Depreciation on Short-Term Rentals: 7-Day Rule and Cost Segregation

Depreciation on a short-term rental can do something an ordinary landlord’s depreciation cannot: wipe out W-2 wages and other ordinary income in the year you claim it. The mechanism is a chain of rules. If your property’s average guest stay is seven days or less, the IRS stops treating it as a rental activity. If you also materially participate, the resulting loss is active. And if you pair a cost segregation study with 100% bonus depreciation, you can front-load years of deductions into year one. Miss any link and the loss gets trapped behind the passive activity rules, where it can only offset passive income.

The Seven-Day Rule That Changes Everything

For most landlords, depreciation losses are passive under IRC Section 469, and passive losses can only offset passive income — not salary or business earnings.¹ The only common escape is qualifying as a real estate professional, which demands more than 750 hours a year in real estate trades and more time in real estate than in any other job. Most W-2 earners cannot meet it.

Short-term rentals get out through a different door. Treasury Regulation 1.469-1T(e)(3)(ii)(A) says an activity is not a rental activity at all if the average period of customer use is seven days or less.² When your average stay clears that bar, the IRS treats the property as an ordinary trade or business. You are no longer a landlord for passive-loss purposes. You do not need real estate professional status.

The math is simple: divide the total number of days across all rental periods by the number of separate rentals during the tax year.³ Fifty bookings totaling 200 guest-nights averages four days. That clears the threshold easily. A few 30-day off-season stays mixed into weekend bookings can push the average over seven, so track this all year, not just at filing time.

What if your average stay runs longer than seven days? The property falls back into rental activity classification and the loss goes passive. There is a small safety valve — an active participation allowance of up to $25,000 in rental losses against non-passive income — but it phases out dollar-for-dollar between $100,000 and $150,000 of modified adjusted gross income.⁴ For the high earners this strategy typically targets, that allowance is gone.

Material Participation Is the Second Gate

Clearing seven days strips off the automatic passive label. It does not, on its own, make your losses active. You also have to materially participate in the business. The IRS provides seven tests and you only need to pass one. Three matter for most STR owners.³

The 500-hour test: you spend more than 500 hours on the activity during the year. About 10 hours a week.
The substantially-all test: your participation is substantially all the participation by anyone, including contractors and employees. This fits owners doing everything themselves without a property manager.
The 100-hour test: you spend more than 100 hours and no other single person spends more. Most STR owners rely on this one. You have to log more hours than your cleaner, your handyman, or your property manager — measured individually, not combined.

What Counts as Participation

Managing bookings, communicating with guests, coordinating turnovers, restocking, handling maintenance, setting pricing, and reviewing performance all count. Time spent as an investor does not: browsing listings for your next purchase, running your own return-on-investment spreadsheets, or reviewing financials for personal analysis. The line is between operating the business you own and researching the next one.

Documenting Your Hours

The IRS does not mandate a format. A calendar, appointment book, or narrative summary is acceptable.³ What loses audits is vague after-the-fact estimation. Keep a contemporaneous log with date, task, and time. Timestamps from your property management software — guest messages, task assignments — corroborate the log. If the IRS cannot verify your hours, it will reclassify the activity as passive and disallow the loss against ordinary income.

Figuring the Depreciable Basis

Depreciation starts with the number you can depreciate. Your basis is the purchase price plus certain acquisition costs — title insurance, legal fees, recording fees, transfer taxes, surveys — plus later improvements with a useful life beyond one year. Prepaid interest, prorated property taxes, and mortgage insurance premiums are not part of basis; they are handled elsewhere on the return.⁵

Then subtract the land. Land does not wear out, so it is not depreciable.⁵ The common shortcut is to use the land-to-building ratio from the county tax assessment. If that ratio understates the building’s share, an appraisal can justify a higher depreciable amount, and the difference compounds every year for 27.5 years.

Residential rental property, including short-term rentals, depreciates under MACRS over 27.5 years using straight-line.⁶ On a $400,000 building, that is about $14,545 a year. Modest. The real power comes from accelerating it.

Cost Segregation and 100% Bonus Depreciation

A cost segregation study is an engineering analysis that reclassifies building components into shorter MACRS recovery periods instead of the full 27.5 years.⁷

5-year property: appliances, carpeting, furniture, certain decorative fixtures.
7-year property: office furniture, safes, filing cabinets.
15-year property: land improvements like driveways, fencing, sidewalks, and landscaping.

On a typical single-family STR, a study often shifts 20% to 40% of the building’s basis into these shorter-lived categories. Professional studies for a residential property generally run $5,000 to $10,000, with software-driven options available for simpler homes.

Bonus depreciation under IRC Section 168(k) lets you deduct qualified property — MACRS assets with a recovery period of 20 years or less — immediately in the year placed in service, instead of spreading it over 5, 7, or 15 years.⁸ Under the Tax Cuts and Jobs Act, bonus was phasing down: 60% in 2024, 40% in 2025. The One Big Beautiful Bill Act reversed that trajectory. For qualified property acquired after January 19, 2025, bonus depreciation is restored to 100% on a permanent basis.⁹

Combine the two. Suppose you buy a $600,000 property with $100,000 in land and $500,000 in building. A cost segregation study pulls $150,000 out of the 27.5-year bucket and into shorter-lived assets. At 100% bonus, that entire $150,000 is deductible in year one. The remaining $350,000 of building continues on the 27.5-year schedule, adding about $12,727 in the first full year. First-year depreciation over $160,000 is realistic. With STR active status, that loss offsets salary dollar-for-dollar.

If You Already Own the Property

Never ran a cost segregation study on an STR you have owned for years? A look-back study identifies the shorter-lived assets retroactively. You claim the entire cumulative missed deduction in the current year by filing Form 3115, Application for Change in Accounting Method.¹⁰ The IRS treats it as a Section 481(a) catch-up adjustment, taken all at once, with no need to amend prior returns. It falls under an automatic consent procedure, so you file with your current return without waiting for IRS approval.

Personal Use Can Erase the Benefit

Using the property yourself has consequences. Under IRC Section 280A, if personal use exceeds the greater of 14 days or 10% of the days the property is rented at a fair price, the IRS classifies the dwelling as a personal residence rather than a pure rental.¹¹ Once that happens, rental expenses including depreciation cannot exceed rental income. No net loss is possible.

Even under the threshold, you have to prorate depreciation between rental and personal days using the IRS formula: total rental days divided by combined rental and personal days.⁶ If you rent for 200 days, personal use above 20 days triggers the residence classification. Days spent on maintenance and repairs generally do not count as personal use, but mixing repair work with vacation time creates the kind of gray area the IRS examines.

Recapture When You Sell

Every dollar of depreciation reduces your adjusted basis, which increases your taxable gain when you sell. The portion of gain attributable to prior depreciation — unrecaptured Section 1250 gain — is taxed at a federal rate of up to 25%, above the 15% or 20% long-term capital gains rate most sellers pay.¹²

The math still favors aggressive depreciation. A deduction that saves 32% or 37% in ordinary income tax today outweighs 25% recapture years later, and the time value of the deferred tax makes the early deduction worth more still. You can also defer recapture entirely with a like-kind exchange under IRC Section 1031, rolling the proceeds into another qualifying investment property. The gain, including recapture, carries over to the replacement property.¹³ Strict deadlines apply: 45 days to identify replacements, 180 days to close.

Your State May Not Follow Along

Everything above is federal. A significant number of states decouple from federal bonus depreciation and do not recognize the 100% first-year write-off under Section 168(k). In those states, you calculate depreciation on a separate schedule as if bonus did not exist, spreading the deduction over standard recovery periods. Your first-year state deduction shrinks and your state taxable income runs higher than your federal return suggests.

Decoupled states may also require separate basis figures, carryforward adjustments, and depreciation schedules for each asset. Check your state’s conformity before you model the after-tax return on an STR purchase. If it does not conform, your CPA will maintain parallel depreciation records for as long as you own the property, and the projected numbers should reflect that.

1
Internal Revenue Service. Topic no. 425, Passive activities – Losses and credits
2
eCFR. 26 CFR 1.469-1T – General Rules (Temporary)
3
Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
4
Internal Revenue Service. Instructions for Form 8582 (2025)
5
Internal Revenue Service. Publication 551 (12/2025), Basis of Assets
6
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
7
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
8
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
9
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill
10
Internal Revenue Service. About Form 3115, Application for Change in Accounting Method
11
Office of the Law Revision Counsel. 26 U.S. Code 280A – Disallowance of Certain Expenses in Connection With Business Use of Home, Rental of Vacation Homes, Etc.
12
eCFR. 26 CFR 1.453-12 – Allocation of Unrecaptured Section 1250 Gain Reported on the Installment Method
13
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Property Held for Productive Use or Investment