Short-Term Rental Loophole Gets Stronger With Permanent 100% Bonus Depreciation

What changed

The One Big Beautiful Bill Act (OBBBA, P.L. 119-21, signed July 4, 2025) permanently restored 100% first-year bonus depreciation for qualifying property acquired after January 19, 2025. Under interim guidance in IRS Notice 2026-11 (January 14, 2026), investors can rely on that rule for property with a MACRS recovery period of 20 years or less — the five-year personal property and 15-year land improvements that a cost segregation study identifies inside a rental building. Previously the TCJA bonus rate was phasing down: 40% for property placed in service in 2025 and 20% in 2026 under the old schedule for property under binding contract before January 20, 2025. The OBBBA eliminated the phase-down for newly acquired property entirely. 24/7 Wall Street reported on October 30, 2026 that this development directly strengthens the short-term rental tax strategy for investors.

Why it matters to investors

The short-term rental (STR) tax strategy stacks two separate provisions. First, under 26 CFR § 1.469-1T(e)(3)(ii)(A), a rental property where the average guest stay is seven days or less falls outside the definition of a “rental activity” under the passive activity loss (PAL) rules. If you also materially participate in that activity — generally, spending more than 500 hours per year or meeting another test under Treas. Reg. § 1.469-5T — any operating loss from the property is non-passive and can offset W-2 wages, business income, or other active-income sources. Without both conditions, rental losses are passive and can only offset passive income.

Second, a cost segregation study reclassifies personal-property components — appliances, flooring, furniture, certain fixtures — from the 27.5-year residential building into five-year property, and land improvements (parking, landscaping, walkways) into 15-year property. With permanent 100% bonus depreciation now available under Notice 2026-11, all of those reclassified components may be expensed in the year the property is placed in service.

Concretely: suppose an investor purchases a short-term rental for $600,000, with $100,000 allocated to land and $500,000 to depreciable improvements. A cost segregation study identifies $180,000 of five-year personal property and $60,000 of 15-year land improvements, leaving $260,000 as the 27.5-year building shell. The $240,000 of reclassified components qualifies for 100% first-year bonus depreciation. For an investor in the 37% federal bracket who materially participates and averages fewer than seven days per guest stay, that deduction offsets $240,000 of active income — roughly $88,800 in immediate federal tax deferral. The strategy existed before, but the phase-down to sub-100% rates had reduced its magnitude; permanent 100% bonus depreciation fully restores it. Sources: 24/7 Wall Street, October 30, 2026; IRS Notice 2026-11, January 14, 2026 (summarized by CBIZ); IRS Publication 925, Passive Activity and At-Risk Rules.

What to do

Verify your average-stay data before year-end. The seven-day average-stay test is the gateway to non-passive treatment. If your booking records show an average above seven days, the non-passive designation is unavailable regardless of the size of the depreciation deduction.

Document material participation contemporaneously. Short-term rental material participation is a known IRS audit focus area. Keep a contemporaneous log of hours spent on the activity — guest communications, maintenance coordination, listing management, cleaning oversight. Notes assembled after the fact carry less weight on examination.

Commission a cost segregation study before the property is placed in service. Bonus depreciation is claimed in the year of placement in service. Missing the window means losing the accelerated deduction for those components; a retroactive catch-up requires filing Form 3115 in a later year, and the applicable bonus percentage for prior-year components differs from the current 100% rate.

Model the Section 1245 recapture before you sell. Five-year and 15-year components expensed via cost segregation are § 1245 property. Their depreciation is recaptured as ordinary income at sale — at your full marginal rate, not the 25%-capped rate that applies to the building shell. The strategy is a tax-deferral tool; a 1031 exchange or a step-up in basis at death can further defer or eliminate the eventual recapture.

Educational context only — not tax advice. Primary sources: 24/7 Wall Street, October 30, 2026; IRS Notice 2026-11, January 14, 2026; IRS Publication 925. Consult a qualified tax professional before acting.

Frequently asked questions

Does permanent 100% bonus depreciation eliminate the seven-day average-stay requirement?

No. The seven-day average-stay test derives from the passive activity regulations (26 CFR § 1.469-1T(e)(3)(ii)(A)), not the depreciation rules. You must still average seven days or fewer per guest AND materially participate for losses to be non-passive and offset active income. Bonus depreciation only increases the size of the deduction once both thresholds are satisfied.

Will the bonus depreciation I claim on a short-term rental be recaptured at sale?

Yes. Personal-property components reclassified by a cost segregation study and expensed via bonus depreciation are Section 1245 property. On sale, the depreciation claimed is recaptured as ordinary income up to the gain on those components, at your full marginal rate with no 25% cap. The strategy accelerates deductions into year one and defers the tax cost to a future disposition — a 1031 exchange or step-up in basis at death can further defer or permanently eliminate the eventual recapture.

Sources

Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.