Special Depreciation Rules for Short-Term Rentals (STR) and Long-Term Rentals (LTR)

[Malik Javed]

The most recent data show that record momentum continues for the residential rental industry especially for the short-term rental industry, with year-over-year bookings now exceeding pre-pandemic levels.

The complexity of the problem hinges on the definitions of “short-term” versus “long-term” rentals for tax purposes. Depreciation rules for the two definitions are different.

A short-term rental (STR) is a dwelling unit that is used on a "transient" basis. If the unit is occupied more than half the days of a taxpayer/owner's tax year by a tenant(s) that stays for less than 30 days, it is considered a transient basis rental. (Note that this is the typical arrangement for Airbnb rentals and other temporary rental-type properties.)

Rental property used on a transient basis is depreciated over a 39-year period, not over 27.5-years as is the case with longer-term residential rental property (LTR). Long-term rentals typically derive at least 80% of their gross rental income from residential dwelling units. If any portion of the building or structure is occupied by the taxpayer, the gross rental income from the property must includes the fair rental value of the unit occupied by the taxpayer.

IRC 168(e) defines a dwelling unit as “a house or apartment used to provide living accommodations. A dwelling unit does not include a unit in a hotel, motel, or other establishment in which more than 50% of the units are used on a transient basis.”)

Benefits of a Cost Segregation Study

Capturing depreciation on STR property begins with a cost segregation strategy to maximize deductions. Cost segregation is a commonly used strategic tax planning tool that allows companies and individuals who have constructed, purchased, expanded or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes.

When a property is purchased, not only does it include a building structure, but it also includes all of its interior and exterior components. On average, 20% to 40% of those components fall into tax categories that can be written off much quicker than the building structure.

A Cost Segregation study dissects the construction cost or purchase price of the property that would otherwise be depreciated over 27.5 or 39 years. The primary goal is to identify all property-related costs that can be depreciated over five, seven and 15 years. The studies can address current year assets as well as those placed in service in prior tax years without the need to amend prior tax returns.

Conclusion

Understanding the difference between short-term and long-term rentals is crucial for real estate investors, particularly when it comes to depreciation and tax planning. By correctly classifying your property, you can ensure that you’re complying with IRS guidelines and maximizing your tax benefits. Performing a cost segregation study on these types of properties can offer additional tax savings. While substantial financial benefits are available, it's essential to meet IRS criteria, keep meticulous records understand depreciation, and stay informed about local regulations.

When considering a Cost Segregation study, here are a few things to consider:

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