Short-Term Rental Depreciation: Rules, Loss Limits, and Recapture

Depreciation on a short-term rental lets you deduct the cost of the building and its contents over time, cutting your taxable income without spending additional cash. The building itself is written off over 27.5 years, but the bigger deduction comes from breaking the property into shorter-life components through a cost segregation study and then claiming 100% first-year bonus depreciation on those components under the One Big Beautiful Bill signed in 2025. Whether those deductions offset your wages and other income, or sit frozen until you sell, depends on two tests: your average guest stay and how much time you personally put into the activity.

What You Can Depreciate and Over How Long

You can depreciate the structure, not the land it sits on. Before you calculate anything, you have to split your purchase price between building and land based on their fair market values at acquisition. Property tax assessment records are the usual starting point; the assessed values for land and improvements give you a ready ratio.¹

Take a $500,000 purchase with the assessment attributing 20% to land. Your depreciable basis is $400,000. Under the default General Depreciation System, residential rental property is written off straight-line over 27.5 years,² which comes to roughly $14,545 a year. Useful, but not the number that makes STR investors pay attention.

The Mid-Month Convention

Residential rental property uses a mid-month convention. The IRS treats you as placing the property in service on the 15th of whatever month you actually started, whether the true date was the 3rd or the 28th. Close in March and make the property available for guests that month, and you get a half-month for March plus the nine remaining full months. The formula is full months in service plus 0.5, divided by 12, applied to a full year’s depreciation.²

The placed-in-service date is when the property was ready and available for rental use, not necessarily the day your first guest arrived.¹ That distinction matters for both the mid-month math and bonus depreciation eligibility.

Cost Segregation and 100% Bonus Depreciation

The 27.5-year schedule is the baseline. The real leverage comes from pulling components out of that long life and into much shorter ones, then writing them off immediately.

A cost segregation study is an engineering analysis that breaks the property into individual components and assigns each to the right asset class. Instead of everything sitting inside a single 27.5-year building, the study identifies items that belong in shorter recovery periods:

5-year property: carpeting, window treatments, certain appliances, specialized electrical and plumbing connections, and decorative finishes.
7-year property: office furniture and specialized equipment not embedded in the structure.
15-year property: land improvements like driveways, walkways, fencing, landscaping, and parking areas, which are separate from both the building and the non-depreciable land.

The study typically involves reviewing blueprints, construction invoices, and an on-site inspection. Tech-enabled providers offer desktop analyses starting around $500 for straightforward single-family properties. Traditional engineering firms doing full on-site inspections charge $5,000 to $10,000 or more. For most STR purchases, the first-year tax savings dwarf the study fee.

The 100% Rate Under the One Big Beautiful Bill

Bonus depreciation is what makes cost segregation powerful. It lets you deduct a percentage of the cost of short-life assets in the year the property is placed in service, instead of spreading the deduction over 5, 7, or 15 years.

For property acquired after January 19, 2025, the One Big Beautiful Bill restored a permanent 100% first-year bonus depreciation deduction for qualified assets with a recovery period of 20 years or less.³ That covers every class a cost segregation study would identify.

Put the numbers together. Buy an STR in 2026 for $500,000, allocate $100,000 to land and $400,000 to the building and its contents. A cost segregation study reclassifies $120,000 of the $400,000 into short-life classes. Under 100% bonus depreciation, the full $120,000 comes off in year one. The remaining $280,000 building value continues over 27.5 years, adding roughly $10,180 per year. First-year depreciation totals about $130,180, almost all of it from the accelerated piece. For an investor in the 37% bracket, that translates to more than $48,000 of federal tax savings in year one, assuming the losses are usable against non-passive income.

If You Bought Before January 19, 2025

The 100% rate applies only to property acquired after January 19, 2025. Property acquired before that date and placed in service in 2026 gets 20%; the same older acquisitions placed in service in 2025 get 40%.³ The rest of the cost depreciates normally over the assigned periods.

Can You Actually Use the Loss This Year?

A big first-year deduction sounds great, but a paper loss on a rental is normally passive. Passive losses only offset passive income, and anything left over is suspended and carried forward.⁴ For a landlord collecting monthly rent, that classification is nearly impossible to escape. Short-term rentals have a specific workaround.

The Seven-Day Average Stay Rule

When the average guest stay at your property is seven days or less, the IRS does not treat the activity as a “rental activity” for passive loss purposes.⁵ That single line is what separates a typical Airbnb listing from a year-long lease and opens the door to non-passive treatment.

Clearing the seven-day threshold is only step one. You then have to materially participate in running the activity.

Material Participation

The IRS provides seven material participation tests. Three cover most STR owners:⁶

500-hour test: more than 500 hours on the activity during the year.
Substantially-all test: your participation made up substantially all of the participation by anyone, including employees and contractors.
100-hour test: more than 100 hours on the activity, and no other person spent more time than you did.

Meet the seven-day rule and any one of these tests, and your STR is a non-passive trade or business. Depreciation losses flow through to offset wages, self-employment income, portfolio income, and anything else on your return. This is where the tax firepower lives.

The $25,000 Exception if You Don’t Materially Participate

Miss material participation and your losses are not necessarily worthless. Individuals who actively participate in a rental real estate activity can deduct up to $25,000 in passive rental losses against non-passive income each year.⁷ Active participation is a lower bar than material participation. It generally means you make management decisions like approving tenants, setting rental terms, or authorizing repairs.

The $25,000 allowance phases out once your AGI exceeds $100,000, losing $1 for every $2 above the threshold, and disappearing entirely at $150,000.⁷ A lot of STR investors sit well above that range, which is exactly why the seven-day rule and material participation route matter so much.

Losses that exceed both your passive income and the $25,000 allowance are suspended and carried forward. They become fully deductible when you sell the property in a taxable transaction to an unrelated party.⁸

Personal Use Can Kill the Loss

Using your STR for personal vacations has a tax cost that catches owners off guard. If your personal use exceeds the greater of 14 days or 10% of the days the property is rented at a fair price, the IRS reclassifies the property as a personal residence.⁹ Once that happens, rental expenses including depreciation are capped at your gross rental income. No paper loss, no matter how large your cost segregation deduction would have been.

The math: if your STR is rented for 200 nights, personal use up to 20 days is safe. Stay 21 nights and you lose the ability to take a net rental loss for the year. Expenses beyond the gross-income cap carry forward, but only against future rental income from the same property, subject to the same limit.⁹

A separate quirk sits at the other end. If you rent the property fewer than 15 days during the entire year, the rental income is tax-free, but no rental expenses are deductible.

What You Pay Back When You Sell

Depreciation reduces the property’s tax basis. When you sell, the IRS recaptures some of the benefit by taxing the gain attributable to prior depreciation at rates higher than the standard long-term capital gains rate. The rules differ depending on the asset.

The Building

Depreciation on the 27.5-year building is recaptured as “unrecaptured Section 1250 gain,” at a maximum federal rate of 25%. If you claimed $80,000 in cumulative building depreciation and sold at a gain, up to $80,000 of that gain is taxed at 25%. Gain beyond the total depreciation is taxed at standard long-term capital gains rates, topping out at 20%.

Short-Life Components

Recapture is harsher for the assets a cost segregation study identifies. Depreciation on 5-year, 7-year, and 15-year personal property is recaptured as ordinary income, taxed at your marginal rate.¹⁰ If you took $120,000 in bonus depreciation on those components and the property sells at a gain, that $120,000 could come back at rates up to 37%.

This is the trade-off for front-loading deductions. The immediate benefit still tends to beat the eventual bill for most investors because a dollar of tax savings today outweighs a dollar of tax owed a decade from now, and the deferral period is often much longer than that.

Deferring the Bill With a 1031 Exchange

A like-kind exchange under Section 1031 lets you defer both capital gains and depreciation recapture by reinvesting sale proceeds into another qualifying investment property.¹¹ The property must be real property held for business or investment use, the replacement identified within 45 days, and closing completed within 180 days.

Investors who exchange serially can defer recapture indefinitely. If the property is held until death, heirs receive a stepped-up basis, potentially wiping out the deferred gain and recapture entirely.

Records That Will Survive an Audit

The IRS does not require contemporaneous daily time logs to prove material participation, but hours have to be established by some reasonable method. An appointment book, calendar entries, or a written summary describing services performed and approximate hours spent will do.⁶ Tracking hours in real time reads far more credibly during an exam than a year-end reconstruction.

Also keep the land-versus-building allocation, the cost segregation report if you commissioned one, receipts for capital improvements, and documentation of the placed-in-service date. Those records tie directly to the numbers on your return and are the first things an examiner will ask for.

1
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
2
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
3
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill
4
Internal Revenue Service. Topic No. 425, Passive Activities – Losses and Credits
5
eCFR. 26 CFR 1.469-1 – General Rules
6
Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
7
Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
8
Internal Revenue Service. Instructions for Form 8582 – Passive Activity Loss Limitations
9
Internal Revenue Service. Topic No. 415, Renting Residential and Vacation Property
10
Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
11
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment