In 2018, I did a 1031 exchange for a rental property. The prior property sold in the exchange was previously reported on Schedule E and had significant carryover of passive losses. I'm using the new property acquired in the exchange for short term rentals (typically less than 7 days), so it is reported on Schedule C. I use a management company to run all aspects of the rental business for this property and I don't materially participate, so it is passive income even though it is reported on Schedule C. Can I use the Schedule E passive loss carryover from the prior property to offset the passive income from this Schedule C rental? What is the rule that allows or prevents it?
short-term rentals ate not passive if you provide significant services and thus they are reported on schedule C. if no significant services are provided then the rentals are passive and go on schedule E. if it produces net income then your prior suspended rental passive losses can be used to offset the income. Note that if you have net income properly reported on schedule C you'll owe self-employment taxes. Properly reporting on Schulele C means the activity is not passive so you can't use the suspended passive losses to offset the
According to the IRS, not all rental property activity should be reported on Schedule E. If the property owner provides “substantial services” to short-term renters, the IRS says that the rental activity should be reported on Schedule C, and that the property owner must pay self-employment taxes on the income. If there is a loss, it can be fully deducted without regard for the passive loss limitation rules. If you provide substantial services that are primarily for your tenant's convenience, such as regular cleaning, changing linen, or maid service, you
report your rental income and expenses on Schedule C. Substantial services don’t include the furnishing of heat and light, cleaning of public areas, trash collection, etc. Also, you may have to pay self-employment tax on your rental income using Schedule SE. For a discussion of “substantial services,” see Real Estate Rents in chapter 5 of Pub. 334.
@Mike9241 No significant services are provided, but my understanding was when rentals are typically shorter than 7 days, the activity needed to be reported on Schedule C, but could still be passive income based on whether I materially participated. Otherwise not sure why our CPA put it on Sch C back in 2018. Schedule C can still have passive income, correct?
There has been (and still is) considerable disagreement (and confusion) with respect to the "7-days or less" rule. It has been interpreted (more likely misinterpreted) for a number of years.
Regardless, the rule appears to have been deleted from the most current Regulations and a memo was issued which indicates the rule is strictly for the purposes of Section 469.
See https://www.irs.gov/pub/irs-wd/202151005.pdf
Also, note that your interest in a business can be passive, but income reported on Schedule C is generally considered to be nonpassive by default (and subject to SE tax).
I will page @AmeliesUncle to see if he has anything to add.
@Ahnold wrote:In 2018,
As Mike and Tagteam said, it belongs on Schedule E.
Are you preparing the 2019 return? If not, what have you been doing with the passive losses and income for the last few years?
A few additional comments:
@Rick19744 @Anonymous_ after reading the temporary reg and the situations it presets it seem the IRS says 7 day rentals are never passive. since the taxpayer says they don't provide significant services it doesn't go on schedule C but schedule E. to avoid being treated as passive there is a box to check in turbo tax for schedule E which says "other passive exception". checking it will treat any income/loss as non passive.
@Mike9241 wrote:
@Rick19744 @Anonymous_ after reading the temporary reg.....
The Reg is no longer temporary (note (e)(3)(i)–(e)(3)(ii) has been reserved).
@Mike9241 wrote:after reading the temporary reg and the situations it presets it seem the IRS says 7 day rentals are never passive.
The seven day thing means it is not treated as a "rental activity" (which is automatically passive) for purposes of the passive rules. That means the passive versus non-passive determination is based on if there is Material Participation or not.
I think you are right, the only way to tell the program that this situation is non-passive is to check that box.