Avoinding SE tax using a Limited PS

[Jesse]

Sometimes goose chasing is a good thing!

Actually I had one of those "Oh Sh!t" moments, as I have a client that has cabins rented out for short periods, anywhere from a weekend to two weeks. I've been reporting on schedule C for several years now. I had to rediscover the reason I concluded Schedule C and not Schedule E.

Like it or not we learn from our mistakes, I'd rather the mistake be around this virtual water cooler rather than on an actual return! A good tax pro can't see in only black and white because Facts and circumstances create shades of grey.

[dsi]

B, all the running around makes for a real good learning experience, at least for me. I appreciate all the comments and I look forward to much more participation in the future.
Many thanks to all.

[BHoffman]

Jesse - that info you provided clearly supports Sch C, and I apologize to Dave for running this thread around.

I guess I'm inclined to see rental activities on Sch E, but it is what it is.

Sorry for the goose chase.

B

[dsi]

Jesse, that's awesome. Thanks for locating that source. Years ago when I set this client up, I knew I had done some research and determined it was in fact a Sch C activity.

[Jesse]

Another link

http://www.irs.gov/businesses/small/...146832,00.html

[Jesse]

Found this on a different CPA site:

He has several cabins that he rents out to vacationers during the year. They are rented out by the day, and sometimes for the week. i.e., a group of snow skiers from Southern CA want to come up the the area and spend a week skiing. They would rent one of his cabins for the week. All rentals are short term. This is a Sch C activity, not E.

Beware Commercial Rentals: Not all rental activities are considered a passive activity and meet the $25,000 loss deduction rules (IRC 469). Rentals averaging seven days or less, such as auto, hotels, and many resort condos, have an average period of customer use which is seven days or less. As a result, the activity is no longer a rental by definition and does not qualify for the $25,000 deduction. In Letter Ruling 9505002, the IRS concluded that taxpayers who owned and rented a condo in Ocean City did not have a rental activity for purposes of IRC 469 and were not eligible for the $25,000 loss deduction. IRS based their opinion on the fact that the average rental period was seven days or less. Therefore, it was classified as a business activity. Unless a taxpayer can prove that they materially participated in the business, the loss is classified as passive and could be only deducted against passive income.

Tax Tip: If you are renting on a month to month basis or any period greater than a week, you do not have a problem. The key is that the average rental period must be more than seven days. For example, during the busy summer months rent out by the week but then fill in during the off season for reduced rates with two weeks or month rentals to get your average rental period to be greater than seven days.

[BHoffman]

The definition of "Material Participation", leading to "Real Estate Professional" seems to be the question. The following is a link to how the IRS defines "Material Participation" in its Passive Activity Loss ATG:

http://www.irs.gov/businesses/small/...146335,00.html

This is especially interesting because the audit guide presented argues against rental losses being taken as ordinary under almost any circumstances. The guide seems to indicate that losses (and therefore income) from rental activities are passive even if the owner materially participates and shows that an auditor is to carefully screen the return to prevent taxpayers from erroneously claiming ordinary losses from rental activities when the IRS considers substantially ALL rental activity to be passive in nature. I already posted the exception.

That said, what about hotels and motels? They are a bona fide business operation and their income/losses wouldn't be passive, would they? Does your client's cabin rental operation meet the definition of a motel? Maybe. Would the IRS deny an ordinary loss from these rentals, and argue that the loss is passive? Maybe.

Is your client a Real Estate Professional? If not, then I think this belongs on Sch E.

[dsi]

Maybe not as tenants come and go, but doing it as guests come and go on weekly or more basis 52+/- times a year is a bit more than renting a fully furnished place. I bet toilet paper, paper towels, soap. shampoo etc, etc is also provided, lawn service, snow shoveling and plowing.

Indeed....snow removal, toilet paper, paper towels, trash service, and more. All provided by my client.

[newbie]

.......... just renting a fully furnished place does not make it a Sch C, nor does the owner having someone come in after the renter has left to ready the place for a new renter.

Maybe not as tenants come and go, but doing it as guests come and go on weekly or more basis 52+/- times a year is a bit more than renting a fully furnished place. I bet toilet paper, paper towels, soap. shampoo etc, etc is also provided, lawn service, snow shoveling and plowing.

[kaimana]

If your client provides maid service during the time that the place is being rented then I would agree on a Sch C but just renting a fully furnished place does not make it a Sch C, nor does the owner having someone come in after the renter has left to ready the place for a new renter.

[BHoffman]

This client has a management company handle all of the bookkeepings, collection of cash, etc. So he doesn't really participate, except for perhaps making the big decisions on repairs.

Hmmmm.....

Do you believe he meets the requirements in (i) and (ii)?

If you can answer that question, then I think the scales will tip one way or another but for now my Magic 8 ball says it's time for supper.

[dsi]

My client does have a maid who changes the linen, does the laundry, and the cleaning of each of the cabins...not apartments...cabins. He even does some of the repairs himself.

[BHoffman]

I've changed my mind. I'm voting for Sch E based on the following:

dsi says the taxpayer does not provide services. He hires a management company who takes care of all the daily work.

IRC 469(c)(2)

All rental activites are passive, even if the taxpayer materially participates, unless he or she is a real estate professional.

See also IRC 469(c)(7) for information regarding whether the activity rises to the level of a business. See a snip below:

"(7) Special rules for taxpayers in real property business

(B) Taxpayers to whom paragraph applies
This paragraph shall apply to a taxpayer for a taxable year
if -
(i) more than one-half of the personal services performed
in trades or businesses by the taxpayer during such taxable
year are performed in real property trades or businesses in
which the taxpayer materially participates, and
(ii) such taxpayer performs more than 750 hours of services
during the taxable year in real property trades or businesses
in which the taxpayer materially participates.

So, does the client satisfy (i) and (ii)? If so, then it looks like Sch C. If not, then I think Sch E.

Hope this helps.

[newbie]

If you provide significant services that are primarily for your tenant's convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ, Net Profit From Business. Significant services do not include the furnishing of heat and light, cleaning of public areas, trash collection, etc.

Even if only one cabin I sway toward Schedule C if you're providing more than the norm in the way of service such as furnishing of furniture, beds, dishes, linens with cabins cleaned and bedding changed before and after guests(or at least I would hope) all for the convenience of the guests, short term guests as opposed to tenants.

Would agree that the living trust only offers a potential savings by avoiding probate.

[kaimana]

Sounds like an obvious attempt to avoid SE tax...and if it is obvious attempt, knowledgable attempt, isn't that illegal? anyone agree?