8700 / What special passive activity rules apply to taxpayers who invest in rental real estate?

Except as provided below, a passive activity includes any rental activity, without regard to whether the taxpayer materially participates in the activity.¹ A rental activity is any activity where rental payments are made principally for the use of tangible property.²

There are a number of exceptions to this rule. An activity is not treated as a rental activity if:

(1)  the average rental period is less than eight days;

(2)  the average rental period is less than 31 days and the owner of the property provides significant personal services in order to make it available for use by customers;

(3)  the rental of the property is incidental to the receipt of personal services or to a nonrental activity;

(4)  the taxpayer makes the property available on a nonexclusive basis during regular business hours;

(5)  the taxpayer rents property to a pass-through entity engaged in a nonrental activity, in his capacity as an owner of that entity; or

(6)  the personal use of a residence that is also rented out exceeds the greater of
14 days or 10 percent of the rental days.³

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Planning Point: For purpose of (2) above, in determining if a property owner's rental services are significant, all relevant facts and services—including the frequency of the services, type and amount of labor needed to perform them, and their value relative to the amount charged for the property's use—are taken into account.⁴

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If an individual actively participates in a rental real estate activity subject to the passive activity rules, the individual may use up to $25,000 of losses and the deduction-equivalent of credits to offset nonpassive income. An individual need not actively participate in a rental real estate activity to obtain the $25,000 rental real estate exemption with respect to taking the low-income housing credit or rehabilitation tax credit.

If the investment is in real estate which is not rental property, the real estate activity will generally be considered a passive activity subject to the passive loss rules unless the taxpayer materially participates in the activity. The $25,000 rental real estate exemption is not available with respect to nonrental property.