Material Participation to Recognize Rental Property Losses

[earlvanze]

You know what's an AUTHORITATIVE source? Publication 925, the section called Material Participation. It literally outlines what you must do if you're managing an STR BUSINESS (Active Income, NOT Passive). It's NOT disputed at all, except by uneducated CPAs.

https://www.irs.gov/forms-pubs/about-publication-925

[Mike9241]

@earlvanze a STR can be active or passive despite material participation. the rules of IRC. 469 come into play.

this is from reg 1.469-1T

Exceptions. For purposes of this paragraph (e)(3), an activity involving the use of tangible property is not a rental activity for a taxable year if for such taxable year—

(A) The average period of customer use for such property is seven days or less;

(B) The average period of customer use for such property is 30 days or less, and significant personal services (within the meaning of paragraph (e)(3)(iv) of this section) are provided by or on behalf of the owner of the property in connection with making the property available for use by customers;

(C) Extraordinary personal services (within the meaning of paragraph (e)(3)(v) of this section) are provided by or on behalf of the owner of the property in connection with making such property available for use by customers (without regard to the average period of customer use);

(iv) Significant personal services—(A) In general. For purposes of paragraph (e)(3)(ii)(B) of this section, personal services include only services performed by individuals, and do not include excluded services (within the meaning of paragraph (e)(3)(iv)(B) of this section). In determining whether personal services provided in connection with making property available for use by customers are significant, all of the relevant facts and circumstances shall be taken into account. Relevant facts and circumstances include the frequency with which such services are provided, the type and amount of labor required to perform such services, and the value of such services relative to the amount charged for the use of the property.

(B) Excluded services. For purposes of paragraph (e)(3)(iv)(A) of this section, the term “excluded services” means, with respect to any property made available for use by customers—

(1) Services necessary to permit the lawful use of the property;

(2) Services performed in connection with the construction of improvements to the property, or in connection with the performance of repairs that extend the property's useful life for a period substantially longer than the average period for which such property is used by customers; and

(3) Services, provided in connection with the use of any improved real property, that are similar to those commonly provided in connection with long-term rentals of high-grade commercial or residential real property (e.g., cleaning and maintenance of common areas, routine repairs, trash collection, elevator service, and security at entrances or perimeters).

(v) Extraordinary personal services. For purposes of paragraph (e)(3)(ii)(C) of this section, extraordinary personal services are provided in connection with making property available for use by customers only if the services provided in connection with the use of the property are performed by individuals, and the use by customers of the property is incidental to their receipt of such services. For example, the use by patients of a hospital's boarding facilities generally is incidental to their receipt of the personal services provided by the hospital's medical and nursing staff. Similarly, the use by students of a boarding school's dormitories generally is incidental to their receipt of the personal services provided by the school's teaching staff.

average period of customer use

(C) Average period of customer use for class of property. In determining an activity's average period of customer use for a taxable year, the average period of customer use for a class of property held in connection with an activity is determined by dividing—

(1) The aggregate number of days in all periods of customer use for property in the class (taking into account only periods that end during the taxable year or that include the last day of the taxable year); by

(2) The number of those periods of customer use.

[earlco]

Thank you, I've read this before. That's good to know material participation is not necessary. This could be beneficial some years when you have STR losses you want to offset against your W-2 income, and can hurt other years when you have gains that are now subject to self-employment tax.

[AmeliesUncle]

I'm a bit lost on the conversation, but here is a summary of the rules:

1.  Non-passive losses can offset any other income.
2. Passive losses are generally only deductible against passive income, so any losses may be carried forward to future years.  
   1. However, your income is below certain levels and you "Actively Participate" in a real estate rental, you may be able to deduct up to $25,000 of losses.
   2. If you qualify as a Real Estate Professional AND you "Materially Participate" in the rental, it is non-passive.
3. Income from long term rentals is passive.  
4. Short term rentals that you DON'T "Materially Participate" are passive.  
5. Short term rentals that you DO "Materially Participate" are non-passive.
6. Self Employment Tax has nothing to do with it being long term, short term, passive, or nonpassive.  It is based on if "services" (such as maid service and meals) are provided to the tenants.

[Mike9241]

Short term rentals that you DON'T "Materially Participate" are passive. Short term rentals that you DO "Materially Participate" are non-passive. Self Employment Tax has nothing to do with it being long term, short term, passive, or nonpassive. It is based on if "services" (such as maid service and meals) are provided to the tenants.

not quite. material participation is not the only factor for determining whether short-term rentals are passive or active.

The general rule is that any rental activity is a passive activity [IRC Sec 469(c)(2)]. However, an activity involving the use of tangible property (like a house) is not a rental activity (not passive) for the tax year if [Temp Reg 1.469-1T (e) (3)(ii)]:

1) average period of customer use is 7 days or less or

2) average period of customer use is 30 days or less and significant personal services (SPS) are provided 

what are SPS 

Significant personal services only include services performed by individuals, and do not include excluded services. In determining whether personal services provided in connection with making property available for use by customers are significant, all of the relevant facts and circumstances shall be taken into account. Relevant facts and circumstances include the frequency with which such services are provided, the type and amount of labor required to perform such services, and the value of such services relative to the amount charged for the use of the property.

The term “excluded services” means, with respect to any property made available for use by customers—

(1) Services necessary to permit the lawful use of the property;

(2) Services performed in connection with the construction of improvements to the property, or in connection with the performance of repairs that extend the property's useful life for a period substantially longer than the average period for which such property is used by customers; and

(3) Services, provided in connection with the use of any improved real property, that are similar to those commonly provided in connection with long-term rentals of high-grade commercial or residential real property (e.g., cleaning and maintenance of common areas, routine repairs, trash collection, elevator service, and security at entrances or perimeters).

Examples of Substantial Services:
Cleaning of the rental each day while the property is occupied by the same guests.
Changing bed sheets and other linens each day while the property is occupied by the same guests.
Concierge services.
Conducting guest tours and outings.
Providing meals and entertainment (like providing breakfast each morning).
Providing transportation.
Providing other “hotel-like” services.
Regrettably, the IRS hasn’t provided much guidance other than the few items above. There aren’t any court cases, Revenue Rulings, or Treasury Regs on this topic.

The activities listed above are not considered rental activities. However they are still passive if there is no material participation. 

passive STR are reported on schedule E

nonpassive STR are reported on Schedule C and profits are subject to self-employment tax. 

[AmeliesUncle]

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@Mike9241 wrote:

 material participation is not the only factor for determining whether short-term rentals are passive or active.

The activities listed above are not considered rental activities. However they are still passive if there is no material participation. 

passive STR are reported on schedule E

nonpassive STR are reported on Schedule C and profits are subject to self-employment tax. 

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As you just said, those short term rentals (the 7 day and 30 day scenarios) are still passive if there is no Material Participation.  And they are not Passive if there is Material Participation.

You are incorrect.  Nonpassive STR are still on Schedule E unless "services" are provided.  There is no SE tax for a Nonpasive STR if "services" are not provided.

[AmeliesUncle]

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@Anonymous_ wrote:

Short-term rentals are covered by Section 280A and, believe it or not, when a taxpayer uses a short-term rental (aka vacation home) as a residence (i.e., uses it more than the greater of 14 days or 10% of the number of days rented at fair rental value), that is not a passive activity. 

Rental income = $10,000

Management fees = $10,000

Commissions = $5,000

Loss = $5,000 which is nonpassive

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I agree.  To add another thought to that, some of the 'shared' expenses (for example, repairs and home insurance) would trigger the Vacation Home rules which would be a separate carryover.   So being nonpassive could possibly allow a loss, the separate "vacation home" rules may suspend some or all of the loss for other reasons.

[gibrahimov]

Hi

was reading this post and wanted to share this.

Section 7805(e) applies to regulation issued after 11/20/1988.
Reg. sec. 1.469-1T was issued before 11/20/1988 so it’s not subject to the 3-year expiration rule.

Also IRS still use 1.469-1T.

[TSC1020]

Does anyone know if H & R blocks software is still working with this loophole? We bought an STR in 2023, and we were adding information into our TT preliminarily. I noticed that we were not going to be able to roll our losses over to our W2 income. We meet the tests for our business to be considered non passive. We have used TT for 5 years, but unfortunately if they are willing to leave money on the table for hard working taxpayers we will not be doing our taxes on TT anymore. 

[Mike9241]

if you meet the criteria for short-term rentals to be non-passive reporting is done on schedule C not E