Do Real Estate Professionals automatically qualify Short-Term Rentals as Active Income?

For a real estate (RE) professional, the classification of rental income and losses from short-term rentals is not automatic. It depends on material participation. Even if you qualify as a real estate professional under the IRS rules, you must also meet the material participation tests to treat rental income and losses as non-passive. Here's the distinction:

Real Estate Professional Status:

• To be considered a real estate professional, you must spend more than half of your working hours and over 750 hours per year in real property businesses in which you materially participate.

Material Participation:

• For each rental activity, you must meet one of the seven IRS tests for material participation. If you don't materially participate in a particular rental activity, the income or loss from that activity could still be considered passive, even if you are a real estate professional.

Short-Term Rentals:

• The IRS sometimes treats short-term rentals (average rental of 7 days or less) not as passive rental activities but as a trade or business, especially if substantial services (like hotel-type services) are provided to the guests. If this is the case, the income and losses from these activities could be considered non-passive business income or losses, which can be fully active irrespective of the real estate professional status.

Combining RE Professional Status with Material Participation:

• If you are a real estate professional and you materially participate in your rental activities, your net rental income is treated as non-passive, and you can use any losses to offset other sources of income, such as wages, without being limited by passive activity loss rules.

Record Keeping:

• It's crucial to maintain detailed records and documentation of your participation in the activities to substantiate your claims if questioned by the IRS.

In summary, real estate professional status in itself does not automatically make rental income and losses non-passive. Material participation in each rental activity is also required to determine the correct classification. Given the complexities and nuances in tax law, it's often beneficial to consult with a tax advisor or accountant who specializes in real estate taxation to ensure you meet the necessary requirements and properly report your income and losses.