Short-term rentals are a topic that stirs up much discussion among tax professionals. For property owners juggling short-term and long-term rentals, understanding how the distinctions impact depreciation can be the difference between compliance and costly errors.
When a taxpayer has a short-term rental property, our first thought might be to use the standard 27.5-year class life typically applied to other rental properties used for lodging. However, the tax code has a specific requirement for residential rentals: they must contain “dwelling units.” And here’s the crucial part: if a property is used on a transient basis, those properties are not considered dwelling units.[1]
So, what exactly does “transient basis” mean?
While the current Code doesn’t define it, the IRS and even tax courts have referenced older regulations and definitions from investment tax credit rules. These sources generally agree that accommodations are used on a transient basis if the rental period is usually less than 30 days.[2] Since short-term rentals typically have stays under 30 days, the property usually doesn’t qualify as residential real property for depreciation. Because it doesn’t meet the dwelling unit definition due to its transient use, the property is classified as nonresidential, which means a class life of 39 years.[3]
Often, taxpayers will change the use of the property from short to long-term, or vice-versa. How do we treat depreciation in these situations?
1. Changing from Residential (Long-Term) to Nonresidential (Short-Term)
If a taxpayer’s property was previously rented long-term (residential) and switches to being used as a short-term rental (nonresidential), you must adjust the depreciation. The regulations require that the property is depreciated as though the longer 39-year class life was used from the date it was placed in service.[4]
This change in depreciation is triggered in the year that more than 20% of the rental income comes from tenants staying less than 30 days on average.[5]
Real Life Example:
- Charles bought a residential rental in June 2020.
- In 2023, he started using it as a short-term rental with stays under 30 days.
- For 2023, Charles needs to recompute depreciation using the 39-year class life.
- The remaining recovery period is calculated by subtracting the depreciation already taken (based on the 27.5-year life) from the total 39 years.
- Since the property was depreciated for part of 2020 and full years 2021 and 2022, the remaining period beginning in 2023 is 36.46 years.
Note: In Lacerte tax software, simply changing the depreciation method to nonresidential will properly recompute depreciation based on the change in use.
2. Changing from Nonresidential (Short-Term) to Residential (Long-Term)
Taxpayers sometimes switch from the short-term rental business to a more straightforward long-term tenant arrangement, often because the short-term hustle is a lot of work.
If a property changes from a nonresidential short-term rental to a residential long-term rental, the taxpayer has a choice. They can either:[6]
- Continue depreciating the property using the original, longer 39-year class life or
- They can recompute depreciation as if the property was placed into service again using the remaining adjusted basis on the first day of the year the use changed, using the shorter 27.5-year class life.
This change is triggered in the year that 80% or more of the rental income comes from tenants staying 30 days or more on average.
Real Life Example:
Fred bought a short-term rental on January 1, 2020, with a $1,000,000 depreciable basis. He has been depreciating the property using the 39-year life. Frustrated with the hassle of short-term renters, on January 1, 2023, he switched to a long-term tenant. His adjusted basis at the start of 2023 was $924,145.
- If Fred continues using the 39-year life, his 2023 depreciation is $25,641.
- If he chooses to switch to the 27.5-year life, his 2023 depreciation is $33,605 (calculated as 1/27.5 of his $924,145 adjusted basis at the start of the year).
For Fred, switching to the shorter life provided a bigger depreciation deduction – about $8,000 more. However, this isn’t always the outcome.
What if Fred waited until 2035 (after 15 years of depreciation on the 39-year schedule) to switch to a long-term tenant? At the start of 2035, his adjusted basis would be $624,417.
- If he sticks with the original 39-year life, his depreciation would continue at $25,641 annually.
- If he changes to the 27.5-year life, his annual depreciation would be $22,706 (1/27.5 of the adjusted basis).
In this case, sticking with the longer life gives a larger deduction.
There’s a helpful rule of thumb for this nonresidential-to-residential change:
If the property has been depreciated using the 39-year life for less than 11.57 years, switching to the shorter 27.5-year life will generally result in a larger annual deduction.
If it has been depreciated for 11.57 years or longer on the 39-year schedule, continuing with the original 39-year life will usually provide a larger deduction.
Reviewing a new client’s return and discovering that depreciation was improperly calculated is common. This issue is not to be confused with adjusting the depreciation for a change in use; incorrect depreciation only occurs when the wrong amount of depreciation was claimed in a prior year.
Change in Use: Does it require a Form 3115?
A change in use of the property resulting in a different class life does not result in the use of Form 3115 because the depreciation method changes in the year of change in use. So, it does not require the taxpayer to recompute depreciation in prior years.
However, preparers unfamiliar with these rules may realize a change in use occurred in a prior year, which would require using Form 3115 if the error spans over two or more taxable years. Errors in depreciation can be corrected in the year they are discovered using Form 3115. For more information about using Form 3115 to correct depreciation errors, check out our Form 3115 seminar here.
Final Thought
The rules underlying short-term rentals can cause a massive headache and affect tax reporting, depreciation, and strategy. If you’re looking for a comprehensive look at short-term rentals, tricks for depreciation, and other high-end real estate taxation strategies, join us at our Tax Toolbox coming September of 2025. Registration is available here.
[1] IRC §168(e)(2)(A)(ii)(I)
[2] IRS Reg §1.48-1(h)(2)(ii)
[3] IRC §168(e)(2)(B)
[4] IRS Reg §1.168(i)-4(d)(4)
[5] IRC §168(e)(2)(A)(i)
[6] IRS Reg §1.168(i)-4(d)(3)