Depreciation is where it starts
When you buy a rental, you do not deduct the purchase price. You depreciate the building over time: 27.5 years for residential property and 39 years for commercial. The land is never depreciable, so the first job is splitting the purchase price between land and building correctly.
That sounds basic. It is also where a lot of returns go wrong:
- Depreciation never started, so years of deductions were skipped
- The whole price was depreciated, land included
- Improvements were expensed, or never added to the basis
- A property was converted from a home to a rental and nobody reset the basis
Every one of those costs money every single year, quietly.
Cost segregation
A building is not one thing. Part of what you bought is flooring, appliances, cabinets, lighting, landscaping, fencing and paving. Those pieces have 5, 7 or 15 year lives instead of 27.5 or 39.
A cost segregation study identifies them, which pulls deductions forward into the early years of ownership. Combined with bonus depreciation, the first year deduction can be large enough to change your whole tax picture.
Two things to know:
- Timing matters. The property has to be placed in service in the year you want the deduction. If you are buying in the fourth quarter, talk to us before closing, not after.
- It is not always worth it. The study has a cost, the deductions can be recaptured when you sell, and a large loss only helps if you can actually use it. We run the numbers first.
Missed depreciation can be caught up
If you have owned a rental for years without claiming depreciation, or without a cost segregation study, the deductions are not lost.
The IRS lets you file an accounting method change on Form 3115 and take the entire missed amount as a single catch up adjustment in the current year. No amending old returns. It is one of the most valuable filings in real estate tax, and one of the least known.
Short term rentals and your W-2 income
Rental losses are normally passive. They can only offset passive income, not your salary. That is why most high earners with rentals see their losses pile up unused.
Short term rentals can be different. If the average guest stay is seven days or less, the property is not treated as a rental activity under the passive loss rules. If you also materially participate, for example by spending more than 100 hours on it and more time than anyone else, the losses can offset W-2 and business income.
This is powerful and it is audited. It only works with:
- A property that genuinely meets the average stay test
- A contemporaneous log of your hours, kept during the year
- Depreciation, often a cost segregation study, set up correctly
Our STR Tax Strategy Package, a $2,500 add-on to your tax return engagement, covers the eligibility review, the documentation setup and carrying it through the return.
Real estate professional status and other planning
Real estate professional status (REPS)
If you or your spouse spend more than 750 hours a year in real property businesses, and more than half your working time, rental losses can become non passive for long term rentals too. It is a high bar and the IRS checks it, so the time records matter as much as the hours.
The $25,000 allowance
Landlords who actively participate can deduct up to $25,000 of rental losses against other income. It phases out between $100,000 and $150,000 of modified adjusted gross income, which is why many investors think it does not apply to them. Often they are right, and the answer is one of the strategies above.
Buying, selling and 1031 exchanges
Selling triggers depreciation recapture and capital gains. A 1031 exchange can defer both if the timelines are met. Planning the sale before you list is worth far more than cleaning it up after.
These fit into year round tax planning, and broader engagements are scoped after a strategy call.
Rentals across the Carolinas
Many investors around Charlotte own property in both Carolinas. A rental in the other state means a nonresident return there, and the income is also reported on your home state return with a credit. We handle both. See NC and SC dual-state taxes.
Short term rentals also carry sales and occupancy tax obligations that depend on the county and on what the booking platform already collects for you. We check that for each property.
Questions we get asked
What is a cost segregation study?
An engineering based study that breaks a building into components with shorter depreciation lives, such as flooring, fixtures and land improvements. It moves deductions into the early years of ownership instead of spreading them over 27.5 or 39 years.
Can I still claim depreciation I missed in past years?
Yes. An accounting method change on Form 3115 lets you claim the full missed amount as a catch up adjustment in the current year, without amending prior returns.
Can rental losses offset my W-2 income?
Usually not, because rental losses are passive. The main exceptions are short term rentals with an average stay of seven days or less where you materially participate, and real estate professional status. Both need records kept during the year.
How much does the STR Tax Strategy Package cost?
$2,500, added to your tax return engagement. It covers the eligibility and participation review, documentation guidance, the strategy meeting and carrying the treatment through your return. A third party cost segregation study is billed separately by the study provider.