Passive Losses Into Active Losses - Is This Possible??

Question

I've got several properties with the unique advantage of having my father, a 20 year veteran in the property management business, manage them . He works for a property management company that I pay a 10% management fee to, and then he receives his portion from his employer that is paid to his Scorp.  I have a full time W2 job outside of real estate and also have an active license, although I haven't used it in the few months I've had it.

The main barrier I have with not 'materially and actively participating' is the fact that I am still paying a property management company.

My question is this: is there a way for me to get added as an officer to my dad's Scorp, pay 'my' Scorp the 10% management fee, and then pay the management company through from the Scorp? *His employer is fine with this, and would then pay him his portion back to the Scorp*

Thanks in advance!

Ashish Acharya · Answer

@Jeremy Kuchenbecker

Your plan up there is just shifting the expense from one vendor to another vendor ( your S-crop).

You S-corp won't have a loss because you are just funneling your money, the money coming in might be income and when you pay your dads employer, the net effect is zero.  I might not be understanding your strategy.

There are actually other ways to use passive losses:

1) Look into self-charged interest ( your interest income from lending to your business) that converts your interest income ( which is normally a portfolio income)  to passive income. You can then offset a passive loss.  ( I know it is a complicated topic, please talk to qualified professional)

2) investing in a property that might provide a cash flow and income rather than a loss.

3) investing in other businesses as a passive investor

4)  as @Dave Toelkes mentioned, upping your involvement so that you can qualify for active participation. you dont have to qualify for Material participation. Active participation is less strict and can be easily achieved if you have that many properties.

5) Disposing of a property that is not performing so you can release the suspended losses.

and few other, you get an idea.

Talk to your CPA.

Dave Toelkes · Answer

@Jeremy Kuchenbecker

Even though you have outsourced day-to-day property management, you are still actively participating if you reserve have the final say on key management decisions.  Determine the rent you will accept, determine whether to renew a lease, decide which contractor to use for a major repair, decide when an appliance is to be replaced are all examples of active participation in your rental activity.

Even deciding which property manager to use is active participation.

Michael Plaks · Answer

@Jeremy Kuchenbecker

There's likely some confusion in the big picture.

1. Active participation. From what you described, you qualify already. AP allows you to deduct some losses (technically classified as "passive") against your non-passive income, such as your W-2. This deduction is limited to $25k, and it is phased out once your regular (W2) income goes above $100k.

2. Material participation. It will be very difficult for you to meet this much stricter standard. MP is needed to overcome the income-based limitation I mentioned above. The technical term is "Real Estate Professional." However, because of your regular job, this road is closed for you. No point to even try MP.

3. Irma losses. These losses can be taken in full, even of your other losses are limited by your income. Casualty losses are deductible regardless of your income.

Jeremy Kuchenbecker · Answer

@Dave Toelkes I have the final say on pretty much every aspect except contractors where I will generally let my dad's do the work, but I have input and ultimately final say on them. My dad will give me the details of tenant applications i.e. credit score, income requirements (3x rent) etc and his recommendation, and I will approve or disprove. Similar process with contractors, setting lease terms, pet fees, and whether to repair/replace items etc.

@Ashish Acharya I think you may have understood it, but the net effect for the scorp would be zero, however it would show there I am personally paying the scorp to manage my properties, thus allowing me to substantively prove I am managing my own properties. I could be way off base but that was the thought behind it. I've got a >2x debt service on all my properties but because hurricane Irma turned out to be quite expensive last year, I'm trying to maximize the tax benefit as much as possible.

Love the feedback though - after digging up active vs material participation I can probably justify to my CPA that I qualify for that which will be a huge help. Appreciate it!

Passive Losses Into Active Losses - Is This Possible??

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