TurboTax Online Incorrectly Restricts Non-Passive Classification for Material Participants

[MCSmith1974]

Summary of Issue

I discovered a structural limitation in TurboTax Online (Premium / Live Assisted) regarding the classification of rental real-estate activities under IRS §469.

TurboTax Online currently allows non-passive (material participation) treatment only when a taxpayer selects the Real Estate Professional path. However, under IRS Publication 925, material participation and real-estate-professional status are distinct tests:

• Material participation (§469(h)): Involvement on a regular, continuous, and substantial basis (e.g., personally managing, maintaining, and operating the property).

• Real-Estate-Professional (§469(c)(7)): 750+ hours and more than half of total working time in real-property trades or businesses.

A taxpayer can materially participate in a rental activity and therefore be non-passive without meeting the real-estate-professional thresholds.
TurboTax Online merges these two separate IRS standards into a single workflow, meaning:

• Users who materially participate but are not real-estate professionals are automatically classified as passive,

• Form 8582 (Passive Activity Loss Limitations) is generated unnecessarily, and

• Legitimate current-year losses are partially or fully disallowed and carried forward, contrary to IRS rules.

This design inflates taxable income and misrepresents compliance for taxpayers who self-manage their rentals (e.g., single-property landlords who do all maintenance, leasing, and management work).

Question

Can TurboTax confirm whether the Online product will be updated to allow non-passive (material-participation) treatment for rental activities without requiring the taxpayer to select “Real Estate Professional” status?

If not, can TurboTax provide an official recommendation for users who materially participate but are not real-estate professionals — specifically, whether they must use TurboTax Desktop Home & Business to ensure correct classification and eliminate Form 8582?

Closing

I would appreciate clarification or documentation confirming how TurboTax intends to handle this distinction so that materially participating landlords can file accurately under §469(h) without being forced into the §469(c)(7) real-estate-professional election.

[M-MTax]

I'm going to page @AmeliesUncle for this one, but I believe this has been an ongoing issue over the past few years.

You can make the adjustment with the desktop products in Forms Mode but I suspect you may be SOL with the online versions. 

[MCSmith1974]

Yeah, thanks.

I don't mean to keep posting about it, but it's a major issue (at least for me).

Until yesterday, I didn't even realize my last 8 years of Turbo Tax Online were done incorrectly. 

[M-MTax]

That is indeed unfortunate. I believe the best solution would be to switch to a desktop version, if you can manage to do that with your hardware configuration.

[AmeliesUncle · Accepted solution]

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@MCSmith1974 wrote:

A taxpayer can materially participate in a rental activity and therefore be non-passive without meeting the real-estate-professional thresholds.

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Why do you say that?  Do you have special circumstances, such as short-term rental that would make it NOT a "rental activity" or have enough personal use of the property that may make it not a rental activity?  Or are you doing certain grouping elections with your business?

Material Participation in a "rental activity" does NOT make it non-passive.

Or am I misunderstanding your situation or what you are asking about?

Publication 925 [see also §469(c)(2)], under "Passive Activities" says:

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.

https://www.irs.gov/publications/p925#en_US_2024_publink1000104565

[M-MTax]

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@AmeliesUncle wrote:
....Do you have special circumstances, such as short-term rental that would make it NOT a "rental activity"....

I made the assumption that was the case in my first response.

[AmeliesUncle]

Yeah, I figured that you assumed it was a short-term rental (in which case your comments are accurate), but after re-reading the OP's post, I realized she didn't say anything about that, which is why I asked for more details about why she thinks it should be non-passive.

[M-MTax]

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@AmeliesUncle wrote:

......which is why I asked for more details about why she thinks it should be non-passive.

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You asked the right questions because, thinking about it, there are quite a few users who hold the (mistaken) belief that material participation is sufficient. 

My original post was based on the couple of users both of us responded to who did have short-term rentals (but were not REPs) and were trying to get the program to treat them as nonpassive (which it won't unless you use Forms Mode).

[Mike9241]

@M-MTax 

Doesn't IRC 469 (c)(4)  block TPs other than real estate pros as treating rental real estate as a nonpassive activity 

(c)(2)Passive activity includes any rental activity
Except as provided in paragraph (7), the term “passive activity” includes any rental activity.

(c)(4)Material participation not required for paragraphs (2) and (3)
Paragraphs (2) and (3) shall be applied without regard to whether or not the taxpayer materially participates in the activity.

[M-MTax]

@Mike9241 

You can dive into this with @AmeliesUncle, but the short-term rental scenario is an exception to the general rule requiring an owner to be an REP in order to avoid the passive loss rules.

[MCSmith1974]

Correction and Clarification Regarding Rental Activity Classification

After reviewing IRS rules under IRC §469, I want to correct my earlier statement that “A taxpayer can materially participate in a rental activity and therefore be non-passive without meeting the real-estate-professional thresholds.”

That statement was (and is) incorrect.

Under §469(c)(2), all rental activities are legally passive by definition, regardless of how actively the owner manages the property. The only exceptions are:

1. When the taxpayer qualifies as a Real-Estate Professional under §469(c)(7) (more than 750 hours per year and more than half of total working time in real-property trades or businesses); or
2. When the activity is not considered a “rental activity” (for example, short-term rentals averaging seven days or less, or rentals providing hotel-like services).

For most long-term landlords, like myself, rental income and losses remain passive. However, “active participation” allows up to a $25,000 deduction against non-passive income if AGI is below $100,000, phased out up to $150,000, with any remaining losses carried forward under Form 8582. 

My earlier understanding and guidance was mistaken — material participation alone does not make a long-term rental non-passive under current IRS law.

Thanks for the help in enlightening me on this subject. 

[Mike9241]

i agree as to short-term rentals if they meet the criteria but aren't they supposed to be reported on schedule C? 

[M-MTax]

Only if "substantial services" are provided.