Passive Activity Loss ATG - Exhibit 2.7: Vacation Rentals/Condos/B&Bs/ Hotels Reg. § 1.469-1T(e)(3)(ii) and Reg. § 1.469-5T(a)
Publication Date - December 2004
NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.
Exhibit 2.7: Vacation Rentals/Condos/B&Bs/ Hotels Reg. § 1.469-1T(e)(3)(ii) and Reg. § 1.469-5T(a)
ISSUE: Should the activity be treated as a rental real estate activity qualifying for the $25,000 offset, OR should it be treated like a business in which taxpayer must materially participate (Reg. § 1.469-5T(a)). Condos rented on average seven days or less are treated as businesses.
If taxpayer deducted losses from a vacation rental or condo on Schedule E, Schedule C or line l of Form 8582, giving himself the benefit of the $25,000 offset, ask . . .
_____ Did the taxpayer or related parties spend more than 14 personal days at the property OR 10 percent of the days rented at fair rental value? In other words, are deductions limited under IRC § 280A(c)(5)? If so, the passive loss rules do not apply. See IRC § 469(j)(10). Losses are limited to income from the activity under IRC § 280A. In other words, expenses may not be deducted beyond gross rents under IRC § 280A. Qualified residence interest and taxes that exceed gross income may be deducted on Schedule A as itemized deductions.
If IRC § 280A does not apply, pursue passive loss issue:
_____ What is the average rental period?
The activity is not deemed a rental and does not qualify for the $25,000 offset if:
- The average period of customer use is 7 days or less; OR,
- The average period of customer use is 30 days or less and significant personal services are provided (such as maid service, cleaning services, etc.)
If neither of the above apply, the taxpayer qualifies for the $25,000 offset, if active. If either of the above exceptions apply, the activity is not a rental activity. It is treated as a business , and the far more stringent material participation standard applies.
QUESTIONS to ask if rental period requirement is not met, and the taxpayer must materially participate:
_____ Is there a management service or anyone who manages the property other than the taxpayer?
_____ How many hours a month does the taxpayer spend working on activity? Ask taxpayer to provide documentation of hours worked for the years under examination. The initial interview is the best time to secure a statement from the taxpayer of hours and types of participation performed. If statements are self-serving or questionable, be sure to request telephone records, documents or third party verification to corroborate taxpayer's statements. The IRS does not need to accept self-serving testimony or narrative summaries, which do not make sense.
_____ Does taxpayer and/or spouse work more than 500 hours a year on activities related to the vacation rental? Reading reports and otherwise monitoring the condo in a non-managerial capacity does not constitute material participation.
_____ Does the taxpayer perform substantially all the work?
If there is a management firm, the answer is no.
_____ Does the taxpayer work at least 100 hours and no one works more?
If there is a management firm, it would be difficult for taxpayer to meet this standard. See Reg. § 1.469.5T(f)(2)(ii). It is the taxpayer's burden to prove how many hours he worked and how many hours employees worked. If taxpayer is not involved in day-to-day management or operations, certain activities are disregarded when counting hours for material participation. The following activities would not constitute material participation: studying financial reports, preparing analysis for taxpayer's own use, and monitoring finances or operations in a non-managerial capacity. Periodic consultation is not sufficient to meet material participation standard.
_____ Does taxpayer have several passive businesses with losses in which he participates 100-500 hours, and the total participation in these activities exceeds 500 hours?
_____ Did taxpayer materially participate for any 5 out of the last 10 years?
_____ Do facts and circumstances indicate taxpayer materially participates? This test in Reg. § 1.469-5T(a)(7) does not apply unless the taxpayer worked more than 100 hours a year. Furthermore, it does not apply if (1) any person received compensation for managing the activity or (2) if any person spent more hours than taxpayer managing the activity.
NOTE: If the taxpayer's statements or narrative summary appears to be self-serving or questionable, be sure to request supporting documents, telephone records or third party verification. We need not accept at face value uncorroborated testimony if it is questionable, improbable or unreasonable.
_____ Request any management contract with condo association’s responsibilities highlighted. Frequently, there is little left for the taxpayer to do.
CONCLUSION: Activity does/does not meet the definition of a rental per
Reg. § l.469-lT(e)(3)(ii) and taxpayer does/does not meet the material participation standard per Reg. § l.469-5T(a). If activity is not a rental and taxpayer is not materially participating, loss is disallowed unless taxpayer has other passive income on the return.