Material Participation to Recognize Rental Property Losses

[Rich_FL]

I have losses from a new rental property that I put into service in 2022. I also qualify for material participation.  However, TurboTax is not letting me recognize the loss (i'm assuming due to the material participation).

The rental property is held and operated under my personal name and not an LLC, though that's not supposed to affect taxes, depreciation, losses, etc.

Any ideas as to why TurboTax isn't recognizing the loss?

[tagteam]

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Any ideas as to why TurboTax isn't recognizing the loss?

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You have to materially participate as a real estate professional.

[Rich_FL]

I should have also specified that this is a short term rental property. For STR, there's another classification in addition to the "Real Estate Professional" status and that is "Material Participation".  

One of the qualifications for material participation is "at least 100 hours of participation and more than any other person at the property".

I qualify on that criteria. I'm just figuring out how to get TurboTax to recognize that so I can recognize the loss.

[tagteam]

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@Rich_FL wrote:

One of the qualifications for material participation is "at least 100 hours of participation and more than any other person at the property".

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The material participation rules apply to any activity, but with respect to the passive activity rules for rental real estate, Section 469(c)(7) carves out an exception for real estate professionals who materially participate in the rental activity (or activities).

See https://www.law.cornell.edu/uscode/text/26/469

[tagteam · Accepted solution]

The bottom line here is that you will not qualify on material participation alone for the purposes of avoiding the passive loss rules.

If you have short-term rental property and provide substantial services to your renters then the rental of the property should be reported on Schedule C. 

[Mike9241]

it's the rules for passive activity losses. unless it's reportable on schedule C because significant services are provided, then by definition (tax law definition) the income/loss is passive. passive losses are subject to limitations. see form 8582.

[taxtime24]

Hi @Rich_FL, 

I am also trying to find out how to do this for my short term rental. Were you able to get any other answers?

[tagteam]

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@taxtime24 wrote:

I am also trying to find out how to do this for my short term rental. Were you able to get any other answers?

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There is only one correct answer.

See https://www.law.cornell.edu/uscode/text/26/469

(c)(2) Passive activity includes any rental activity

Except as provided in paragraph (7), the term “passive activity” includes any rental activity.

(c)(7) (7) Special rules for taxpayers in real property business........

[Rich_FL]

****EDIT**** - DO NOT DO WHAT I SUGGESTED IN THIS POST*****

@taxtime24 What I figured out is that the depreciation needs to be recognized on Schedule C Under Business Items instead of using Rental Properties and Royalties (Schedule E).

Hope that helps!

[tagteam]

You are doing it wrong unless you provide significant services to your renters or you are a real estate dealer. If not, income and expenses (including depreciation) should not be reported on Schedule C.

https://www.irs.gov/publications/p925#en_US_2022_publink1000104568:

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

[taxtime24]

Hi @Rich_FL,

I tried H&R Block's software to compare. Near the end of the Schedule E, it asked me two questions. If the rental property was a short term rental averaging 7 days or less and if I materially participated. After answering yes to both questions it allowed me to use my losses to offset non-passive income. There are definitely benefits to sticking with the Schedule E versus the Schedule C. This is of course as long as you do not provide substantial services - if you did you would need to file a Schedule C. Just thought I would update you since I had the same issue. I will be processing my return with H&R Block because of this. It seems TurboTax did not build their system to capitalize on this important tax break for short term rentals.

For those who aren't informed about this strategy - @tagteam, here is an article: https://www.therealestatecpa.com/blog/short-term-rental-tax-strategy 

[tagteam]

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@taxtime24 wrote:

For those who aren't informed about this strategy - @tagteam, here is an article: https://www.therealestatecpa.com/blog/short-term-rental-tax-strategy 

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You should be aware that not all tax professionals agree with the approach adopted by H&R Block nor that mentioned in the article you cited (which was written by a small CPA firm in North Carolina).

The article cites Treas. Reg. §1.469-1T(e)(3)(ii)(A), which are exceptions to the definition of "rental activity". 

First of all, note that this is a temporary regulation and temporary regulations expire per Section 7805(e)(2).

See https://www.law.cornell.edu/uscode/text/26/7805

Further, the relevant section of the temporary Treasury Regulations that was cited as an exclusion to the definition of "rental activity" no longer appears in the relevant section of the final Regulations (Ref Section 1.469-1(e)(3)(i)-(e)(3)(ii)).

See https://www.law.cornell.edu/cfr/text/26/1.469-1

I am not inclined to argue this further, but have laid out my argument against your approach based on relevant law and regulations. You, of course, are perfectly free to draw an alternate conclusion, and act accordingly, but you would be wrong to claim it is the only conclusion that can be drawn. 

Also, should you feel inclined to respond with cites to other articles, including IRS instructions and publications, you should be informed that those sources are not authoritative and carry little to no weight, in contradistinction to the relevant statues and regulations.

[Rich_FL]

Thanks for that update!

I did confirm that @tagteam was correct that it needs to be on Schedule E and not C.

@tagteam I also acknowledge that there is disagreement over material participation of short term rentals and applying losses toward W2.  I am choosing to take the direction of my CPA advisor who's entire practice is built around clients that own/operate short term rental properties.

[tagteam]

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@Rich_FL wrote:

@tagteam I also acknowledge that there is disagreement over material participation of short term rentals and applying losses toward W2.  I am choosing to take the direction of my CPA advisor....

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That is almost certainly a proper choice as it will be the advisor's responsibility if any issue happens to arise (at least, hopefully, the advisor will assume that responsibility). 

If you are so inclined, you could mention the IRC sections and Regs I cited in my previous post. Frankly, my son is a CPA (and has an MaCC), and I can tell you that there are certain things you do not learn without having been through law school.

[SalMat]

That is wrong-because Short term rental is not considered real estate by the IRS, it is the Short Term Rental, STR loophole, and yes, you can materially participate and can take an active loss. So many people are uninformed on short term rentals. the question was valid and he can legitimately take a loss and take advantage of cost segregation analysis for rapid depreciation.