How to meet material participation hours for out of state investors

PinnedTampa, Florida
Tax, SDIRAs & Cost Segregation
1yFollow

How to meet material participation hours for out of state investors

Annie Anson
Member since 2024 · 8 posts · 9 votes

My husband and I are ready to invest in our first vacation property, likely in Florida. We hope to eventually have multiple properties, but want to take our time to learn and make the right decisions with our first rental. I should add it will be a short term rental property. 

What adds complexity to our plan, is that we live in Minnesota. We would like for the investment to be treated as active, of course. However, we will likely need a property manager to assist with some facets of running this rental (since we would not live locally) and would primarily market it through platforms such as Airbnb and VRBO to start, (eventually setting up a direct booking process).

Here's our question for those who have experience in STR's or who might be involved in a similar scenario: How challenging is it to meet the material participation hours needed to achieve active status? My husband is a high income W2 earner, and meeting active criteria would put some of our tax dollars back in our pocket. Is it possible to have a property manager who manages some of the property, while I manage the rest remotely? For instance, said property manager manages maintenance issues, problems that arise during bookings, basically anything that needs a physical person at the property, while I manage the rest? (i.e. initial decorating and painting, bookings, rate structures, marketing, bookkeeping housekeeping, etc)?


According to what I have read straight from the IRS website and other places, we need to either meet 500 hours, or at least 100 hours and also work more than anyone else on the property. I feel I could definitely meet both of those on my own, as my husband works full-time , and I will be the only person besides the hourly employees stated above that would be accruing hours. However, the one CPA I briefly talked to said the investment would be treated as passive. No real explanation as to why or whether there were exceptions to that. 


We are newbies, and don't want to miss out on a great investment and tax savings opportunity, but obviously want to do everything correctly in the eyes of Uncle Sam. Thank you so much in advance for your help.

4Reply
162 views

Most Popular Reply

Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
1y
Quote from @Annie Anson:

My husband and I are ready to invest in our first vacation property, likely in Florida...  a short term rental property. 

What adds complexity to our plan, is that we live in Minnesota... 

...How challenging is it to meet the material participation hours needed to achieve active status?.. Is it possible to have a property manager who manages some of the property, while I manage the rest remotely? For instance, said property manager manages maintenance issues, problems that arise during bookings, basically anything that needs a physical person at the property, while I manage the rest? (i.e. initial decorating and painting, bookings, rate structures, marketing, bookkeeping housekeeping, etc)? 

First, do not get upset with the words "likely" or "possibly" - these words are accurate. Yes, I was tempted to type "these words are likely accurate" ;)  The reason is because tax rules are very much case-by-case, and your mileage may vary.

Here is an important clue in your particular situation: 
...I manage the rest? (i.e. initial decorating and painting, bookings, rate structures, marketing, bookkeeping housekeeping, etc)...

Let's count how much time you are going to spend doing what you described. Let's say you spent a month on the initial preparation: cleaning, painting, shopping for furnishings, assembling IKEA furniture and so on. We're possibly (sorry for using the p-word) talking about 200 hours. For the next 10 months (40 weeks) you spend a fairly reasonable 5 hours a week marketing, communicating with guests and your property manager and bookkeeping. Here is another 200 hours. We now have 400 hours in the bag, and hitting 500 is attainable during your first year.

But what if you only spent 2 days visiting this property and from that point on outsourced all work? Yes, you still do online shopping and coordination and so on, but hitting 500 hours in this case becomes far more challenging. Do you see why we accountants say "likely" and "possibly" in every paragraph we write?

If you cannot make 500 hours, then you need to make 100 hours and "outwork" everybody else. Let's say you have a guest every week for 10 months. This is 40 guests. And you use a cleaning lady who spends 5 hours to reset the property for the next guest. Now your cleaner has 200 hours, and you will have to spend at least 201. Is it doable? Well, at least it's much easier to gather 201 hours than 500 hours. But now you have a challenge of documenting both your time AND time of everybody else involved with the property.

Now, to answer your question - is it possible from out of state? Yes, it is, particularly if you undertake the initial preparation and furnishing of the property yourself. But the only way to have a definitive answer and avoid "likely" and "possibly" is to analyze your plan with your own CPA and find ways to boost your hours. Here is how to find such a CPA:
https://www.biggerpockets.com/forums/51/topics/1222774-expla...

You probably (argh, can't help myself) noticed that I was pointedly talking about the initial year. What about the second and third year when you no longer have the labor-intensive initial setup? Actually, you may not need to qualify in the second year. Why? Because your second year is likely (oops, I did it again) to show a net profit instead of net loss. It is your first year when you get the major tax savings windfall due to cost segregation and bonus depreciation. More about the concept of STR tax savings is here:
https://www.biggerpockets.com/forums/51/topics/1122635-the-s...

As to one CPA saying that your losses would still be passive, we cannot comment. Maybe you misunderstood what that CPA said. Maybe they meant a different context. Maybe they were not very good. But now you know.

4Reply
See this reply in the discussion

26 Replies

Jump to latestLatest
  • Jason MalabuteBusiness Member
    Accountant · Los Angeles, CA · Member since 2016 · 2k+ posts · 900 votes
    1y

    Great question! When it comes to material participation for short-term rentals (STRs), you’re correct that the IRS requires you to meet certain hour thresholds to qualify for non-passive status. There are a few ways to establish material participation:

    1. 500-hour rule – You must participate in the activity for at least 500 hours during the year.

    2. 100-hour rule – You must participate for at least 100 hours, and no other individual (including property managers) can participate more than you.

    3. Significant participation activity – You can aggregate all your participation in rental activities to reach 500 hours.

    Additionally, to qualify for non-passive treatment, you need to own at least 10% or more of the property—which sounds like it won’t be an issue for you.

    A key consideration is that hiring a property manager could impact your ability to qualify if they are performing more work than you. However, if you are the primary individual handling key aspects such as bookings, pricing, guest communications, and operational decisions, you can still make a strong case for material participation.

    One strategy to consider is documenting all hours meticulously—keep logs of tasks performed, emails, and time spent managing the rental. If one spouse qualifies as a real estate professional (REP) under IRS rules (750+ hours in real estate activities and more than 50% of their working time), then the tax benefits can apply to both spouses when filing jointly, which could be very beneficial.

    It sounds like you’re on the right track, and with proper documentation, you should be able to achieve material participation. Just be mindful of how much work the property manager is doing in comparison to your own involvement. Hope this helps

    Malabute & Company CPAs525 Reviews
    WebsiteView Page
    1Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free