Short-term rentals (STRs) have become a booming asset class, offering investors a unique combination of income potential and flexibility. But beyond the revenue from bookings, STRs offer another major advantage: significant tax benefits. One of the most impactful strategies for STR owners to reduce their tax liability is cost segregation. Let’s dive into how this powerful tool can help property owners unlock savings and maximize their investments.
What is Cost Segregation?
Cost segregation is a tax planning strategy that allows property owners to accelerate depreciation deductions by reclassifying certain components of their property. While residential properties are typically depreciated over 27.5 years and commercial properties over 39 years, cost segregation breaks down a property into components with shorter depreciation periods—like 5, 7, or 15 years.
This accelerated depreciation leads to larger deductions in the early years of ownership, reducing taxable income and increasing cash flow.
Key Benefits of Cost Segregation for STR Owners
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Accelerated Depreciation
Certain property components, like personal property and land improvements, can be depreciated more quickly. This allows owners to front-load their deductions and significantly reduce taxes in the first few years of ownership. -
Higher Deductions
By accelerating depreciation, STR owners can deduct a larger portion of their property’s cost early on, leading to reduced taxable income and lower tax liabilities. -
Bonus Depreciation
Cost segregation identifies assets that qualify for bonus depreciation, enabling owners to deduct a significant percentage of qualifying property costs in the first year—creating immediate and substantial tax savings. -
Real Estate Professional Status
Owners with real estate professional status can leverage cost segregation to offset other sources of income with the generated losses, amplifying the tax benefits.
A Real-World Example of Cost Segregation
Imagine Emily, an STR investor, purchases a property for $500,000. Without cost segregation, she would depreciate the entire property over 27.5 years. However, a professional cost segregation study reveals that $110,362 of the property’s value can be reclassified into shorter recovery periods, like 5 and 15 years.
Using bonus depreciation, Emily deducts 80% of the reclassified value in the first year. Instead of paying $67,273 in taxes without cost segregation, her tax liability drops to $33,166. That’s a savings of $34,107 in just one year.
| Without Cost Segregation |
80% Bonus Depreciation (2023) |
|
| Gross Income | $200,000 | $200,000 |
| Depreciation | ($18,182) | ($110,362) ↑ |
| Net Taxable Income | $181,818 | $89,638 ↓ |
| Taxes | $67,273 | $33,166 ↓ |
| $34,107 More Tax Savings With 80% Bonus Depreciation (assuming 37% tax rate) |
||
Why Work with a Professional?
Cost segregation is a powerful tax strategy, but it requires expertise to execute properly. A qualified tax advisor or cost segregation specialist can:
- Identify assets eligible for accelerated depreciation.
- Ensure compliance with IRS guidelines.
- Maximize your tax savings while minimizing risk.
Conclusion
Cost segregation is a game-changing strategy for short-term rental owners, unlocking significant tax advantages and optimizing financial performance. By reclassifying certain assets, STR owners can accelerate depreciation, reduce taxable income, and maximize profitability.
To make the most of this opportunity, consider consulting a qualified cost segregation expert. With the right guidance, you can leverage this tax strategy to enhance your investment’s success and build long-term financial stability.
Ready to explore the potential of cost segregation? Take the first step today and unlock the hidden tax benefits of your short-term rental property!
