Pass through expenses for STR - active or passive designation?

Question

I'm working with a CPA who is arguing that STR should be considered a passive designation and therefore losses in our holding LLC cannot be applied to my W2 wages (which are > $150k). My spouse and I will be allocating more than 100 hours managing and working in this business. Sure we hire handymen and cleaners, but we are still active in the daily operations and listing set up process.

In addition, we plan to BRRRR properties into LTR holdings (separate LLCs), where the rehab process (even just the leadgen portion) over the year would definitely put us into the 100+ hour territory.

For both the STR and BRRRR LTR, can't we designate those both as active income given our involvement?

Ashish Acharya · Answer

For LTR, you have to qualify as REPS and materially participate in your properties.

For STR, there is no requirement for REPS but you have to materially participate in your properties.

John Bernardo · Answer

Thanks all for the input.@Michael Plaks material participation is super interesting. With cleaners doing 5 cleans per month at ~1 hour each and handymen taking on maintenance items only, I don't see how they would ever exceed our 6-8 hours average per week.

We also do not have a PM and self-manage, with little/no automation yet.

Between myself and my spouse, we will be putting in at least 6-8 hours per week minimum in the operations of the STR. That includes any hands on operations in the STR, lead generation and follow up, coordination, working with agents, developing and operating marketing campaigns.

Michael Plaks · Answer

@John Bernardo

You need to pass the "material participation" test for this business. One of the possible ways to qualify is indeed 100 hours, but it's only half of the rule. You also cannot have any other person, including handymen and cleaners and property managers, work more hours than you. If one of them works 101 hours against your 100, you lose.

Have your CPA explain material participation to you and why he thinks you do not qualify.

Basit Siddiqi · Answer

In general, rental real estate is considered passive.There are some exceptions.You normally hire a professional because he/she is knowledgeable in the field that they practice in. Did you vet that they were a specialist in real estate when hiring him/her.If you are both arguing on a specific topic, you both can go through the tax codes, treasury regulations to provide support of why one is right / wrong.Section 469 discusses passive activities.Best of luck.

John Underwood · Answer

What is your involvement in the STR?

Do you clean and cook meals and mow the grass etc? Or are you not providing meals and have a cleaner?

Most STR'S are passive. Sounds like your CPA may know what he's talking about.

Pass through expenses for STR - active or passive designation?

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