The Same STR, Two Exits

The buyers are a married couple with two high salaries, and they file one joint federal return for 2026. They pay $1.2 million for a short-term rental in Sonoma County and put twenty percent down, about $264,000 with closing costs. They borrow the rest at 6.5% over thirty years. One spouse runs the property and works enough hours on it to pass an IRS test called material participation. Passing it lets them subtract the rental’s losses from their salaries.

In the first year the couple pays for a breakdown of the building into its separate parts, called a cost segregation study. It moves about 28% of the building to a shorter depreciation period. A rule called bonus depreciation lets the couple deduct all of that in the first year, which comes to about $327,000 of federal depreciation. They report a loss of about $303,000 on the rental for the year. Federal law limits the loss a couple can subtract from other income, and for 2026 that limit is $512,000 on a joint return. Their loss is smaller than that, so they use all of it in the first year. They hold none of it for a later year. At 37% the deduction saves them about $112,000 in tax, and the property itself clears about $13,000 in cash in the first year. California does not allow bonus depreciation, so the deduction there is much smaller. The couple runs those numbers separately, and the $112,000 is federal only. Even so, they recover roughly half of their $264,000 inside twelve months.

When the couple sells, they owe tax on the depreciation they already claimed, a tax called recapture.

In a sale called a 1031 exchange they put that tax off, but in an outright sale they pay it.

A couple that exchanges pays no recapture at that sale. They keep the whole $112,000 the deduction saved them in the first year, and they keep the $13,000 the property cleared. They owe nothing on that depreciation until they sell without an exchange.

A couple that sells outright pays the recapture when the sale closes. The tax covers the depreciation they have already taken, and about $327,000 of that came in the first year. The sale has to produce enough cash to pay it.

The table uses a single recapture rate of 25% in every row. The 28% the study reclassified comes back as ordinary income, and the couple pays their full rate on it rather than 25%. A CPA running the couple’s actual schedule would apply the rate that belongs to each part.

The couple can buy a second property and exchange into it, and the tax stays deferred. On the second building they can order a new cost segregation study. They can also hold the property until death, and then the heirs receive it at its value on the date of death. Internal Revenue Code section 1014 sets that value, and no one ever pays the deferred tax.

The couple should take the accelerated depreciation, and they should commit to the exchange before they claim the first year’s deduction. A couple that decides afterward pays the recapture at a sale.