Depreciation on Short-Term Rentals: Seven-Day Rule and Bonus Depreciation

Short-term rental depreciation is the annual non-cash deduction you take for the wear and tear on a property you rent to guests, and under the right conditions it can offset not just your rental income but your W-2 wages and other ordinary earnings. The default schedule spreads the building’s cost over 27.5 years. The powerful version — the one that produces six-figure first-year losses — requires an average guest stay of seven days or less, documented material participation, and a cost segregation study paired with 100% bonus depreciation. Miss any of those pieces and the deduction gets trapped behind the passive activity rules.

What You’re Actually Depreciating

Your depreciable basis starts with the purchase price plus certain closing costs. Title insurance, legal fees, recording fees, transfer taxes, and surveys all get rolled into basis. Prepaid interest, prorated property taxes, and mortgage insurance premiums do not. Any post-closing improvement with a useful life beyond one year — a new roof, an addition, a renovated kitchen — increases basis as well.¹

Then subtract the land. Land does not wear out, and the IRS does not let you depreciate it.¹ The most common split uses the land-to-building ratio from your county property tax assessment. If that ratio understates the building’s share, a professional appraisal can establish a higher depreciable amount, and the difference compounds every year for 27.5 years.

The 27.5-Year Default

Residential rental property, including short-term rentals, is depreciated under the Modified Accelerated Cost Recovery System over 27.5 years using the straight-line method.² Divide the building’s depreciable basis by 27.5 and that is your annual deduction.

The first and last years are prorated. The IRS applies a mid-month convention, treating the property as placed in service on the 15th of whatever month you started renting.³ Close in October and your first-year deduction covers roughly 2.5 months. You report each year’s depreciation on Form 4562.⁴

On its own, this produces a modest number. A $400,000 building generates roughly $14,545 a year. The real leverage comes from how the resulting loss is classified and how much of it you can pull into year one.

The Seven-Day Rule That Changes Everything

For most rental owners, depreciation losses are passive under IRC Section 469. Passive losses can offset only passive income, not W-2 wages or active business earnings.⁵ Long-term landlords are stuck with this unless they qualify as a real estate professional, which requires more than 750 hours per year in real estate and more time there than in any other job.

Short-term rentals get out of that box through a specific regulatory exception. Under Treasury Regulation 1.469-1T(e)(3)(ii)(A), an activity is not treated as a rental activity if the average period of customer use is seven days or less.⁶ When your average guest stay for the year is seven days or fewer, the IRS treats the property as a regular trade or business rather than a rental.

The calculation: divide the total number of rental days by the number of separate rentals during the tax year.⁷ Fifty bookings totaling 200 guest-nights gives you a 4-day average. A few 30-day winter bookings mixed in with weekend stays can push you over the limit, so owners accepting longer reservations during slow seasons need to track this across the whole year.

If your average stays above seven days, the property is a passive rental activity. You still claim depreciation, but the loss generally offsets only passive income. The active-participation $25,000 allowance exists but phases out between $100,000 and $150,000 of modified adjusted gross income, which zeroes it out for most people considering this strategy in the first place.⁸

Material Participation Is the Second Gate

Clearing seven days removes the automatic passive label. It does not automatically make your losses active. You still have to materially participate in the business. The IRS provides seven tests, and meeting any one is enough. Three come up most often for short-term rental owners.⁷

The 500-hour test: more than 500 hours in the activity during the year, roughly 10 hours a week.
The substantially-all test: your participation makes up substantially all the participation by anyone, including contractors and employees. This fits owners who handle everything without a property manager.
The 100-hour test: more than 100 hours during the year, and no single other individual participates more than you do. Most short-term rental owners rely on this one. You must log more hours than your property manager, your cleaner, or your handyman, measured individually rather than combined.

What Counts and What Doesn’t

Hours spent managing bookings, communicating with guests, coordinating turnovers, restocking supplies, handling maintenance, setting pricing, and reviewing performance all count. What does not count is investor work: browsing listings for your next property, running return spreadsheets, or reviewing financial statements for your own analysis. The IRS distinguishes operating a business you own from researching the next one.

Documenting Your Hours

The IRS does not require a particular format. A calendar, an appointment book, or even a narrative summary written after the fact can work.⁷ Vague claims like “about 150 hours” without backup are where audits go badly. The defensible approach is a simple contemporaneous log: date, task, time spent. Property management software that timestamps your guest messages and task assignments gives you corroboration. If the IRS cannot verify the hours, it reclassifies the activity as passive and the loss stops offsetting your ordinary income.

Cost Segregation and Bonus Depreciation

The 27.5-year schedule is slow. Cost segregation paired with bonus depreciation collapses years of future deductions into year one, and for a short-term rental that qualifies as active, that concentrated loss offsets wages directly.

A cost segregation study is an engineering analysis that reclassifies building components into shorter MACRS categories.³ Five-year property includes appliances, carpeting, furniture, and certain decorative fixtures. Fifteen-year property includes land improvements like driveways, fencing, sidewalks, and landscaping. On a typical single-family short-term rental, a study often reclassifies 20% to 40% of the building’s basis into these shorter categories. Professional studies run roughly $5,000 to $10,000 for a residential property, with cheaper software-driven options available for simpler properties.

Bonus Depreciation Is Back at 100%

Bonus depreciation under IRC Section 168(k) lets you deduct a percentage of qualified shorter-lived property in the year it is placed in service rather than spreading it across 5, 7, or 15 years. The original Tax Cuts and Jobs Act had this phasing down. The One Big Beautiful Bill Act reversed that. For qualified property acquired after January 19, 2025, bonus depreciation is restored to 100% on a permanent basis.⁹

Qualified property means MACRS assets with a recovery period of 20 years or less.¹⁰ That covers the 5-year, 7-year, and 15-year components the cost segregation study pulls out. The 27.5-year building shell itself does not qualify and keeps depreciating on the standard schedule.

The math on a worked example. Buy a $600,000 property, $100,000 to land, $500,000 to the building. A cost segregation study reclassifies $150,000 into shorter-lived assets. Under 100% bonus depreciation, you deduct that $150,000 immediately. The remaining $350,000 of building value depreciates over 27.5 years, roughly $12,727 in your first full year. Combined first-year depreciation can top $160,000, and with active status that loss offsets your salary dollar-for-dollar.

If You Already Own the Property

Owners who have held a short-term rental for years without doing a cost segregation study can still catch up. A look-back study identifies the shorter-lived assets retroactively, and you claim the entire cumulative missed deduction in the current tax year by filing Form 3115, Application for Change in Accounting Method.¹¹ The IRS treats this as a Section 481(a) adjustment — a single catch-up deduction with no need to amend prior returns. It falls under automatic consent, so you file with your current return rather than waiting for IRS approval.

Personal Use Can Kill the Deduction

Using the property yourself can erode or eliminate the depreciation benefit. Under IRC Section 280A, if personal use exceeds the greater of 14 days or 10% of the days rented at a fair price, the IRS classifies the dwelling as a personal residence rather than a pure rental.¹²

Once that classification kicks in, rental expenses including depreciation cannot exceed rental income. The net loss disappears. Even below that threshold you must prorate depreciation and other shared expenses between rental days and personal days.²

If you are chasing a large paper loss to offset W-2 income, keep personal use well below the line. Rent the property 200 days and you cannot use it personally for more than 20. Days spent on genuine maintenance and repairs generally do not count as personal use, but staying over after finishing a repair and then using the pool the next morning is the gray area the IRS scrutinizes.

Recapture When You Sell

Every dollar of depreciation reduces your adjusted basis. When you sell, that lower basis increases your taxable gain. The portion attributable to depreciation you previously claimed — unrecaptured Section 1250 gain — is taxed at a maximum federal rate of 25%, higher than the 15% or 20% most sellers pay on long-term capital gains.¹³

Recapture is the price of admission, but the math still favors aggressive depreciation. A deduction today that saves 32% or 37% in ordinary income tax is worth more than 25% recapture tax years later, and the time value of money widens that gap when you invest the savings in the interim.

You can defer recapture entirely with a like-kind exchange under IRC Section 1031. Reinvest the proceeds into another qualifying investment property and the gain, recapture included, carries over to the replacement.¹⁴ Strict timelines apply: 45 days to identify replacement properties and 180 days to close.

Self-Employment Tax and NIIT

Non-rental trade-or-business classification raises a separate question: is the income subject to self-employment tax? Rental income is normally excluded from SE tax. When a short-term rental crosses into trade-or-business territory, the answer depends on whether you provide “substantial services” to guests — daily maid service, concierge arrangements, organized activities. Linens, a welcome guide, and a keypad entry code generally do not cross the line. Daily housekeeping, on-site staff, or guided excursions during the guest’s stay likely do. SE tax runs 15.3% on net earnings up to the Social Security wage base and 2.9% above it.

The 3.8% Net Investment Income Tax applies to passive income above certain thresholds. If your short-term rental income is genuinely non-passive because you materially participate, it falls outside NIIT, which partially offsets any SE tax exposure. Structuring to get an active depreciation loss while keeping the income out of both SE tax and NIIT is where professional tax advice earns its fee.

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, depreciation runs on a separate schedule as though bonus did not exist, spread across the standard recovery periods. Year-one state deduction is much smaller and state taxable income is higher than the federal return would suggest.

Decoupled states may also require separate basis figures, carryforward adjustments, and depreciation schedules for each asset, which adds real cost to your annual filing. Before projecting the after-tax return on a short-term rental purchase, check whether your state conforms to current federal bonus depreciation rules. If it does not, your CPA will maintain parallel depreciation records for as long as you own the property.

1
Internal Revenue Service. Publication 551 (12/2025), Basis of Assets
2
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
3
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
4
Internal Revenue Service. Instructions for Form 4562 (2025)
5
Internal Revenue Service. Topic no. 425, Passive activities – Losses and credits
6
eCFR. 26 CFR 1.469-1T – General Rules (Temporary)
7
Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
8
Internal Revenue Service. Instructions for Form 8582 (2025)
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
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
11
Internal Revenue Service. About Form 3115, Application for Change in Accounting Method
12
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.
13
eCFR. 26 CFR 1.453-12 – Allocation of Unrecaptured Section 1250 Gain Reported on the Installment Method
14
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Property Held for Productive Use or Investment