How Do You Depreciate a Mixed-Use Property?

Understanding the IRS Rules for Buildings With Both Residential, Commercial, and Short-Term Rental Use

If you own a property that serves more than one purpose, for example, retail on the bottom floor and apartments above, or a multi-unit building where some units are long-term rentals, and others operate as short-term rentals, you’ve entered the world the IRS calls mixed-use property.

Mixed-use depreciation is more complex than most investors expect. You cannot depreciate the entire building under a single schedule if different parts of the property are used for different purposes. The IRS requires you to break it out, and the rules depend on how each part of the building generates income.

Below is a clear, easy breakdown of how it works and how the IRS expects you to treat each portion.

The Two Depreciation Lifecycles the IRS Uses

The IRS uses two main depreciation lives for real estate:

Property Type	Depreciation Life	IRS Source
Residential rental property	27.5 years	IRC §168(c); §168(e)(2)(A)(i)
Commercial / nonresidential real property	39 years	IRC §168(c); §168(e)(2)(B)

The key is understanding which parts of your building fall into each category.

Rule #1: The “80% Rule” Determines Whether a Building Is Residential or Commercial

The IRS says that a building is considered residential rental property (and therefore uses the 27.5-year depreciation life) only if:

80% or more of its gross rental income comes from dwelling units.
Treasury Regulation §1.168(e)-1 and IRS Publication 527

If less than 80% of rental income comes from dwelling units, the property is classified as nonresidential real property and must be depreciated over 39 years.

That means the IRS looks at rental income, not square footage, not the number of units.

Simple Example

A building earns:

$700,000 per year from apartments (dwelling units)
$250,000 from retail leases

Residential income = 74% → less than 80%
→ Entire building = 39-year commercial property

Rule #2: If the Uses Are Truly Separate, You May Split the Depreciation

If:

The residential portion and commercial portion are distinct, and
They generate separate revenue streams,

…the IRS allows you to allocate the building’s basisbetween the two uses.

This is permitted under:

Treas. Reg. §1.168(e)-1(mixed-use allocation)
IRS Cost Segregation Audit Technique Guide(reasonable allocation methods)

How Do You Allocate?

The IRS allows “any reasonable method,” but the most supported methods are:

Income ratio(preferred when commercial rents greatly exceed residential rents)
Square footage ratio(acceptable when space usage aligns with value)

Example:
A 60,000 sq. ft. building is:

40,000 sq. ft. apartments
20,000 sq. ft. retail

You could allocate basis:

66.7% to 27.5-year residential
33.3% to 39-year commercial

Rule #3: Long-Term Rentals vs. Short-Term Rentals Are Treated Differently

This is the part most investors don’t realize.

Long-Term Rentals

If the average stay is more than 7 days, the unit is treated as a dwelling unitand depreciated over:

27.5 years
(IRS source: IRC §168(e)(2)(A)(i))

Short-Term Rentals (STRs)

If the average stay is 7 days or less, the IRS does not treat it as a dwelling unit.
Instead, it is treated like a commercial lodging activity(think: hotel or motel).

39-year depreciation

(IRS source: IRC §168(e)(2)(B); also supported by passive activity rules under IRC §469)

So even if all units are inside the same building, their usedetermines their depreciation life.

How to Depreciate a Property That Has Both STR Units and Long-Term Units

If you own a triplex or quadplex where:

Some units are long-term leases
Some units are short-term stays (average < 7 days)

…the IRS requires you to allocate the depreciable basisbetween:

27.5-year residential basis
39-year commercial basis

Again, allocation must use a reasonable methodsupported by documentation:

Allocation Method	When It Is Appropriate
Income Ratio	Used when short-term rental (STR) units produce significantly higher nightly income than other units.
Square Footage	Applied when unit values align closely with the physical space usage.
Unit Count	Rarely used unless all units are highly uniform in size and value.

Your CPA or engineering team must document and apply the method consistently.

Can You “Group” the Activity to Change Depreciation Lives?

No. The IRS grouping election under Treas. Reg. §1.469-4applies only to passive activity testing, used for determining whether losses can offset other income.

Grouping does notallow:

Combining STR + long-term units into one depreciation schedule
Changing 27.5-year property into 39-year property or vice versa
Combining commercial and residential portions for depreciation

Depreciation lives are controlled solely by IRC §168, not by grouping rules.

Key Takeaway for Property Owners

If your property has multiple uses, commercial, long-term residential, or short-term rental, the IRS requires you to depreciate each portion based on how it is actually used, not how the building looks or how you manage it.

This means you may have:

✔One building
✔Two different depreciation lives
✔Multiple asset classifications
✔Separate basis allocations
✔Separate results in a cost segregation study

And that’s exactly why mixed-use properties require engineering-based cost segregationto ensure accuracy and IRS defensibility.