Passive vs non-passive activities (material participation)

2 Replies

Hello everyone!

I'm reading a lot about passive vs non-passive rental activities and cannot really find a clear explanation.

This publication from the IRS says:

1. "Material Participation: A trade or business activity isn’t a passive activity if you materially participated in the activity. Material participation tests. You materially participated in a trade or business activity for a tax year if you satisfy any of the following 7 tests."

2. In the same article under the Real Estate Professional section it says: "Generally, rental activities are passive activities even if you materially participated in them. However, if you qualified as a real estate professional, rental real estate activities in which you materially participated aren’t passive activities."

So in the same publication as far as I can understand, the IRS provides two conflicting viewpoints. On different websites, you can find pretty much the same: sometimes articles say that only Real Estate Professionals (if they qualify and pass a Material Participation test) can take rental real estate activities in which you materially participated as non-passive activities. But others say that there are 3 categories: Active participant, Material participant and Real Estate Professional, and you can treat your passive losses as active if you pass either Material participant or Real Estate Professional test.

My accountant thinks that a Material Participation test would be enough to use the losses from my rental activities to offset our W2 income (we are filing jointly).

It would be great if someone could shed some light on this topic and help to answer the next two questions:

1. Can you treat your losses from rental activities (passive activities by definition) as Non-Passive if you only pass the material participation test (one of the 7 tests according to IRS)?

2. Do you need to group together related businesses as a “single activity” (469(g) election: by filing a statement with the taxpayer's original income tax return for the taxable year) if you have 4 duplexes in order to pass a Material Participation test? According to IRS: If you participated in the activity for more than 500 hours you satisfy one of the 7 tests. Does that mean 500 hours per building, unit, or per all your properties combined?

Thank you in advance!

Originally posted by @Renee H. :

Hello everyone!

I'm reading a lot about passive vs non-passive rental activities and cannot really find a clear explanation.

This publication from the IRS says:

1. "Material Participation: A trade or business activity isn’t a passive activity if you materially participated in the activity. Material participation tests. You materially participated in a trade or business activity for a tax year if you satisfy any of the following 7 tests."

2. In the same article under the Real Estate Professional section it says: "Generally, rental activities are passive activities even if you materially participated in them. However, if you qualified as a real estate professional, rental real estate activities in which you materially participated aren’t passive activities."

So in the same publication as far as I can understand, the IRS provides two conflicting viewpoints. On different websites, you can find pretty much the same: sometimes articles say that only Real Estate Professionals (if they qualify and pass a Material Participation test) can take rental real estate activities in which you materially participated as non-passive activities. But others say that there are 3 categories: Active participant, Material participant and Real Estate Professional, and you can treat your passive losses as active if you pass either Material participant or Real Estate Professional test.

My accountant thinks that a Material Participation test would be enough to use the losses from my rental activities to offset our W2 income (we are filing jointly).

It would be great if someone could shed some light on this topic and help to answer the next two questions:

1. Can you treat your losses from rental activities (passive activities by definition) as Non-Passive if you only pass the material participation test (one of the 7 tests according to IRS)?

2. Do you need to group together related businesses as a “single activity” (469(g) election: by filing a statement with the taxpayer's original income tax return for the taxable year) if you have 4 duplexes in order to pass a Material Participation test? According to IRS: If you participated in the activity for more than 500 hours you satisfy one of the 7 tests. Does that mean 500 hours per building, unit, or per all your properties combined?

Thank you in advance!

 Your accountant is not correct. This is one of the complicated areas and might need more than a post to clarify. 



1. Can you treat your losses from rental activities (passive activities by definition) as Non-Passive if you only pass the material participation test (one of the 7 tests according to IRS)? 

- No


2. Do you need to group together related businesses as a “single activity” (469(g) election: by filing a statement with the taxpayer's original income tax return for the taxable year) if you have 4 duplexes in order to pass a Material Participation test? According to IRS: If you participated in the activity for more than 500 hours you satisfy one of the 7 tests. Does that mean 500 hours per building, unit, or per all your properties combined?

- if you are not even a real estate professional, this election is worthless. Actually, this is harmful if you are not a RE pro. 


Normally, every business activity is passive if you don't meet the material participation test. However, rental is always passive even if you materially participate. The only way to change passive rental activity to non-passive is to qualify as RE pro first. Then, your martial participation in the rental will determine if it is passive vs no-passive. 

Basically, you have to be RE pro first to use those 7 seven tests you mentioned.