Active vs Passive Participant - Considering Hiring a Property Management Company

[rothwem]

I've got a duplex in another city 250 miles away from me.  I have been "managing" it myself for the last year and a half, and things have gone fairly smoothly, but I've had a few annoying things crop up in the last month that I could've easily addressed if I was there, or if there was a property manager onsite to fix these things. 

So anyways, I've been looking around, and I think I'm okay with the price, but I recall when doing my taxes, Turbotax asked me if I was an active participant.  Since I was, I said I was.  If I have a property manager, can I still be an active participant?  What does being an active participant do for/to me as far as taxes are concerned?

[LightStache]

The active participation exemption allows you to deduct losses from your RE business against earned income. It's only relevant if your duplex generates a taxable loss -- check out Pub 527 section on "Exemption for RE with Active Participation."

The IRS says "You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions."

I use property managers, but I make all tenant decisions and repair decisions over $500, so I consider myself an active participant and I deduct losses against my active income. This benefits me long-term because I'm at a marginal combined rate of 33.3% -- when I RE and sell a property, depreciation recapture will be lower at 25% assuming I've moved out of a state that taxes depreciation recapture.

[rothwem]

The active participation exemption allows you to deduct losses from your RE business against earned income. It's only relevant if your duplex generates a taxable loss -- check out Pub 527 section on "Exemption for RE with Active Participation."

The IRS says "You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions."

I use property managers, but I make all tenant decisions and repair decisions over $500, so I consider myself an active participant and I deduct losses against my active income. This benefits me long-term because I'm at a marginal combined rate of 33.3% -- when I RE and sell a property, depreciation recapture will be lower at 25% assuming I've moved out of a state that taxes depreciation recapture.

Awesome reply, thanks.  That IRS reference was exactly what I needed. 

[/thread]

[SeattleCPA]

The active participation exemption allows you to deduct losses from your RE business against earned income. It's only relevant if your duplex generates a taxable loss -- check out Pub 527 section on "Exemption for RE with Active Participation."

The IRS says "You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions."

I use property managers, but I make all tenant decisions and repair decisions over $500, so I consider myself an active participant and I deduct losses against my active income. This benefits me long-term because I'm at a marginal combined rate of 33.3% -- when I RE and sell a property, depreciation recapture will be lower at 25% assuming I've moved out of a state that taxes depreciation recapture.

Awesome reply, thanks.  That IRS reference was exactly what I needed. 

[/thread]

You probably are okay here as FatFI2025 explains... but you want to be careful you're not conflating rules.

The active participant thing mostly applies if your income is $100K or less and then phases out as your income moves from $100K to $150K. But that 33% marginal rate almost suggests that you're not talking about the active participant route to claiming a real estate loss deduction on your tax return but rather the real estate professional route to claiming the deduction. In that case, if you hire a property manager, then your property manager hours no longer count for real estate professional status.

I don't think this is situation you're in...but that high 33% marginal rate probably means you want to double-check.

For more info about this issue, see the discussion "Subtracting Management Hours" in the following blog post:

https://evergreensmallbusiness.com/real-estate-professional-audit-troubles/

[LightStache]

The active participation exemption allows you to deduct losses from your RE business against earned income. It's only relevant if your duplex generates a taxable loss -- check out Pub 527 section on "Exemption for RE with Active Participation."

The IRS says "You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions."

I use property managers, but I make all tenant decisions and repair decisions over $500, so I consider myself an active participant and I deduct losses against my active income. This benefits me long-term because I'm at a marginal combined rate of 33.3% -- when I RE and sell a property, depreciation recapture will be lower at 25% assuming I've moved out of a state that taxes depreciation recapture.

Awesome reply, thanks.  That IRS reference was exactly what I needed. 

[/thread]

You probably are okay here as FatFI2025 explains... but you want to be careful you're not conflating rules.

The active participant thing mostly applies if your income is $100K or less and then phases out as your income moves from $100K to $150K. But that 33% marginal rate almost suggests that you're not talking about the active participant route to claiming a real estate loss deduction on your tax return but rather the real estate professional route to claiming the deduction. In that case, if you hire a property manager, then your property manager hours no longer count for real estate professional status.

I don't think this is situation you're in...but that high 33% marginal rate probably means you want to double-check.

For more info about this issue, see the discussion "Subtracting Management Hours" in the following blog post:

https://evergreensmallbusiness.com/real-estate-professional-audit-troubles/

Yes fair enough -- I included 9.3% from CA plus 24% Federal to get to 33.3% but I haven't confirmed whether CA allows that exemption.