At a Glance
If you own real estate investment properties, you likely use a tax strategy involving depreciation deductions to maximize savings when you file. You can recover some of the cost of your real estate investment property’s purchase price by claiming depreciation deductions on your income tax.
Investors with short-term rental properties can still use depreciation deductions to recoup the cost of their real estate; however, short-term rental depreciation rules differ from the traditional tax strategy.
Explore short-term rental depreciation options to develop a real-estate tax-saving plan for yourself or your business.
What Does the IRS Consider Short Term Rentals?
Before enacting a rental depreciation strategy, you’ll want to work with your real estate accounting team to determine if the IRS considers your property a short-term rental. Short-term rental properties generally follow the “vacation home rules,” assuming the taxpayer is also using the property for personal purposes which exceeds the greater of:
- 14 days per year
- 10% of the total days it was rented to others
Typically, a short-term rental is a first or second home in which the owners use online rental services or rental agents to rent out the property. In the past, these properties were usually limited to beach houses or mountain homes. Now, they may also include properties used as Airbnb or VRBO rentals.
Short Term Rental Depreciation Considerations
When determining a depreciation strategy for your rental property, you have several considerations regarding the eligibility and classification of your property. You also need to consider various depreciation deduction methods to maximize savings on your taxes.
First, you must understand the IRS’s eligibility requirements for depreciation deduction properties. The IRS states that eligible properties must:
- Be owned by you
- Be used in an income-producing or business activity
- Have a finite useful life – meaning it will wear out after a predictable period
- Have a lifespan of at least one year
- Cannot be classified as excepted property, for example, intangible property
If your property is eligible to use depreciation deductions per IRS criteria, you can consider short-term rental depreciation specifics. These can include determining deductions, whether you need to file self-employment taxes, and whether you earned passive or active activity. Each of these elements affects the tax strategy you use to file.
When you own a short-term rental, you must determine whether you have a business that is subject to self-employment tax, affecting your tax-savings opportunities. If your rental yields rental income, you will have to file a Schedule E. If your rental income qualifies as business income, you will file a Schedule C, which is subject to self-employment tax.
The way to determine your classification is by looking at whether you provide substantial services. For example, if you maintain standard services on your rentals, such as internet, heating, AC, and cleaning between guests, your short-term rental income classifies as regular rental income.
Alternatively, if you provide substantial services like meals, entertainment, transportation, and concierge services, you will have to file your income as business income, subject to self-employment tax.
To figure depreciation on your short-term rental property, you need to determine if your rental is a residential or non-residential building. Residential properties depreciate over 27.5 years, while non-residential properties depreciate over 39 years.
If your short-term rental only averages 30 days or less as an average rent period, it would classify as transient. It is therefore classified as a commercial property and depreciates over 39 years.
Another element determining depreciation is separating the land associated with your property versus the building. The IRS does not consider land depreciable, so you must reflect this by only figuring depreciation for the value of the building and other depreciable items.
The depreciation deduction is further carved into deductible amounts based on space rented as a percentage of total space and the number of days rented as a percentage of total days of use.
Determining passive versus nonpassive activity also affects your depreciation deduction strategy. Most rental activity is considered passive, which means you can only deduct an amount up to your passive income level. There are exceptions to this rule when:
- You qualify as a real estate professional per the IRS guidelines, and
- You demonstrate material participation
In some cases, the IRS does not consider the activity to be a rental activity, and you must only demonstrate material participation when:
- The average rental is less than 7 days
- The average period of rental is 30 days or less, and you provide substantial personal services
To demonstrate material participation, the IRS holds several standards you must meet. These include:
- You participate in the activity for over 500 hours during the year
- Your activity substantially makes up all of the participation in that activity
- You participate in over 100 hours during the tax year, and your activity is not less than any other person’s
If you do not meet exceptions to passive activity loss limitations, your passive rental losses can be deducted against nonpassive income up to $25,000 when your modified adjusted gross income (MAGI) is less than $100,000.
Qualified Improvement Property (QIP)
In 2017, the Tax Cuts and Jobs Act created a class of property called a Qualified Improvement Property (QIP). QIP refers to non-structural upgrades to the commercial property’s interior after placing the property in service.
If your short-term rental is a transient or commercial property, and you improve the interior of the building, you may qualify for accelerated depreciation under QIP. This property class has a shorter depreciable life and allows you to claim bonus depreciation in the taxable year the property is placed into service.
Cost Segregation Strategies
As a short-term property owner, you may also consider cost segregation strategies to maximize savings opportunities. Cost segregation allows you to take eligible depreciation deductions on your property assets that depreciate more quickly than the rest of the property.
These assets can include flooring, fixtures, cabinets, and fencing. With cost segregation, you can separate each of these components into property classes that have shorter depreciable lives and are eligible for Section 179 deductions and bonus depreciation, which reduces your tax liability.
You can work with a firm like Windes that provides cost segregation services to maximize your savings with a cost segregation strategy for your short-term rental.
Maximize Your Tax Savings With Professional Real Estate Accounting Services
To maximize tax-saving opportunities on your short-term rental property, work with Windes’ real estate tax professionals.
Our real estate accounting services provide real-world solutions to investors, real estate developers, management companies, rental companies, and realty associations in Long Beach, Orange County, and Los Angeles. Our superior technical expertise can help you identify and implement depreciation and cost segregation strategies to improve your cash flow and maximize tax-saving opportunities.
Contact Windes today at 844.494.6337 or email@example.com to learn how our real estate accounting services can help minimize your short-term rental tax liability.