TurboTax is not permitting me to deduct short-term rental losses against W2 income

[Rick19744]

In reading the original question and follow-up responses, I will add the following comments:

• Qualifying as a short-term rental will require meticulous records to prevail if audited.  The IRS will want to see records of ALL stays and you will need to provide support that you meet the average of 7 days or less.  This can be tricky if some rentals exceed one week; some stay a couple of weeks, some stay one month.  These rentals, while generating rental income, will not be beneficial in determining that you meet the average of 7 days or less.
• If your property does meet the average of 7 days or less, then this rental falls outside of the typical rental real estate provisions under Section 469 and may not be a passive activity.  However, you will  need to meet the material participation rules, just like any other business.
• Keep in mind, that when attempting to qualify under the material participation rules, you need to take into account everyones time involved.
• As noted by @Mike9241 you need to be careful of the services being provided.  Many of these type of short-term rentals provide significant services and are reported on Schedule C; subject to SE Tax.
• If you are not required to report the activity on Schedule C, @Mike9241 provided the key to getting TT to handle this appropriately.  Since short-term rentals don't fall within the typical rental real estate provisions, checking "other" passive activity should solve the issue.
• If you fall within the short-term rental provisions, as noted above, this is not deemed a rental activity for the passive activity rules.  If you fail the material participation rules, you are not able to utilize the active participation rules for the $25,000 allowance.  This is due to the fact that this activity is deemed a trade or business.  In this case, you are only able to offset losses with other passive income.
• Finally, this area is highly scrutinized and you can't maintain too many records to support your position.

[AmeliesUncle]

You are correct that Material Participation in short-term rentals is non-passive, so the losses should offset W-2 income.

But TurboTax is not set up for this.  If you use the CD/downloaded version, you should be able to access the worksheet to manually check the box for "other passive exceptions".  But you can not do that with the online version of TurboTax.

If this is your ONLY rental, you may be able to say you are a Real Estate Professional, and I think it should do the same thing.

[gmyoung]

@EricUT03 

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.

[jwburris]

Where on a tax form does the non-passive loss from qualifying short term rental go?

--on Schedule E?  If so, how do I distinguish it as non-passive, so as to take the loss against my W2 and other business income?

--Schedule C? If I do that, I assume my short rental GAINS the following year will be subject to self-employment tax?  

My situation:  short term rental with material participation, but no extra services that would necessitate filing Schedule C.  I am currently amending my 2021 return in which my first year short term rental lost 40K  (I want to increase that by bonus depreciation after a cost segregation study) and gained 62K in 2022.  Can I use Schedule C for 2021 and then switch to Schedule E for 2022 tax year to avoid self-employment tax going forward?

[jwburris]

H&R Block flow diagram shows that yes, short-term rental with average rental 7 days or less qualifies for "Non-Passive Activity."  I doubt H&R Block posts "loopholes."

https://www.hrblock.com/tax-center/wp-content/uploads/2018/05/airbnb-taxes.pdf

My question is how to report the non-passive activity on Schedule E (not using Turbo Tax currently) and distinguish it from long term rentals with passive activity.

[gmyoung]

@jwburris 

Schedule E has space to list income and deductions for three properties. If you have more than three, complete and attach as many Schedules E as you need to list them.

Line 22 will distinguish properties whose losses can be applied against ordinary income from those whose losses cannot be applied against ordinary income. "Deductible rental real estate loss after limitation, if any,
on Form 8582 (see instructions)." If you determine that the loss is deductible, it will be recorded on this line. If it isn't deductible, it will be left blank.

[priya5]

I am in this situation. But I can't find a way in turbotax to switch or start over with Schedule C. is there a step-by-step guide for those who have short term rentals, who provided substantial guest services and incured a "loss" considering the depreciation of the house?

[DianeW777]

Yes, see the link below.  

• Ten Tax Tips for Short Term Rentals 

Whether you use Schedule C or Schedule E to report your short term rental depends on how actively you are involved in running this business business and what services you offer.  Use:

• Schedule C - If you provide services, like a hotel or B&B would (cooking, cleaning services, maid service etc). 
• Schedule E - If you are just renting out a space and you do not offer any additional services.

How do I report income from self employment?  To get started here are the steps to begin:

To report your short term rental on Schedule C: 

1. Open or continue your return.
2. Search for schedule c and select the Jump to link in the search results.
3. Answer Yes to Did you have any self-employment income or expenses? and follow the instructions.

@priya5 

[priya5]

@DianeW777 ,

Thanks for the reply.

I did provide services, like a hotel  meals, cooking, cleaning services and maid service.

I followed your guidance and started schedule C.  This allows me to enter my income, and expenses including mortgage interest, property taxes and insurance.

How ever there is no place to take depreciation on the property.  How can I calculate and enter home depreciation on Schedule C?.

Thank you

[DianeW777]

When you are in the self employment activity, Select Edit/ADD beside your business.

• Edit beside your business > Scroll to Less Common > Search Assets (or scroll to find it) >  Click in the check box > Continue > Enter your assets
• May need to 'Add expenses for this work'

@priya5 

[johnbaumgartner7]

the law is clear, just look at instructions for form 8582 and rental activity exceptions....ie short term rentals is not a rental activity.   I am disappointed in turbo tax not asking about exceptions.  If there is a fix in turbotax 2023 please let me know. 

[SusanY1]

For the short term rentals (with substantial service), the income needs to be reported on Schedule C not on Schedule E.  There aren't exceptions for rental activities on Schedule E, which is why you're not seeing a question asking about them.  To declare that the income/loss isn't passive, you'll need to delete the Schedule E and enter the data on Schedule C (self-employment income)

The instructions for how to enter the activity on Schedule C are above in this thread. 

[jantzhoffman]

Same problem with a different twist.  Our short term rental is owned in a partnership, so we received a K1 with the losses reported in box 2.  However TT doesn't allow us to treat the box 2 rental losses at nonpassive and such dont get the deduction.  The 4 of us equally manage the short term rental (2 couples) ourselves.  So we do ALL the work as a partnership and the average stay is less than 7 days.  If anyone figures out how to get TT to allow the K1 losses to be treated as nonpassive that would be hepful.

[KrisD15]

The Partnership would need to report the short-term rental as business (not rental) income and use Box 1 on the K-1.

[johnbaumgartner7]

ah ha... after many hours finally found answer in an old note on this site.... you must go to forms and find schedule E form or maybe it is the E worksheet on forms (took me awhile to find) and check non passive.

It works.   Disappointing and surprising turbo tax software does not ask proper questions and handle this.  Note I found referenced good worksheet from HR Block on airbnb treatment.