When is a rental not a rental activity?

This article address the taxation and reporting of rentals of vacation condo, cottage, lake house or similar-type real estate.

Many incorrectly report their rental activities to their disadvantage. 

Before proceeding further, you will first have to determine whether you or those persons related to you spend the greater of 14 personal days at your vacation property or 10% of the days rented at fair rental value.  If so, this discussion is not applicable to you as the vacation home rules as described in Code Section 280A may apply and any losses that you incur on the rental activity may be limited to income from the activity.  If not, then keep reading.

If the average rental period of your rental is 7 days or less (to figure the average rental period of customer use divide the total number of days rented by the number of customers for the year) and you provide significant services, you should be reporting the rental activity on Schedule C rather than Schedule E.  This means that the activity is treated as a trade or business rather than a rental.  However, you as the taxpayer must still materially participate in the activity before it can be treated as nonpassive. 

 In order to meet the material participation standards and claim that your rental activity is not passive one of the following must apply:

1. You work 500 hours or more in the activity during the year;
2. You do all, or nearly all, of the work in the activity;
3. You work more than 100 hours in the activity during the year, and no one else works more than you do;
4. The activity is a significant participation activity (SPA), and the sum of the SPAs in which you work 100-500 hours exceeds 500 hours for the year;
5. You materially participated in the activity in any 5 of the previous 10 years;
6. The activity is a personal service activity and you materially participated in that activity in any three prior years; or,
7. Based on all of the facts and circumstances, you participate in the activity on a regular, continuous, and substantial basis during that year. Note that this test only applies if you work at least 100 hours in the activity, no one else works more hours than you in the activity, and no one else receives compensation for managing the activity.
As we always recommend to our clients, keep good records to prove your material participation.  Note that the use of a management firm makes material participation less likely.

If you meet one of the above, then your Schedule C rental activity is treated as nonpassive.  And consequently, any losses are fully deductible and they will reduce self-employment income from any of your other Schedule C trades or businesses.  In turn, you will have less self-employment tax and regular taxes to pay.  If you have a Schedule C profit that exceeds $400, then you will be subject to self-employment taxes on that profit.

If you fail the material participation test, then your Schedule C rental losses are not deductible against your ordinary income and the unused losses carry forward for possible use in subsequent years.

If you have any questions, do not hesitate to contact the professionals at Dana S. Beane & Company, PLLC



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