Recent News & Blog / Maximizing Tax Benefits with Short-Term Rentals and Cost Segregation
December 9, 2025
By Daryl L. Staley, CPA, MBA, Member of the Firm
Investing in short-term rentals can be a smart move for generating income – but did you know they also offer powerful tax advantages? When combined with cost segregation studies, short-term rental owners can significantly reduce taxable income. Here’s how it works, and why material participation can change the outcome.
Why short-term rentals are a tax strategy game-changer
Short-term rentals (STRs), typically rented for an average stay of seven days or less, can qualify as an active trade or business (treated more like running a business than owning a traditional rental) under IRS rules.
Unlike traditional long-term rentals, which are generally passive, short-term rental activity may allow losses to offset non-passive income (such as W-2 wages or business income) if you meet the material participation standard.
Key tax benefits are:
- Accelerated depreciation: Traditional residential rentals depreciate over 27.5 years. Short-term rentals, when paired with a cost segregation study, give you the opportunity to take more depreciation sooner instead of spreading it evenly, which can create non-passive losses that offset other non-passive income.
- Cost segregation: A cost segregation study reclassifies portions of the property (like flooring, appliances, and landscaping) into shorter depreciation timelines – commonly 5, 7, or 15 years. These components may qualify for bonus depreciation (an IRS rule that lets you deduct certain items right away), allowing substantial first-year deductions.
- Early cash flow impact: Accelerating depreciation reduces taxable income sooner, freeing cash for reinvestment, upgrades, or acquisitions.
What is cost segregation?
Cost segregation is an engineering-based breakdown of your property into three categories:
- Land improvements (15 year life)
- Personal property (5-7 year life)
- Real property (27.5 year or 39 year life)
By shifting assets into shorter-lived categories, you can claim 100% bonus depreciation on qualifying components (meaning many items can be deducted right away), dramatically increasing first-year deductions.
What is material participation?
To unlock short term rental losses against non-passive income, you must materially participate in the rental activity during the tax year.
The IRS defines material participation as involvement on a regular, continuous, and substantial basis. Common tests include:
- 500-Hour Rule: You participate more than 500 hours in the activity during the year.
- Substantially-All Rule: You do substantially all of the participation yourself.
- 100-Hour Plus Rule: You participate over 100 hours and more than any other individual.
Practically, this can mean personally handling or actively overseeing bookings, guest communication, cleaning coordination, and maintenance. Meeting these tests converts the activity from passive to active, so losses (including those from accelerated depreciation) can potentially offset other income.
Timing matters
A cost segregation study can be completed in any year after the property is placed in service (meaning it’s ready and available to rent), but the strategy is most effective when aligned with a year you materially participate.
In other words: plan your participation intentionally in the year you want the largest deduction.
Bottom line
Combining short-term rental status, material participation, and a cost segregation study creates a powerful tax strategy that:
- Accelerates depreciation into earlier years.
- Converts passive losses to active losses.
- Reduces taxable income significantly – especially for high earners.
Important note: These rules are nuanced, and the IRS expects strong documentation. Always consult a qualified CPA or tax advisor before implementation and keep clean records of time spent and responsibilities performed.
Free resource:
Our Short-Term Rental Buyer’s Guide covers the essentials – market demand, local rules and taxes, property and setup considerations, management approach, risk planning, and financial analysis – to give you a clear picture of your investment.
Ready to optimize your investment?
If you’re considering a short-term rental purchase or want to explore cost segregation opportunities, our team can help you maximize your tax savings. Contact us today using the form below to get started.