Purpose Observation care is used to evaluate patients prior to admission or discharge. Often beneficial, such care also imposes greater financial liability on Medicare beneficiaries. While the use of observation care has increased recently, critical access hospitals (CAHs) face different policies than prospective payment (PPS) hospitals, which may influence their observation care use. Methods We used 100% Medicare inpatient and outpatient claims files and enrollment data for years 2007 to 2009, and the 2007 American Hospital Association data to compare trends in the likelihood, prevalence and duration of observation stays between CAHs and PPS hospitals in metro and non‐metro areas among fee‐for‐service Medicare beneficiaries over age 65. Findings While PPS hospitals are more likely to provide any observation care, the 3‐year increase in the proportion of CAHs providing any observation care is approximately 5 times as great as the increase among PPS hospitals. Among hospitals providing any observation care in 2007, the prevalence at CAHs was 35.7% higher than at non‐metro PPS hospitals and 72.8% higher than at metro PPS hospitals. By 2009, these respective figures had increased to 63.1% and 111%. Average stay duration increased more slowly for CAHs than for PPS hospitals. Conclusions These data suggest that a growing proportion of CAHs are providing observation care and that CAHs provide relatively more observation care than PPS hospitals, but they have shorter average stays. This may have important financial implications for Medicare beneficiaries.