As an owner of residential rental properties, short-term rentals (STRs), or vacation rentals such as Airbnb and VRBO, maximizing cash flow and minimizing tax liability are top priorities. One often overlooked but highly effective tax strategy is cost segregation—a method that accelerates depreciation deductions, significantly reducing taxable income and increasing after-tax cash flow.
Understanding Cost Segregation
Cost segregation is a tax strategy that allows property owners to break down and classify components of their property into shorter depreciation schedules. Instead of depreciating the entire building over 27.5 years (for residential rental properties), cost segregation identifies components that can be depreciated over 5, 7, or 15 years. This results in larger deductions in the earlier years of ownership, providing immediate tax benefits.
How Cost Segregation Benefits Residential Rental and STR Owners
1. Accelerated Depreciation for Immediate Tax Savings
By reallocating certain assets—such as flooring, cabinetry, lighting, and land improvements—to shorter depreciation lives, rental property owners can take larger depreciation deductions sooner. This means lower taxable income and more cash in hand to reinvest or use for other financial goals.
2. Bonus Depreciation
The Tax Cuts and Jobs Act (TCJA) introduced 100% bonus depreciation for qualified assets, allowing property owners to deduct the entire cost of eligible assets in the first year. While the bonus depreciation percentage is phasing down, significant upfront deductions are still available, making cost segregation even more valuable.
3. Improved Cash Flow
Lower taxable income results in reduced tax liabilities, allowing property owners to reinvest savings into additional properties, upgrades, or business expansion. This is especially beneficial for short-term rental owners who often face seasonal revenue fluctuations.
4. Potential for Catch-Up Depreciation
If you haven’t performed a cost segregation study in prior years, you can still benefit. The IRS allows you to claim catch-up depreciation without amending prior tax returns by filing a Form 3115 (Change in Accounting Method), enabling you to realize missed deductions in the current year.
Cost Segregation for Short-Term Rental (STR) Owners
Short-term rentals have unique tax advantages, especially for owners who actively manage their properties. STRs can sometimes be classified as non-passive income, allowing depreciation deductions to directly offset earned income. If you actively participate in managing your Airbnb or VRBO rental and meet certain IRS criteria, cost segregation can be even more beneficial by providing greater immediate tax relief.
Is Cost Segregation Right for Your Rental Property?
Cost segregation is particularly beneficial for:
- Rental properties purchased or renovated within the last several years.
- Short-term rental properties that generate substantial revenue.
- Investors looking to maximize tax deductions and improve cash flow.
- Property owners who plan to hold their properties long enough to benefit from accelerated depreciation but may sell before full depreciation recapture.
Take Advantage of Cost Segregation Today
If you’re a residential rental or short-term rental owner, cost segregation can be a game-changer for your tax strategy. By accelerating depreciation deductions, you can increase cash flow, reduce tax liability, and reinvest in growing your portfolio. Consulting with a cost segregation specialist can help you determine the potential savings for your property and how to best leverage this powerful tax strategy.
Interested in learning how cost segregation can benefit your rental property? Contact us today at CSSI for a complimentary consultation!