Start With the Investment Itself
Before we talk about bonus depreciation or any tax strategy tied to short-term rentals, I want you to ask yourself one question: would you buy this property even if there were no tax benefits attached to it?
That answer has to be yes before we go any further. Tax advantages are a bonus, not a business plan. If the only reason you’re considering a short-term rental is the depreciation benefit, that’s not a strong enough foundation. Get clear on whether this is genuinely the right investment for you first, and then we can talk about what the tax code may do for you on top of that.
What the One Big Beautiful Bill Changes
The bonus depreciation provisions in the One Big Beautiful Bill allow you to depreciate certain assets at a much faster rate than previous law permitted. Instead of spreading depreciation across 27.5 years as you would with standard residential real estate, you can front-load a significant portion of that deduction in the early years of ownership. That larger upfront deduction is what gets people excited, and understandably so.
But it’s worth understanding what depreciation actually is. When you eventually sell the property, that depreciation gets recaptured and taxed, unless you use a strategy like a 1031 exchange or benefit from a step-up in basis. Think of bonus depreciation as a short-term loan from the IRS. It delays the tax, it doesn’t eliminate it.
Why Short-Term Rentals Are a Special Case
The reason short-term rentals come up so often in these conversations is because of how the IRS classifies the income they generate. For a property to qualify as a short-term rental, the average guest stay needs to be seven days or fewer. That threshold matters because it opens the door to treating the rental activity as active rather than passive.
Here’s why that distinction is so important. Passive losses can only offset passive income. If you have a W-2 job and your rental generates a passive loss, you cannot use that loss to reduce your W-2 income. Active losses, on the other hand, can offset active income. So if your short-term rental qualifies as an active income activity, a large depreciation deduction becomes a tool that can actually reduce what you owe on your ordinary income.
How Cost Segregation Works
To generate that large upfront depreciation, most people in this situation will commission a cost segregation study. Rather than treating the property as a single depreciable asset, a cost segregation study breaks it down into its components: appliances, flooring, fixtures, land improvements, and so on. Each of those components carries its own depreciation schedule, and many of them depreciate much faster than the structure itself.
For example, appliances might be fully depreciated in the first year rather than over several years. When you add up all of those accelerated deductions across the entire property, you can generate a substantial loss in year one. If that loss is active, it can meaningfully reduce your tax bill.
The 100-Hour Rule Is Widely Misunderstood
This is where I see the most confusion. A lot of people have heard that if you spend 100 hours a year managing your short-term rental, it qualifies as active income. That is not quite right.
The 100-hour rule requires that you spend at least 100 hours on the property and that you spend more time on it than anyone else involved. If you have a property manager logging 250 hours a year and a cleaning crew putting in another 200 hours, your 100 hours does not make this an active endeavor in the eyes of the IRS. You have to be the primary contributor of time and effort, not just a participant.
There is also a 500-hour rule that can be used to demonstrate material participation, which sets a higher but clearer bar. Spouses can combine hours under certain conditions, which is worth discussing with your advisor depending on your situation.
Documentation Is Non-Negotiable
If you are planning to take a large bonus depreciation deduction against active income, your records need to be thorough and credible. That means logging every hour you spend on the property, documenting what you did, and keeping records of how much time every other party spent as well. You want to be able to show, without any ambiguity, that you were the primary person running this operation.
The bigger the tax benefit, the more scrutiny it can attract. Your documentation should be able to stand on its own if questions ever arise.
The Bottom Line
Short-term rentals combined with cost segregation and bonus depreciation can be a genuinely powerful tax strategy under the right circumstances. But the structure only works if the rental activity qualifies as active, your participation holds up under IRS standards, and your documentation supports all of it. And again, it only makes sense if you actually want to be in the short-term rental business in the first place.
Get those fundamentals right, and the tax benefits can be a meaningful addition to an already solid investment decision.
This post is adapted from a recent episode of the Scholar Wealth Podcast. For more perspective on short-term rentals and bonus depreciation, listen to the full podcast episode here.