What happens to the depreciation deductions when I sell?

Depreciation recapture applies. Personal property components are recaptured at ordinary income rates under IRC §1245, and real property components are taxed at a maximum 25% rate as unrecaptured §1250 gain. A 1031 exchange can defer all of this.

What is the difference between bonus depreciation and Section 179?

Bonus depreciation under IRC §168(k) applies automatically, has no income limitation, and can create a loss. Section 179 is elective, cannot reduce income below zero, and has a deduction cap. For real estate investors offsetting ordinary income, bonus depreciation is usually the right tool.

Bonus Depreciation 2026 Rental Property Tax Savings

Q: How many hours do I need to log to hit material participation for the STR loophole?

The most commonly used test is 100 hours in the activity during the year, and more than any other individual including hired managers or cleaners. A second test allows 500+ hours regardless of comparison. Keep a contemporaneous log, not a year-end reconstruction.

Q: Can I use bonus depreciation if I finance the property?

Yes. Bonus depreciation is based on the property's full cost basis, not the cash you put in. A $500,000 purchase financed with $100,000 down still gets depreciated on the full $500,000 minus land value.

I was sitting at the kitchen table in our Arizona house, running numbers on a short-term rental acquisition while Dylan did her math homework next to me, and I remember thinking: if I close on this in February 2025, I can wipe out a significant chunk of our taxable income in year one. Not over five years. Not slowly. Year one.

That is what 100% bonus depreciation actually means for rental investors right now, and most people either do not know it exists, or they think it already went away.

TL;DR

Under the One Big Beautiful Bill Act (signed July 2025), 100% first-year bonus depreciation is now permanent for qualified property with a recovery period of 20 years or less, acquired and placed in service after January 19, 2025. Pair a cost segregation study with a qualifying short-term rental and you can turn a property purchase into a six-figure paper loss that offsets ordinary income in the same year.

Written by Jennifer Beadles, a real estate investor who lives in Arizona with her husband and two kids and manages a rental portfolio remotely while traveling. She writes from hands-on experience underwriting and operating real deals, not theory.

What Is Bonus Depreciation and How Does It Work for Rental Properties in 2026?

Bonus depreciation is a tax provision that lets you deduct the full cost of certain assets in the year you place them in service, instead of spreading the deduction out over the asset's recovery period. Under current law, that rate is 100%, and it applies to MACRS property with a recovery period of 20 years or less.

Here is why that matters for real estate: residential rental buildings themselves have a 27.5-year life, which does not qualify. But a cost segregation study (a formal engineering analysis) reclassifies portions of a building into 5-year, 7-year, and 15-year components. Appliances, flooring, cabinetry, landscaping, certain land improvements, and more fall into those buckets. Those components absolutely qualify for bonus depreciation. A typical cost segregation study on a residential property reclassifies somewhere between 25% and 35% of the building's cost basis into shorter-lived property.

The short version: buy the property, get a cost seg done, and deduct a large chunk of the building's value in year one.

What Changed: The One Big Beautiful Bill Act Made 100% Bonus Depreciation Permanent

Here is where a lot of investors are operating on outdated information. The Tax Cuts and Jobs Act of 2017 had set bonus depreciation on a declining schedule, and many CPAs and online resources were (correctly, at the time) warning that the percentage would step down. That old schedule no longer applies to new purchases.

The One Big Beautiful Bill Act, signed into law in July 2025, permanently restored 100% bonus depreciation for qualified property acquired and placed in service after January 19, 2025. There is no sunset. There is no phase-down for a property you buy today.

The only time a reduced percentage still matters is for property that was acquired on or before January 19, 2025. If you are buying something now, or planning to buy in 2026, you are working with 100%. Full stop.

I know some people will read that and assume there is a catch somewhere. There is not. What there IS, though, is a second question most investors miss: even if you generate a big paper loss, can you actually use it against your ordinary income? The answer depends on which strategy you are using to activate the loss.

Two Ways to Make the Loss Usable: REPS vs. the STR Loophole

Generating a loss is easy. Using it is the part that requires a plan.

Under the passive activity rules of IRC §469, losses from rental real estate are generally passive. Passive losses can only offset passive income, not your ordinary or business income, unless one of two exceptions applies.

Option 1: Real Estate Professional Status (REPS)

Under IRC §469(c)(7), one spouse must spend more than 750 hours per year in real property trades or businesses in which they materially participate, AND that time must represent more than half of their total working hours. If they qualify, rental losses become non-passive and can offset anything.

REPS is powerful but demanding. For a full breakdown of how to track hours and document REPS correctly, this post on REPS and year-end tax moves goes deep on the mechanics.

Option 2: The STR Loophole (No REPS Required)

This is the one I use, and honestly, for investors who are not full-time in real estate, it is usually the more accessible path.

Under Treas. Reg. §1.469-1T(e)(3)(ii)(A), a rental property whose average guest stay is 7 days or less is not classified as a rental activity under IRC §469 at all. That means the passive activity rules do not apply to it in the first place. The income and losses flow through as ordinary business income or loss.

The catch: you need to materially participate in the property. The most common test is the 100-hour test under Treas. Reg. §1.469-5T: you spend at least 100 hours in the activity during the year, and no one else spends more time than you do. No 750-hour requirement. No "more than half of your working hours" hurdle.

If you run a short-term rental (Airbnb, Vrbo, etc.) with an average stay under 7 days and you stay past the 100-hour threshold, the losses from that property are non-passive and offset your ordinary income dollar for dollar. For a thorough walkthrough of this specific strategy, I covered it in detail in the STR loophole explained.

The Math: What Does This Actually Look Like in Practice?

Let me walk through a real scenario so this is concrete.

Assumptions:

Purchase price: $500,000 (short-term rental property)
Cost segregation study reclassifies 30% of the building's cost basis into 5/7/15-year property
Building value (excluding land): $420,000
Reclassified amount: $420,000 × 30% = $126,000
Bonus depreciation rate: 100%
Your ordinary income: $250,000
Federal marginal tax rate: 35%
You materially participate in the STR (100+ hours, more than anyone else)
Average guest stay: under 7 days

Year-One Calculation:

First-year bonus depreciation deduction: $126,000
Remaining building depreciation (27.5-year schedule, straight line): ($420,000 - $126,000) / 27.5 = approximately $10,691
Total depreciation deduction in year one: approximately $136,691
Add operating expenses (mortgage interest, insurance, management, supplies): assume $24,000
Total paper loss from this property: approximately $160,691

Tax Impact:

At a 35% marginal rate, a $160,691 deduction reduces your federal tax bill by approximately $56,242 in year one alone.

To put that in perspective: a $56,000 tax reduction on a $500,000 purchase is an 11.2% return on invested capital from the tax benefit alone, before you count a single dollar of rental income or appreciation. Is that typical every year? No. Year two depreciation resets to the 27.5-year straight-line schedule for the remaining basis, so the deduction drops significantly. But year one is real, and it is large.

That is why I think of cost segregation plus bonus depreciation as a front-loaded strategy. You pull the benefit forward. That is not a bad thing when you are sitting on $250,000 in ordinary income and a tax bill to match.

Key Takeaways

100% bonus depreciation is permanent for property acquired after January 19, 2025. No phase-down. No sunset.
Only property with a MACRS recovery period of 20 years or less qualifies. Cost segregation unlocks this for residential rentals.
The loss is only usable if it is non-passive. The STR loophole (average stay under 7 days + material participation) and REPS are the two primary paths.
Year one is disproportionately powerful. Plan your acquisition timing accordingly.
Cost segregation studies have a cost (typically $3,000 to $10,000 depending on property size). For a $500,000+ property, the math almost always works. For a $150,000 property, run the numbers first.

Bonus Depreciation vs. Section 179: What Is the Difference?

People often conflate these two, so a quick definition block:

Bonus depreciation (IRC §168(k)): Applies automatically to qualifying property. No income limitation. Can create or increase a loss. Works across multiple properties.

Section 179 (IRC §179): An elective deduction. Currently has a $2.5 million deduction cap (phasing out above $4 million in total purchases). Cannot create a loss below zero. Generally used for business equipment.

For real estate investors generating large paper losses to offset ordinary income, bonus depreciation is the right tool. Section 179 is more relevant to business owners buying equipment. They can work together in some situations, but do not mix them up in your planning.

For a broader look at deductions investors commonly miss, 8 missed tax opportunities for real estate investors covers several that pair well with what we have laid out here.

Practical Steps to Actually Use This Strategy

Identify a qualifying STR property. The average guest stay must be 7 days or less. Look at comparable listings in the market before you buy.
Order a cost segregation study after closing. Work with an engineering firm or a CPA who specializes in cost seg. Get it done before you file your return for that year.
Document your hours from day one. Track every hour you spend on the property: guest communication, cleaning coordination, maintenance calls, listing management. You need 100+ hours and more than anyone else on your team.
File correctly. The STR loophole requires a specific reporting position on your return. A generalist CPA who does not work with real estate investors regularly may not know how to position it. This is worth finding the right professional.
Understand the depreciation recapture. When you eventually sell, the IRS recaptures bonus depreciation at a 25% rate (unrecaptured §1250 gain) on the depreciation attributable to real property components, and at ordinary income rates for §1245 personal property. A 1031 exchange can defer this. Plan for it.

There is a lot of overlap between this strategy and a general tax-planning framework. If you want to see how these moves fit into a broader picture, tax strategies real estate investors wish they learned earlier is worth reading alongside this one.

Frequently Asked Questions

Does 100% bonus depreciation apply to regular long-term rentals, or only STRs? Bonus depreciation applies to any qualifying property you own, regardless of rental type. The issue is not whether you get the depreciation deduction; it is whether you can USE the resulting loss against ordinary income. For a long-term rental, you generally need REPS to make the loss non-passive. For an STR with average stays under 7 days and material participation, you do not.

What if I buy a property in late 2026, does it still qualify for 100%? Yes. The One Big Beautiful Bill Act made 100% bonus depreciation permanent for property acquired and placed in service after January 19, 2025. There is no expiration date for current purchases.

How many hours do I actually need to log to hit material participation for the STR loophole? The most commonly used test under Treas. Reg. §1.469-5T is 100 hours in the activity during the year, and more than any other individual (including hired managers or cleaners). A second test allows 500+ hours regardless of comparison. Keep a contemporaneous log, not a year-end reconstruction.

Can I use bonus depreciation if I finance the property? Yes. Bonus depreciation is based on the property's cost basis, not the amount of cash you put in. If you purchase a $500,000 property with $100,000 down and a $400,000 mortgage, you still depreciate based on the full $500,000 (less the land value). The financing amplifies the tax benefit relative to your out-of-pocket cost.

What happens to the depreciation when I sell? Depreciation recapture applies. The portion attributable to personal property (5/7-year assets from the cost seg) is recaptured at ordinary income rates under §1245. The portion attributable to real property is taxed at a maximum 25% rate as unrecaptured §1250 gain. A 1031 exchange defers all of this until a future taxable sale.

The Bottom Line

Here is what I would actually do if I were you: find a market where short-term rentals perform, buy a property where you can clear 100 hours of involvement without hiring that out entirely, commission a cost segregation study the month you close, and talk to a CPA who has run this play before. The tax code is genuinely this favorable right now. You do not need a special structure or a complicated entity stack. You need a qualifying property, documented hours, and the right professional on your team.

The numbers above are not hypothetical edge cases. They are the math that made Travis and me comfortable saying yes to deals that looked aggressive on paper but made total sense after the tax picture was right.

Sources

This article is for educational purposes only and is not tax, legal, or financial advice. Consult a qualified CPA or tax attorney about your specific situation.

Addicted to ROI is education and community, not financial or tax advice. Talk to a qualified professional before making investment or tax decisions.

Bonus Depreciation 2026 Rental Property Tax Savings Explained