Cost Seg and Short Term Rentals
A concise, practical explanation of how cost seg delivers tax benefits to short term rental owners
TLDR: Short term rentals and cost segregation studies can be a highly effective strategy to lower taxes on your active income (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, and others 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.
The Role Of Cost Segregation
As with any income generating property, owners can offset their income with depreciation deductions to lower their taxes. Typically, owners of rental properties recognize depreciation deductions over 27.5 or 39 years using the straight-line method (the appropriate depreciation period for STRs is 39-years). This results in a small amount of depreciation taken each year over a long period of time.
Cost Segregation is an IRS-approved tax planning strategy that allows short term rental owners to accelerate the depreciation deductions associated with their property. The purpose of a cost segregation study is to identify and reclassify the property into shorter tax life components (e.g., 5, 7, or 15 years) so you can accelerate depreciation deductions and improve cash flow. And with the return of 100% bonus depreciation in 2025, STR owners can claim significant depreciation deductions in year 1 of their ownership.
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 causes small actual cash tax savings from this accelerated depreciation.
The Short Term Rental Tax 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, owning an STR can significantly offset W-2 income and lower taxes paid by the property owner. Bonus depreciation has further increased the year 1 benefits of a new STR purchase.
We always recommend you discuss with your CPA or qualified tax preparer to ensure you qualify.
Check out our free calculator tool to estimate how much your STR could reduce your taxes with a cost segregation study.
Cost Seg Example
| Purchase price for a short term rental | $1,000,000 |
| % allocated to land (not depreciable) | 20% |
| Depreciable basis | $800,000 |
| % reclassified into shorter life categories | ~ 25% |
| Assets eligible for bonus depreciation with cost seg | ~ $200,000 |
| Year 1 tax savings with cost seg at a 37% tax rate | ~ $74,000 |
Higher depreciation → lower taxable income → improved cash flow
Note: This example is 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 MVO
MVO helps 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 segregation studies 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 (under our sister brandCost Seg EZ) 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.
Estimate your tax savings here, or schedule a free consultation here and we can help you.
FAQs
The IRS has an Audit Technique Guide, where it describes the best practices for a cost segregation report that will be accepted by the IRS during an audit. The IRS explicitly states that a cost segregation expert should conduct the study and create the report, and that significant construction and engineering experience is required (See page 35).
Savings vary based on property type, value, and your tax situation. Typically, our clients see first-year tax savings up to 10% of their purchase price. Our clients also typically see first-year tax savings of 5x the cost of their study. Every situation varies, but applied correctly cost seg can be a really lucrative and efficient strategy.
We are happy to provide you a personalized quote of your benefits and costs and based on your specific situation, or feel free to use our free estimate tool.
Our typical turnaround time is ~3 weeks, depending on the complexity and size of your property. We'll provide a detailed timeline before we get started. For urgent situations, we offer expedited processing for an additional fee.
We also offer Do-It-Yourself (DIY) options, powered by our sister brand Cost Seg EZ, for simpler properties where the study can be completed much faster.
You can learn more about our different offerings here.
It depends on your property and your desired level of service. We are proud to offer a several options so you can choose.
Do-It-Yourself (DIY) studies, powered by our sister brand Cost Seg EZ, can be generated instantly for $595 per property. This option is available for residential properties (excluding condos) with a cost basis < $1 million and minimal post-acquisition improvements.
Engineer-Reviewed studies takes DIY and adds a detailed review by our experienced engineering team to ensure maximum benefits and accuracy for $895 per property. This option is available for all residential properties (including condos) with a cost basis < $1 million and post-acquisition improvements up to $100,000.
Fully Engineered studies are our core business. This is for larger residential properties and all commercial properties. The pricing depends on the size and scope of the project and starts at $2,250. Get a custom proposal here.
You can learn more about our different offerings here.
Cost segregation studies do not increase your audit risk when done properly. Cost segregation is an IRS-approved strategy, and we've never had a study rejected by the IRS. Our studies follow the IRS guidelines and we lead the industry with engineering-based best practices. A poor quality or inaccurate study is what can increase the risk of an audit or cause issues during an audit.
Yes, we provide lifetime audit protection. If the IRS questions any aspect of our cost segregation study, we'll handle the defense at no additional cost to you for Fully Engineered studies. Our studies follow all current guidelines and we've never had a study rejected by the IRS.
Yes! You can still capture the benefit of cost segregation via a “look back” analysis. This process involves filing a Form 3115 with your next tax return and allows you to “catch up” on any depreciation deductions you missed by not doing the cost segregation study in year 1. This is very common.
Still have questions? We're here to help.