A vacation home can be more than just a personal getaway; it can also be a smart investment when paired with the right tax strategies. One powerful but often overlooked approach is a cost segregation study. This technique allows vacation home owners—especially those using the property as a short-term rental—to accelerate depreciation deductions by reclassifying building components into shorter recovery periods. By doing so, owners can substantially reduce their taxable income in the earlier years of ownership, boosting cash flow and enabling reinvestment in the property or other ventures.
What Is Cost Segregation for Vacation Homes?
Cost segregation breaks down a vacation home into its component parts to identify assets that depreciate faster than the building’s standard 27.5-year schedule for residential rental properties (short-term rental properties are required to be depreciated over 39 years). Items such as flooring, appliances, cabinetry, landscaping, lighting, and even outdoor amenities like hot tubs, saunas, and outdoor kitchens may qualify for depreciation periods of 5, 7, or 15 years instead of decades. These faster write-offs provide immediate tax relief and improve liquidity for owners, making the vacation home a more financially efficient asset—especially valuable for Airbnb or Vrbo hosts aiming to maximize profitability early in their rental operations.
How the Process Works
The cost segregation study involves several key steps:
- Engaging Specialists: A qualified team, typically consisting of accountants, tax advisors, or engineers, will review the property, inspect the physical site, and analyze construction documents, purchase agreements, and renovation invoices to identify assets for accelerated depreciation.
- Asset Classification: The property’s components are categorized under IRS guidelines—personal property assets are depreciated over 5 or 7 years, land improvements over 15 years, and the building itself over 27.5 or 39 years.
- Tax Adjustments: Once assets are reclassified, tax filings are adjusted accordingly. Often, a form called IRS Form 3115 is used to capture depreciation missed in prior years without filing amended returns. So, even if the rental property was placed in service in a prior year, you capture all the benefits of accelerated depreciation missed in the tax filing.
- Applying Bonus Depreciation: Now that bonus depreciation has been made permanent for assets placed in service after January 19, 2025, the tax benefits of a cost segregation will be more valuable than ever.
Financial Benefits of Cost Segregation for Vacation Homes
By accelerating depreciation, vacation home owners can enjoy significantly larger tax deductions during the initial years of ownership. For example, one of our recent studies of a $1.12 million vacation rental found that reclassifying assets into shorter depreciation categories generated a first-year tax saving of nearly $60,000—money that can be reinvested in marketing, upgrades, or additional property acquisitions. This early boost in cash flow not only improves return on investment but also strengthens the financial foundation of the vacation rental business.
Who Should Consider This Strategy?
- Vacation home owners who rent their properties on platforms like Airbnb, Vrbo, or Booking.com.
- Properties with significant furnishings, luxury features, or outdoor amenities.
- Investors planning to hold the property long-term to maximize tax benefits and mitigate depreciation recapture risks.
Risks and Important Considerations
- Depreciation recapture may increase taxable gains upon sale, so the strategy is most advantageous for owners with medium- to long-term horizons.
- IRS compliance and documentation are critical to avoid audit risks. Aggressive or poorly documented studies can trigger scrutiny. A properly done cost segregation study is the only way you can substantiate the depreciation of some components of a building using shorter lives.
- The property must be used for rental or business purposes, not exclusively for personal use.
How Archer Lewis Can Help
Navigating the complexities of cost segregation can be daunting, but Archer Lewis offers expert guidance every step of the way. Our specialists conduct site inspections and thorough document reviews to ensure all qualifying assets are accurately identified and classified according to IRS standards. Archer Lewis assists business and vacation home owners with adjusting current and prior tax filings, including handling IRS Form 3115 submissions for retroactive benefits.
Beyond technical expertise, Archer Lewis provides tailored consultations to align the cost segregation study with the owner’s broader tax planning, financial goals, and estate planning. They prepare clients for potential audits by ensuring robust documentation and defensible methodologies. Additionally, Archer Lewis helps manage accounting logistics so owners can focus on enhancing their vacation rental business while confidently leveraging the full tax-saving potential of cost segregation.
In summary, vacation home owners who use their properties as rental investments can greatly benefit from a cost segregation study. By accelerating depreciation on select property components, owners increase early-year cash flow and reduce taxable income substantially. With seasoned guidance from Archer Lewis, the process becomes streamlined, compliant, and fully optimized to support long-term financial success in the vacation rental market. This strategy transforms a vacation home from just a leisure asset into a potent catalyst for growing wealth and strengthening overall investment returns.
