Published by AE Tax Advisors Team • 2026-04-14

Converting LTR to STR Unlocks $125,000 in Additional Deductions

The Client

Vanessa Morales, a real estate investor in San Diego, California, owned a beachfront condo she had rented long-term for five years. The property was purchased for $720,000 and had been generating $30,000 in annual rental income with net losses of $8,000 per year (after depreciation, mortgage interest, and expenses) -- all suspended as passive losses.

The Problem

As a long-term rental, the condo's losses were passive and could not offset Vanessa's $195,000 W-2 income (her MAGI was too high for the $25,000 allowance). Five years of suspended passive losses totaled $40,000 sitting unused. Additionally, no cost segregation study had been performed.

Our Strategy

We converted the property from long-term to short-term rental when the lease expired, listing it on vacation rental platforms. The San Diego beachfront location generated significantly higher revenue -- $72,000 annually vs. $30,000 from long-term. We performed a cost segregation study with a Form 3115 catch-up adjustment, generating $95,000 in catch-up depreciation. Vanessa documented material participation in the STR operations, reclassifying the activity from passive to non-passive.

The Results

The conversion unlocked $125,000 in deductions -- $95,000 from cost seg catch-up depreciation and $30,000 from releasing the previously suspended passive losses (now deductible as the activity shifted from passive to non-passive). Tax savings exceeded $48,000 in Year 1, and ongoing revenue doubled. Vanessa's net operating income also improved from a loss to a $15,000 annual profit.

Key Takeaway

Converting a long-term rental to a short-term rental in a strong vacation market can simultaneously increase revenue, unlock suspended passive losses, and enable cost segregation catch-up depreciation -- a triple benefit that transforms the property's tax profile.