Short Term Rental Depreciation for Physicians: Tax Planning for the Year One Bonus Depreciation Loss
Your lake house rented 140 nights last year and cleared $9,000 after the mortgage, cleaning crew, and the hot tub repair. Then your return shows a $150,000 loss from the same property, and your tax bill can drop by tens of thousands of dollars.
That gap is depreciation, and specifically bonus depreciation. It is the engine behind the short term rental tax planning you keep hearing about at conferences. It is also the part most people describe wrong, in ways that cost real money or invite an audit.
This post walks through how short term rental depreciation actually works under current law: what you can depreciate, over how many years, what qualifies for the 100% first year deduction, when the loss can offset your clinical income, and what the IRS takes back when you sell.
In This Blog
What is depreciation on a short term rental?
Depreciation is the annual deduction for the wear on a building and its contents. You did not spend the money this year, but the tax code lets you deduct a slice of the purchase price every year the property is in service.
Start with your depreciable basis:
• Purchase price, plus closing costs and improvements
• Minus the value of the land
Land never depreciates. The IRS puts it plainly in Publication 946: you cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up. So the first job is splitting the price between land and building.
If you are not certain of the fair market values, IRS Publication 527 allows you to divide the cost based on the assessed values for real estate tax purposes. Your county assessor's land to building ratio is the usual starting point.
On an $800,000 purchase with 20% allocated to land, your depreciable basis is $640,000. Everything below runs off that number.
Is a short term rental depreciated over 27.5 or 39 years?
For most true short term rentals, the answer is 39 years, but reasonable professionals will disagree.
The 27.5 year schedule belongs to “residential rental property.” Under IRC section 168(e)(2)(A), a building qualifies only if 80% or more of its gross rental income comes from dwelling units. A dwelling unit does not include a unit in a hotel, motel, or other establishment where more than half of the units are used on a transient basis. A property rented to guests a few nights at a time is being used the way a hotel is used, so it generally falls into nonresidential real property at 39 years. However, some practitioners will take the position that the property would only be depreciated over 39 years if hotel or motel type services are provided in connection with the rental, such as daily maid services or meals.
What counts as transient? Section 168 does not put a number on it. Many practitioners borrow the investment credit regulation, Treas. Reg. 1.48-1(h)(2)(ii), which treats accommodations as used on a transient basis if the rental period is normally less than 30 days. It is a benchmark by analogy, not a depreciation rule, and your tax team should confirm how it applies to your rental pattern.
Here is what the difference looks like on a $640,000 building basis:
• 27.5 years: about $23,273 per year
• 39 years: about $16,410 per year
That is a real gap, but it matters less than you might think. Once bonus depreciation is in play, the building is the slow lane either way. The year one loss comes from the components, not the structure.
How does bonus depreciation work on a short term rental?
Bonus depreciation lets you deduct the full cost of qualifying property in the year you place it in service instead of spreading it over its recovery period.
Under current law, the allowance is 100% of the adjusted basis of qualified property under IRC section 168(k). The One Big Beautiful Bill Act (P.L. 119-21) restored that 100% rate for qualified property acquired and placed in service after January 19, 2025, and IRC section 168(k) no longer contains a phase down schedule. The old paragraph that stepped the rate down each year, section 168(k)(6), was repealed.
Acquisition date matters. Property acquired before January 20, 2025 stays on the older schedule: 60% if placed in service in 2024 and 40% if placed in service in 2025, per the Form 4562 instructions.
Bonus depreciation is also the default, not a mandate. You can elect out for any class of property by attaching a statement to your timely filed return, and once made, the election cannot be revoked without IRS consent.
Why would anyone turn down a deduction? To manage the excess business loss cap covered below. A physician whose year one loss would exceed the $512,000 joint cap for 2026 has a choice: take the full bonus deduction and carry the excess forward as a net operating loss, or elect out for a class of assets and spread that depreciation over its normal schedule.
Neither path wastes the deduction; they time it differently. That is a decision for your tax team, made before the return is filed.
Now the part that trips up nearly every blog post on this topic. Qualified property for bonus depreciation is MACRS property with a recovery period of 20 years or less. The building itself is 27.5 year or 39 year property. It never qualifies. You cannot bonus depreciate the house.
What you can generally bonus depreciate is the shorter lived property a study identifies: furniture, appliances, and carpet (typically 5 year property) and land improvements such as the driveway, landscaping, and fencing (typically 15 year property). Structural components stay with the building. Getting the short lived items out of the 39 year bucket is the job of cost segregation.
One more tool sits next to bonus depreciation. Since the tax code lifted the old lodging exclusion, section 179 expensing can also apply to furniture and equipment in a rental. For the 2026 tax year the section 179 limit is $2,560,000, phasing out once purchases exceed $4,090,000 (Rev. Proc. 2025-32). Section 179 carries its own business income limits, so whether it fits better than bonus on a given asset is a judgment call for your tax team, not a rule.
Why does cost segregation matter for short term rental depreciation?
Cost segregation is the study that separates a single purchase price into its parts. Without it, your $640,000 basis is one 39 year asset. With it, the study identifies section 1245 property (personal property and land improvements) and assigns it to shorter MACRS classes, typically 5 year, 7 year, and 15 year property under the IRS recovery period tables. The exact class for each component comes from the study.
Those components have recovery periods under 20 years, so they qualify for 100% bonus depreciation.
The IRS describes the effect itself in its Cost Segregation Audit Technique Guide: a faster depreciation write off can be obtained by allocating costs to section 1245 property. The same guide also notes there are currently no standards regarding the preparation of these studies and that they vary widely in methodology, documentation, depth, and the expertise of the preparer.
Read that as a warning and a reassurance. The IRS accepts cost segregation as a method and scrutinizes the quality of the study. Its Audit Technique Guide lists 13 principal elements of a quality study, starting with the requirement that it be accurate and well documented on how assets were classified, why, and what they cost. The guide also notes that preparing one requires knowledge of both the construction process and the tax law on property classification.
You will see vendors quote a typical percentage that gets reclassified. There is no official figure for that. The share depends on the property, how it is furnished, and what the study finds. Treat any percentage in an example, including ours below, as an assumption for that example, not a rule of thumb.
If you want the fuller picture on studies, including when a professional study is worth the fee, our guide to cost segregation for physicians covers it.
When can a physician actually take the deduction?
Depreciation starts when the property is placed in service, and the IRS defines that as the point when it is ready and available for a specific use in the rental activity. Not the closing date. Not the day you bought the furniture. The day the listing could go live and take a booking.
A December closing with a January listing is a next year deduction. If you want the loss on this year's return, the property has to be furnished, permitted, and available to rent before December 31.
The first year math runs on conventions.
• The building uses the mid month convention under section 168(d)(2). Whatever day in the month you place it in service, the code treats it as the mid-point of that month. An October placed in service date gives you two and a half months of building depreciation in year one.
• The short lived components normally use the half year convention under section 168(d)(1), but if more than 40% of the aggregate basis of your MACRS personal property for the year is placed in service in the last three months, the mid-quarter convention applies to all of it (section 168(d)(3)).
With 100% bonus, the convention question mostly affects whatever you did not bonus-depreciate. A December placed in service date still captures the full 100% on qualifying components. The building is what gets prorated.
How does the depreciation loss offset physician W-2 or 1099 income?
Depreciation creates the loss. A different section of the code, section 469, decides whether you can use it against the income you earn in the hospital. W-2 or 1099, the analysis of the rental loss is the same.
Rental losses are normally passive, and passive losses can only offset passive income. Most physicians do not have real estate professional status, so a long term rental's paper loss usually just sits there, suspended.
Short term rentals get out of that box through the regulations. This is the mechanism behind the short term rental tax loophole for physicians, and our full guide covers the whole picture.
Under Treas. Reg. 1.469-1T(e)(3)(ii), an activity is not treated as a rental activity if the average period of customer use is seven days or less. There is a second path: average customer use of 30 days or less combined with significant personal services.
Clearing the seven day test does not by itself make the loss usable. It only removes the “rental activity” label. The loss is nonpassive only if you also materially participate. Among the tests in Treas. Reg. 1.469-5T(a), the three that short term rental owners rely on are:
• More than 500 hours in the activity during the year
• Your participation constitutes substantially all of the participation by anyone
• More than 100 hours, and not less than the participation of any other individual
That last test is the one most working physicians use. It means you must out work your cleaner, your co-host, and your property manager, and you need a contemporaneous log to prove it. Our post on the 100 hour material participation test explains the rules in detail.
Even a nonpassive loss is capped in the year it arises by the excess business loss limitation in section 461(l). The One Big Beautiful Bill Act struck the provision's sunset, so plan on it staying.
For the 2026 tax year the threshold is $256,000, or $512,000 for a joint return, per Rev. Proc. 2025-32. That is lower than the 2025 figure of $313,000 and $626,000, because the law reset the inflation base year. Any loss above the cap is not lost; it carries forward as a net operating loss.
Two related traps deserve their own posts: personal use of the property, which we cover in the 14 day personal use trap, and whether you should be pursuing real estate professional status instead. Those posts are currently being drafted.
Dr. Rivera's year one numbers
This hypothetical is for illustration, uses the 2026 tax year, and assumes married filing jointly. Your results will differ.
• W-2 wages: $400,000
• Purchase price: $800,000
• Placed in service: October 1, 2026
• Average customer use: four nights
• Participation: 130 hours, more than anyone else
• Land allocation (20%): $160,000
• Depreciable basis: $640,000
• Cost-segregated short lived property (25% example assumption): $160,000
• Remaining 39 year building basis: $480,000
• Bonus depreciation: $160,000
• Building depreciation: about $2,564
• Total year one depreciation: about $162,600
• Net rental income before depreciation: $9,000
• Year one nonpassive tax loss: about $153,600
What is that loss worth? For 2026, joint filers pay 24% on taxable income between $211,400 and $403,550, and 32% only above that (Rev. Proc. 2025-32).
Dr. Rivera's taxable income (roughly $400,000 of wages less the standard deduction and other items) lands inside the 24% bracket, so the loss could potentially reduce her federal tax by roughly $36,900 (about $153,600 times 24%), before state tax. Your exact figure depends on everything else on the return.
Without a cost segregation study, the whole $640,000 is 39 year property except for the land. Year one depreciation, mid-month from October, is about $3,419. The study is the difference between a $3,400 deduction and a $162,600 deduction.
What happens to the depreciation when you sell?
Bonus depreciation is a timing benefit, not a permanent one. Every dollar you deduct lowers your adjusted basis, and the IRS collects on the difference at sale.
Recapture splits by asset type:
• The reclassified components (furniture and land improvements) are section 1245 property. Under IRC section 1245(a)(1), gain on that property is treated as ordinary income to the extent of the depreciation you took. The $160,000 Dr. Rivera deducted at 24% comes back at ordinary rates when she sells, to the extent the sale price supports it.
• The building's depreciation is unrecaptured section 1250 gain. Under IRC section 1(h)(1)(E), that portion is taxed at a maximum 25% rate.
• If the activity is passive to you in the year of sale, the 3.8% net investment income tax under section 1411 can apply on top.
None of that makes the planning a bad idea. Deferring tax for years and paying it later on a sale you control can be a real benefit, but it depends on your bracket in the year you sell. In Dr. Rivera's example the bonus portion was deducted at 24% and comes back at ordinary rates, so the exit needs to be planned from the start.
Our post on depreciation recapture at sale walks through the math and is currently being drafted. Your tax team should model the sale before you buy.
Do states follow federal bonus depreciation?
Many do not, and this is the most common surprise on a physician's first short term rental return.
State law is not federal law. New Jersey, for example, decoupled from federal bonus depreciation for gross income tax purposes for taxable years beginning on or after January 1, 2004, and requires its own depreciation adjustment. A physician in a decoupled state can show a $153,600 loss on the federal return and a much smaller one on the state return, with a separate state depreciation schedule running for the life of the property.
Rules vary by state and change often. Before you count on the state level benefit, have your tax team confirm your state's position on section 168(k).
Common mistakes physicians make with short term rental depreciation
• Claiming bonus depreciation on the building itself. Only property with a recovery period of 20 years or less qualifies.
• Counting the closing date as the placed in service date.
• Buying furniture in December, placing more than 40% of personal property in service in the fourth quarter, and forgetting the mid-quarter convention on the non bonus remainder.
• Keeping no contemporaneous hour log, then trying to reconstruct 130 hours in April.
• Ignoring the excess business loss cap in a big purchase year.
• Assuming the state return will match the federal one.
• Treating recapture as someone else's problem at a sale five years out.
Get the depreciation right before you buy
The short term rental tax planning that works is the version where the depreciation schedule, the cost segregation study, the hour log, and the exit are mapped out before closing. The version that fails is the one assembled in March from a vendor's blog post.
If you are looking at a short term rental this year, or you already own one and are not sure your depreciation was set up correctly, contact your tax team today and expect prompt, dependable communication, year round.
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This material is intended for educational and informational purposes only and does not constitute tax, legal, accounting, or financial advice. The content is general in nature and may not apply to your specific circumstances. Tax laws and financial regulations are subject to change and interpretation, and the application of these laws can vary based on individual situations. Before making any decisions, you should consult with a qualified tax advisor, legal counsel, or financial professional.
