Active Participation - Anyone have audit experience with this?

Question

I've seen people in the BP forums with differing opinions on the topic (shocker!). Some say as soon as you get a Property Manager you are passive no matter what. Others quote the readily available Internet information saying  "if you (and your spouse) owned at least 10% of the rental property and you made management decisions"... blah, blah.

But I'm curious to know, has anyone in the forums actually been audited to be able to speak authoritatively on this subject? Has anyone with a prop. mgr. been audited and proved that they actively participated in the rental activities and been deemed by the IRS as actively participating?

Ashish Acharya · Answer

@Thomas Condon,

I was going to wait until someone replied... but looks like no one has been audited. And that’s consistent with what I have seen.  You don’t get audited because IRS sees that passive loss deduction on your return. Most of the court cases, the active participation was one of the aspect tax court analyzed on the cases that has other major tax issue. There are millions of taxpayers who are considered active in the RE and also have property management.

Based on the tax court cases, yes you can have property manager but still actively participate in the rental.

You will  still be approving tenants, big repairs and improvements, and other stuff.

Jeff O. · Answer

Hello @Michael Plaks and @Ashish Acharya, are you allowed to change/switch the category of your engagement to the property from Passive to Active participant in the future once you classify them when you acquired the property?

The reason I ask is because I bought my rental from a turnkey company last year and so far, there haven't been any major repairs.  But I imagine the maintenance repairs would come in the future and those will require my approval if it exceeds a certain $ amount.  In addition, I won't be benefiting from the $25k special allowance as an Active participant right now because my income is beyond the limit.  But if my income drops in the future, classifying it as active participant might come in handy.

Thinking if it's better to classify as an Active participant now even though I am not getting any benefit out of it so I won't have to change it in the future?

Would switching between the two categories trigger potential audits?

Thomas C. · Answer

@Michael Plaks and @Ashish Acharya, thanks for the replies! I’m a little more relieved to hear these responses. ESPECIALLY from Tax Accountants!

Michael Plaks · Answer

@Thomas Condon

Let's be sure we're talking about the same thing. "Active participation" is a test required to deduct up to $25k of rental losses against some other type of income, like W2 income, as long as the income is not too high. It's a fairly liberal test where it's enough to simply be involved in decision making - for instance, approving a tenant or a major repair. Property manager is not an obstacle for this test. 10% ownership is part of this deal, too, and it prevents most syndication investors from using this deduction. I have never seen this particular issue audited in 20 years of working exclusively with REI investors.

Passive v. non-passive losses is an entirely different issue which deals with the "real estate professional" status where you need to prove "material participation" - a much more restrictive test. Hiring a property manager does complicate this other situation significantly.

Active Participation - Anyone have audit experience with this?

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