🇺🇸 Made in America·100% U.S.-Based Team · 24+ Years in Cost Segregation
A hotel, motel or inn is nonresidential real property on a 39-year schedule, because transient lodging is not residential rental property under the tax code. A fully engineered and accounted cost segregation study breaks that one line into the components the engineering supports as 5-, 7- and 15-year property, and with 100 percent bonus depreciation back for property acquired and placed in service after January 19, 2025, those components are deducted in full in year one. The catch is whether you can use the loss. For an owner who works the property, lodging has a door through the passive loss rules that ordinary landlords do not have. For an owner who hands it to a management company and checks in monthly, the loss is passive and waits. Lodging typically lands in the middle to upper part of the 20 to 35 percent of depreciable basis that an engineered study reclassifies.
Nina Dunn bought a 24-room motel on the east side of Spokane, Washington, in January 2026. It was tired but clean, it sat a quarter mile from the interstate exit, and the numbers worked. She paid $3,200,000. Her closing attorney handed her a stack of paper, her CPA handed her a depreciation schedule, and everybody congratulated her.
The schedule showed one line: one building, one recovery period of 39 years, about $63,000 of depreciation for the first year.
Nina has no tax background. She runs a front desk, argues with a linen supplier every other Tuesday and takes the six-in-the-morning call when a water heater quits. But she looked at that line and asked the question most buyers never ask. "Is everything in this building really going to wear out in 39 years? The carpet? The parking lot? The sign out front?"
The carpet will not last 39 years. Neither will the parking lot. Her question is the whole idea behind cost segregation, and the answer changed her first-year tax bill by a six-figure number. Nina is illustrative; the rules and the arithmetic are real.
Under Section 168(e)(2), a building is residential rental property only if 80 percent or more of its gross rental income comes from dwelling units, and a unit in a hotel, motel or similar establishment where more than half the units are used on a transient basis is not a dwelling unit. Transient lodging is therefore nonresidential real property: 39 years, straight line, mid-month convention. One building sits on one schedule; there is no splitting a motel between 27.5 and 39.
That cuts two ways. Thirty-nine years is a long time, so an owner who does nothing gets a small deduction for four decades. But the gap between 39 years and 5 years is wider than the gap between 27.5 and 5, so every dollar the study moves does more work in lodging than in apartments. And a hotel is full of things that are not the building: guest room carpet, decorative lighting, data and telecom cabling, security and low-voltage systems, dedicated circuits for ice machines and laundry, exterior signage, the parking lot, sidewalks, pole lighting, fencing and landscaping.
A cost segregation study is an engineered analysis of what you bought, component by component, assigning each piece to its recovery class under the tax rules. The categories that come up in lodging, where the engineering supports them:
The legal footing is old and settled. Hospital Corporation of America v. Commissioner, 109 T.C. 21 (1997), confirmed that many items inside a building are personal property rather than structural components. Whiteco Industries v. Commissioner, 65 T.C. 664 (1975), gave the six factors for deciding which is which. The IRS Audit Techniques Guide describes six common approaches to a study, prescribes none, and calls the detailed engineering approach from actual cost records the most methodical and accurate.
Illustrative. Land comes out first, and the January mid-month table rate for 39-year property is 2.461 percent.
| Line | No study | With study |
|---|---|---|
| Purchase price | $3,200,000 | $3,200,000 |
| Land (20%) | $640,000 | $640,000 |
| Depreciable basis | $2,560,000 | $2,560,000 |
| Reclassified to 5-, 7- and 15-year (25%) | $0 | $640,000 |
| Bonus depreciation, year 1 (100%) | $0 | $640,000 |
| Building on 39 years | $2,560,000 | $1,920,000 |
| Building depreciation, year 1 (2.461%) | $63,002 | $47,251 |
| Total first-year depreciation | $63,002 | $687,251 |
| Additional first-year deduction | $624,249 | |
| Federal tax value at 37%, before the Section 461(l) cap | $230,972 |
Used property qualifies for 100 percent bonus as long as Nina never used it before and bought it from an unrelated seller. Nina runs the desk herself, so the motel is a trade or business she materially participates in and the loss is nonpassive. She and her husband file jointly, which matters because Section 461(l) caps the business loss a household can use against other income. For tax years beginning in 2026 the cap is $512,000 for joint filers and $256,000 for single filers, adjusted annually. If the motel's net loss for 2026 came to the full $624,249, $512,000 of it offsets the household's other income on the 2026 return, worth $189,440 at 37 percent, and the remaining $112,249 carries forward as a net operating loss. A single owner would have used $256,000 and carried $368,249. The money stayed in her operating account instead of going to the Treasury in April. Without the study, those same $640,000 of components would have come back at about $16,400 a year, and she would have been waiting on the parking lot deduction in 2065.
This is where Amos Okafor comes in. Amos is a dentist in Boone, North Carolina. He earns well and pays a lot of tax. A friend told him to buy real estate and use depreciation to wipe out his dental income. Amos bought a 12-room inn in Blowing Rock in June 2025, ordered a study, and showed up in March with a $480,000 paper loss and a big smile.
His CPA delivered the bad news first. Rental activities are passive under Section 469, passive losses offset only passive income, and a dentist has no passive income. The loss was real and it was stuck, suspended until Amos had passive income or sold.
Then the CPA kept going, because lodging gets a route through Section 469 that ordinary rentals do not.
Under IRC 469(j)(8) and Reg. 1.469-1T(e)(3)(ii)(A), an activity is not a rental activity if the average period of customer use is seven days or less. An inn where guests stay two or three nights is under that line. The same regulation reaches average stays of 30 days or less when significant personal services are provided, and daily housekeeping, a staffed desk and breakfast are the services that point that way. Clearing that test removes the automatic passive label. The inn becomes a trade or business, and the question becomes whether Amos materially participates.
Seven tests, pass one. The two that matter for a hands-on owner: more than 500 hours in the year, or more than 100 hours and not less than any other individual, including the housekeeper and the night clerk. If Amos works the inn, makes the operating decisions and keeps a log, he can get there. If he hires a management company and reads a report once a month, he cannot. The deduction follows the work.
Under Section 469(c)(7), an owner with more than 750 hours and more than half of total working time in real property trades or businesses, who also materially participates, treats rental losses as nonpassive. Spouses cannot combine hours for the 750, though one spouse qualifying on a joint return is enough. A full-time dental practice makes the more-than-half test impossible for Amos. His inn still works through the average stay test. Know which route you are relying on before you spend a dollar.
Section 461(l) caps the business loss a noncorporate taxpayer can use against wages and other nonbusiness income in a single year. For 2025 the cap is $626,000 joint and $313,000 single; for 2026 it is $512,000 and $256,000, adjusted annually, and the One Big Beautiful Bill Act made the cap permanent. Anything above it becomes a net operating loss carryforward. Amos and his wife file jointly, so his $480,000 fits under the 2025 cap; had he been single, $313,000 would have been usable in 2025 and $167,000 would have carried forward. Nina's larger 2026 loss ran into the cap, as the table above shows, and that conversation belongs before the study is ordered. Our article on the 2026 loss cap has the detail.
The acquisition date is generally when you signed a written binding contract. A contract signed on or before January 19, 2025 can hold the property in the old phase-down percentages even if closing came later. The placed-in-service date is when the property is ready and available for its intended use, which for a hotel is the day you can take guests. Closing day has nothing to do with it.
The year-end version of this is expensive. If you buy a motel in October and renovate it, the placed-in-service date controls the tax year. Doors open December 28, the components in service get bonus this year. Doors open January 3, the deduction moves a full return later. A one-week construction delay can slide a six-figure deduction into next year.
Gordon and Dee Hargrove have owned a 40-room roadside hotel outside Zanesville, Ohio, for eleven years. In 2025 they spent $1,100,000 on a full guest room renovation: flooring, lighting, data cabling, fixtures and furniture. Their bookkeeper put the whole $1,100,000 on the books as one building improvement.
That was two mistakes. First, a large share of those costs belongs in 5- and 7-year classes with 100 percent bonus. Second, the interior work that is part of the building is qualified improvement property: an interior improvement to a nonresidential building made by the taxpayer after the building was placed in service, excluding enlargements, elevators and escalators, and structural framework. QIP is its own class, 15-year straight line, and bonus-eligible. Putting all of it on 39 years deferred deductions they were entitled to take immediately.
There is a third tool pointing the other way. When you tear out and replace part of a building, you can write off the remaining basis of the piece you removed under Reg. 1.168(i)-8, a partial asset disposition. Gordon and Dee scrapped eleven-year-old carpet and fixtures that still had book value on their schedule, and nobody wrote it off. The election is made on a timely filed return for the year of the replacement, and you need a component schedule to know what the retired pieces were worth. Renovation in lodging may push the reclassified share above the usual range.
If you have owned the hotel for years and never did a study, the look-back path applies. Cost Seg America prepares the Section 481(a) computation and, for a separate fee, the Form 3115 itself. Your CPA files it with the current return. No amended returns. The catch-up lands in the year of change at the bonus rate that applied when the property was placed in service.
Gain tied to the 5- and 7-year components is Section 1245 recapture, taxed as ordinary income up to the depreciation taken. Gain tied to the building is Section 1250, with unrecaptured 1250 gain capped at 25 percent federal. Fifteen-year land improvements are 1250 property with ordinary recapture on the excess over straight-line. That sounds like a penalty. Three things make it something else. You had the money for years and it worked for you. A 1031 exchange can defer the recapture, subject to the replacement property having enough 1245 property of its own, and a step-up at death erases it for heirs. And if you never took the depreciation, the code treats you as if you had, under the allowed-or-allowable rule: skipping the study forfeits the benefit and leaves the recapture in place. Our article on what happens to recapture when you sell walks the numbers.
A fully engineered and accounted cost segregation study prices every component under the first two approaches in the IRS Audit Techniques Guide, Approach 1 from actual cost records and Approach 2 from engineered estimates reconciled to the purchase price. On a property Nina's size, an in-house analyst does a proper inspection; on a smaller inn it is a live video walkthrough or a guided photo and video checklist the owner follows, with the team reviewing every frame. The deliverable is a component schedule your CPA can import and the engineering support behind it, signed by credentialed professionals and engineered in the United States, which an examiner can trace line by line. An estimated study applies a lodging percentage and produces no schedule, which means no partial dispositions later, no clean 1245 and 1250 split at sale, and nothing to hand an examiner. Cost Seg America defends every study for as long as you own the building, with no time limit, hour cap or additional fee, through written responses and participation in examiner calls alongside your CPA.
If the property has less than $180,000 of depreciable basis after land, the fee eats too much of the benefit. If you plan to sell in a couple of years without exchanging, the ordinary-rate recapture on the reclassified components arrives before the time value has done much. If a management company runs everything and your stays average more than seven days, the loss is passive, and unless you have passive income or your spouse qualifies as a real estate professional, it will sit suspended until sale. And if your income is taxed at 22 percent this year but you expect to sell as a 37 percent taxpayer, you are trading a cheap deduction for an expensive recapture. The free proposal will say any of this plainly.
Yes. Hotels, motels, inns, lodges and boutique properties are nonresidential real property on 39 years, and a study identifies the components the engineering supports as 5-, 7- and 15-year property.
No, when more than half the units are used on a transient basis. Those units are not dwelling units under Section 168(e)(2), and the building goes on 39 years.
Possibly. If the average stay is seven days or less, or 30 days or less with significant personal services, the activity is not a rental activity, and if you materially participate the loss is nonpassive. Section 461(l) may still cap how much you use this year.
Yes, when it is acquired from an unrelated party after January 19, 2025, you did not use it before, and it is placed in service after that date.
Acquisition is generally the written binding contract date. Placed in service is when the property is ready and available to take guests. Both have to fall after January 19, 2025 for 100 percent bonus.
Yes. The missed depreciation is claimed through a Form 3115 change in accounting method filed with the current return, with no amended returns, at the bonus rate of the year the hotel was placed in service.
Yes. Renovation spending includes 5- and 7-year components, qualified improvement property on 15-year straight line, and partial dispositions of what you removed. A study sorts the three.
Furnishings included in the purchase price are examined as short-lived property in the study. Furnishings you buy separately later are already short-lived on their own invoices and get bonus without a study.
Depreciation on the components is recaptured as ordinary income and building depreciation is taxed at up to 25 percent. A 1031 exchange can defer it, subject to the replacement property, and a step-up at death eliminates it.
Send the property address, the purchase price, the contract and opening dates and the room count. Jim Dougherty and his team will send a free proposal within 24 hours showing the projected first-year deduction on your property, and the study itself is done in 30 days, with rush available. Call 1-888-365-5023 or email info@costsegamerica.com.
This article is educational and does not constitute tax, legal or accounting advice; thresholds are indexed each year, so review your situation with your CPA before acting.
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