Investors & landlords

gmyoung · ‎February 9, 2023

I'm following this thread with great interest and (and some bemusement at the level of misplaced confidence in the responses of certain participants). I am wondering whether you've found a solution in TurboTax, as I am in a similar situation--bought and rented out a short-term rental in 2022 and am unable in TurboTax to apply my loss against my nontaxable income.

There is no question that I should be able to apply the loss against my nonpassive (i.e., W-2) income. Relevant facts from IRS Publication 527 (2022) Residential Rental Property:

The rental activity is reported on Schedule E if you rent buildings, rooms, or apartments, and provide basic services such as heat and light, trash collection and
on Schedule C if you provide "substantial services" [note: per at least one expert, cleaning between turns is not considered a substantial service, though daily cleaning may be].

If you have a loss from your rental real estate activity, two sets of rules may limit the amount of loss you can report on Schedule E: at-risk rules and passive-activity limits. "Generally, rental real estate activities are considered passive activities and losses aren’t deductible unless you have income from other passive activities to offset them. However, there are exceptions." These exceptions are outlined in IRS Publication 925 (2022), Passive Activity and At-Risk Rules:

"There are two kinds of passive activities.

Trade or business activities in which you don’t materially participate during the year.
Rental activities, even if you do materially participate in them, unless you’re a real estate professional."

"A rental activity is a passive activity even if you materially participated in that activity, unless you materially participated as a real estate professional."

HOWEVER...it goes on:

"Exceptions. Your activity isn’t a rental activity if any of the following apply:

The average period of customer use of the property is 7 days or less. You figure the average period of customer use by dividing the total number of days in all rental periods by the number of rentals during the tax year..."

As you know, this average length-of-stay is trivial to calculate (in fact, Airbnb does it for you).

This so-called 7-day "loophole"--or, as the IRS says less provocatively, "exception"--is straightforward and not at all aggressive. It is followed by this statement: "If you meet any of the exceptions listed above, see the Instructions for Form 8582 for information about how to report any income or loss from the activity." Form 8582 says:

"If an activity meets any of the five exceptions listed above [including the 7-day rule above], it’s not a rental activity. You must then determine:
1. Whether your rental of the property is a trade or business activity (see Trade or Business Activities,
earlier), and, if so,
2. Whether you materially participated in the activity for the tax year (see Material Participation, later)."

#1 is easily shown, but what about #2? There are seven tests (only one must be met). Arguably the easiest to meet is the third one (which is the one I meet): "You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year."

I'm skeptical of the claim that the IRS applies heavy scrutiny to this material participation criterion. The guidance on how to provide proof of participation strikes me as reasonable and easy to prove: "Proof of participation. You may prove your participation in an activity by any reasonable means. You don’t have to maintain contemporaneous daily time reports, logs, or similar documents if you can establish your participation by other reasonable means. For this purpose, reasonable means include, but are not limited to, identifying services performed over a period of time and the approximate number of hours spent performing the services during that period, based on appointment books, calendars, or narrative summaries."

Anyway, with that longwinded preamble, I'm curious to know whether you were able to successfully apply your losses against your nonpassive income. With how popular short-term rentals have become, I'm surprised TurboTax is stumbling. This doesn't strike me as an esoteric edge case.