Depreciation considerations of short-term rental property


In recent years, demand for short-term rentals advertised on sites like Airbnb and VRBO has skyrocketed. Investors are increasingly being drawn to these properties to generate passive income and are aggressively entering the market. Entries grew by 9.4% in 2021, and they are expected to grow by 20.5% in 2022. However, investors and their CPAs need to be aware of the depreciation rules that apply to the short-term rental market.

The good news is that the write-off will provide significant tax savings for many of these investors. Full cost segregation or other strategies to maximize these deductions can increase these savings even further. However, taxpayers must first check whether they can take advantage of these deductions. Many short-term rental properties are owned by non-real estate professionals as passive investments. These owners need to consider passive investment restrictions as they could reduce the amount of deductions they can take advantage of. However, if the owner is not subject to the passive restrictions or if he generates sufficient income, depreciation deductions can help to reduce the associated tax burden.

When calculating depreciation, the first thing to do is to determine the amount of land attached to the property. When a homeowner purchases a rental property for $500,000, the entire amount is non-depreciable—the IRS requires the taxpayer to separate the non-depreciable land from the depreciable building. The easiest way to do this is to look at the tax assessment of the property and use the ratio of land to building. For example, if the appraisal for a property lists the land as $100,000 and the building as $300,000, the IRS would consider the property to be 25% land. This means that if the purchase price is $500,000, the buyer can write off $375,000 of the purchase, with the other $125,000 being attributed to the land. If a buyer finds the valuation ratio inaccurate, the property can be revalued to determine its fair market value. However, this can often be expensive.

Many investors think they don’t have land because they own a rental in a condominium building. But they are usually wrong since the condo owner also owns an interest in the common elements, including lots, lobbies, elevators, etc. The IRS addresses this particular issue in Publication 527, “Residential Rental Property.” For example, in Chapter 4, the IRS explains that while condo owners may pay dues to the homeowners’ association, the assets are owned by the condo owners.

The second issue short-term rental owners need to consider is getting the depreciation period right. Most homeowners expect their rent to be depreciated as a residential rental property over 27.5 years. However, this is often not the case. According to the IRS, 27.5-year assets are reserved for assets where 80% or more of income is generated from residential units. In order to achieve the lifespan of 27.5 years, these housing units cannot be used “temporarily”. The IRS traditionally defines “temporary” as stays of 30 days or less. This means that most short-term rentals are considered non-residential and have a depreciable life of 39 years, similar to a hotel.

All is not bleak when a property has to be written off as a 39-year-old asset. The Tax Cuts and Jobs Act 2017 created a new class of property – Qualified Improvement Property. QIP consists of non-structural improvements to the interior finishes of non-residential properties after the property has become operational. If a short-term lease qualifies as non-residential, that means all interior renovations can qualify as QIP, which is good news – QIP is currently eligible for 100% bonus depreciation and can be depreciated in the year the assets come into use will.

Additionally, short-term rental owners may be looking for other ways to maximize depreciation, such as: B. Studies on cost segregation. These studies can help an owner maximize depreciation deductions and balance the income generated from the property. In the end, the owner maximizes cash flow that can be used to pay down debt or acquire additional properties.

While the short-term rental market is red hot, investors should understand the tax implications of getting into it. Depreciation is just one of the many aspects to consider when building an investment portfolio.


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