How Cost Segregation on a Short-Term Rental Can Lower Taxes for High Earners

If you earn a high W-2 or business income and own (or are thinking about buying) a short-term rental in St. George, Hurricane, Springdale, or anywhere else in Washington County, there’s a strategy you should know about. Pairing a cost segregation study with a short-term rental that you actively manage can create a large first-year deduction that offsets your other income, not just your rental income.

It’s often called the “short-term rental loophole.” It isn’t a loophole so much as a few tax rules that fit together. Here’s how short-term rental cost segregation works.

Why most rental losses don’t help high earners

Rental real estate is normally a passive activity, and passive losses can only offset passive income (IRS Publication 925 covers the details). There’s a $25,000 allowance for people who actively participate in their rentals, but it phases out between $100,000 and $150,000 of income. Above that, your rental losses just carry forward.

So for a doctor, engineer, or business owner making $300,000 a year, a big depreciation deduction on a long-term rental usually does nothing for this year’s tax bill.

Why short-term rentals are different

If the average guest stay is 7 days or less, the IRS doesn’t treat the property as a “rental activity.” Most Airbnb and VRBO properties around Zion and St. George fit.

That means if you materially participate, a loss from the property can offset your wages and business income. You don’t need real estate professional status, which is why this works for people with full-time jobs.

The most common ways to materially participate:

• Spend at least 100 hours on the property during the year, and more than anyone else (including your cleaner or co-host), or
• Spend more than 500 hours on it during the year.

Your spouse’s hours count. A property manager’s hours don’t. Either way, keep a log of your time as you go.

Where cost segregation comes in

Normally a short-term rental building is depreciated over 39 years, which means a small deduction each year. A cost segregation study breaks the property into parts that can be written off much faster: furniture, appliances, flooring, and fixtures (5 and 7 years), and landscaping, driveways, fencing, and patios (15 years).

Under the 2025 tax law changes, those shorter-life parts qualify for 100% bonus depreciation, so you can deduct their full cost in the first year.

The IRS reviews these studies closely and explains what it looks for in its Cost Segregation Audit Techniques Guide, so an engineering-based study from a qualified provider is worth the cost.

A simplified example

Say a married couple with $650,000 of W-2 income buys a short-term rental near Hurricane for $600,000. After setting aside about $120,000 for land, a cost segregation study reclassifies about $120,000 of the building into 5-, 7-, and 15-year property. With bonus depreciation, that’s all deductible in year one.

If the couple materially participates and the property shows a loss of about $110,000, that loss offsets their wages. At a 35% federal bracket, that’s roughly $38,000 in federal tax savings in the first year, plus Utah savings.

Every property is different, and the actual results depend on the property and how it’s furnished.

What to watch out for

• Keep the average stay at 7 days or less. A few long winter bookings can push you over.
• Track your hours. If the IRS asks, a log you kept during the year is your best proof.
• Timing matters. The property has to be ready and available for rent during the year you want the deduction.
• Depreciation is recaptured when you sell. This works best if you plan to hold the property for several years.

There are a few other rules that can limit the deduction, and we’ll check them before you commit to a study.

Is this a fit for you?

It usually makes sense if your income is high, you’re willing to manage the property yourself, your guests stay a week or less, and you plan to hold the property for a while.

Talk to a local tax professional before you buy

Short-term rentals are a big part of the Washington County economy, and this is one of the most effective legal tax strategies available to high-income owners. The details matter, though, and getting them wrong can cost you the deduction.

RK Accounting and Tax Services is based in La Verkin and works with short-term rental owners throughout St. George, Hurricane, and Washington County. Short-term rental cost segregation works best as part of a year-round tax planning strategy, with the material participation and depreciation reporting handled correctly when we prepare your return. If you’re considering a short-term rental or already own one, contact us to see whether cost segregation makes sense for you.

Written by Robert Kuehler, EA, MAcc, owner of RK Accounting and Tax Services.

This article is for general information only and isn’t tax advice for your specific situation.