identifies and reclassifies components of your property into shorter useful life buckets to accelerate depreciation deductions. This IRS-approved strategy reduces your taxes and increase your cash flow. Our engineering team reviews the details of your property - including the appraisal, property condition report, site survey, construction drawings, renovation costs, etc. - and builds a detailed, engineering-based replacement cost estimate for each component of the property.
And with the return of 100% bonus depreciation in 2025, STR owners can claim significant depreciation deductions in year 1 of their ownership. We usually see successful investors use this cash flow to reinvest in more properties, pay down debt, or make other investments.
What About Bonus Depreciation?
Bonus depreciation is a tax incentive first enacted by Congress back in 2001. It is meant to incentivize investment and allows property owners to deduct their depreciation costs in the first year of ownership instead of spreading those depreciation deductions over time. Bonus depreciation does not create more overall depreciation - instead it further accelerates the depreciation that can be deducted in year 1. “Accelerated depreciation” would probably be a more descriptive name. Bonus depreciation only applies to the components and costs in the shorter life tax categories (i.e., the 5 year, 7 year, and 15 year property).
The One Big Beautiful Bill Act (“OBBB” or “OB3”) was signed into law on July 4, 2025 and returns bonus depreciation to 100% for properties acquired or construction work performed after January 19, 2025.
With 100% bonus depreciation, you deduct 100% of the costs of the reclassified components in shorter life tax categories in year 1. So, for example, instead of recognizing depreciation deductions from 5 year property over 5 years, you will recognize 100% of it in year 1.
Bonus depreciation significantly accelerates your depreciation, increasing the potential tax savings from cost segregation materially.The Limits of Passive Losses
Real estate rental income is generally considered a passive activity in the tax code and so can be subject to passive activity loss limitations. These limitations can prevent a taxpayer from utilizing losses from rental activities to reduce their taxable income from other non-passive or active sources (i.e., W-2 salary income).
A passive loss is generated when the expenses (including depreciation) from rental activities exceed the income generated by the properties. Cost segregation frequently creates such losses, as the accelerated depreciation can greatly exceed the yearly income generated by the rental property. But the limits on passive activity losses often cause small actual cash tax savings from this accelerated depreciation.
The STR "Loophole"
Historically, the primary method for avoiding the passive activity loss limitations was to qualify as a real estate professional. Real estate professional status is difficult to achieve as it requires a taxpayer to work more than 750 hrs per year in a real property trade or business and have that be a “majority” of their working time (i.e., >50%).
The STR "loophole" lowers this threshold dramatically! The qualifications are:
- The average period of customer use must be 7 days or less, and
- The taxpayer must “materially participate” in the business, typically meaning they worked more than 100 hours operating the rental AND no one else worked more than the taxpayer (there are several different ways to meet the “material participation” requirement, but this is the most commonly utilized one).
If these requirements are met, depreciation deductions from a STR can offset W-2 income and significantly lower the taxes paid by the property owner. Bonus depreciation shifts the benefits of a new STR purchase into the first year.
We always recommend you discuss with your CPA or qualified tax preparer to ensure you qualify.
Cost Seg Example
| Purchase price for a short term rental property | $1,000,000 |
| % of purchase price allocated to land (which is non-depreciable) | 20% |
| Depreciable basis | $800,000 |
| % of depreciable basis reclassified into shorter life categories with a cost seg | ≈ 25% |
| Assets eligible for Year 1 100% bonus depreciation with a cost seg | ≈ $200,000 |
| Year 1 tax savings at a 37% federal income tax rate with a cost seg | ≈ $74,000 |
Higher depreciation → lower taxable income → improved cash flow
Note: This estimate is provided for informational purposes; actual results will depend on the specific features of your property (e.g., quality of the property, condition, year of purchase, renovation work, location, etc.).
Why Choose Us
We help real asset owners navigate the complex worlds of tax credits and incentives. Our team has 20+ years of experience performing cost segregation studies. We specialize in cost segregations for Airbnbs, ensuring all your investments (furniture, decorations, etc.) get properly allocated to maximize savings.
We are unique in the market by offering a full range of cost segregation services, from DIY studies for single-family residential properties, to fully engineered studies for more complex properties and situations. We focus on delivering the highest quality reports, at a price that ensures a high ROI.
Get a free proposal with your estimated tax savings here, or schedule a free consultation here and we can help you.
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