Will your short-term rental losses offset your other income?

Will your short-term rental losses offset your other income?

You may have heard that you are allowed to deduct losses from a vacation home. Not exactly true, but sometimes the fact pattern fits. Here is how the rules work.

Normally, rentals are passive activities and you cannot use losses to offset your income. This applies to almost all rentals. But we have exceptions. One of those exceptions is if the average period of customer use is 7 days or less, or if it is 30 days or less and the owner provides significant personal services. Ordinary rental services do not automatically qualify as significant personal services.

Great. So does this mean you get to deduct losses if you have a rental that fits these criteria? No. This just means that the rental is not treated as a "rental activity", it is treated as a regular passive activity.

We have one more hurdle to overcome - you or your spouse (if you file jointly) must materially participate in the activity. This is a much lower standard than the real estate professional test, and any of the tests may be met. The ones that may apply here would be:

• Your work is substantially all participation, including the work of nonowners.
• More than 100 hours, and at least as much as any other individual.
• More than 500 combined hours in qualifying significant-participation activities, with more than 100 hours in each.
• More than 500 hours in the activity.

Investor work generally does not count unless you are directly involved in day-to-day management or operations. Hiring a property manager can affect the comparison of your work with other people's work.

Then test personal use.

If personal use exceeds the greater of 14 days or 10% of fair-rental days, the unit is treated as a residence. Section 280A can limit rental deductions and prevent the loss you expected. Family use and below-market rentals need to be counted under the rules; they are not automatically business days.

Finally, test whether the deduction can be used.

Basis, at-risk, passive-loss and excess-business-loss limits still apply. When a loss is allowed, qualifying nonpassive treatment may let an otherwise deductible operating loss offset ordinary, nonpassive income.

But the exception can remove benefits too. Nonpassive income cannot absorb unrelated suspended passive losses.

Define and group the activity under the rules. Keep contemporaneous calendars, messages, vendor records and task logs. Build the participation file during the year - not after a challenge.

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