My CPA is using my Passive Activity Losses to write off my non-passive income????????

Question

I don't know if my CPA understands and is preparing my taxes correctly.

I love her and want to grow my business with her, but I need some knowledge so I can have a good conversation with her.

Here's the scenario:

In 2022 I earned $109K at my W2.  Non-passive income, right?

Also in 2022 I spent $28k renovating 430SF of my primary residence and launched that space on Nov 14th 2022 as a short term rental earning $500 of income for the year.  So I took a loss of $27,500 not counting any depreciation which my CPA said she will still calculate because it will carry over, right?

My average night stays were less than 7 nights and I did work of course to operation the short term rental, but I did not record my hours.  My CPA btw isn't aware of the less than 7 average nights rule thing that's apparently in the tax code.

She does understand the $25,000 cap of writing off losses towards my non-passive W2 income if earned less than $100K and then the $25k cap gets reduced as you approach $150k in earnings and after $150k you can't write off anything.  She did speak to that.

But she says it's ok to write off those losses towards my non-passive W2 income because I'm running a "business". I'm worried that my business is considered "real estate" and therefore generates passive income and passive activity losses and therefore cannot be used to offset my non-passive W2income.

Can anyone speak to my specific situation and is my CPA doing the right thing by writing off my AirBNB losses towards my non-passive W2 income?

She also said that she will depreciate over 27.5 years and not 39 years because it's residential not commercial, but this is a short term rental not a long term rental.  So is 27.5 correct?

Thanks - Mike

Michael Meegan · Answer

I’m going to look for and find a CPA that knows RE IRC.  Easier said than done when you don’t know what you don’t know, right?

But, I have a strategy.

I will ask for CPA referrals from other investors in my area and reach out. I will ask these CPAs if they are taking new clients and if so I will ask them if it would be alright if I explained my operations, income and expenses for 2022 and if that’s alright I will explain and after that if they offer to explain to me how they would file my taxes and explain to me why they will do it that way and why they know to do it that way then honestly I’m not sure what I will do after that. Because it seems like it would be easier to find Bigfoot.

What on earth would I do with myself if a CPA can actually explain to me what they recommend and why?I think I may become a tax professional.  It’s the only way I think I’ll ever know the truth.

I will name the firm “Bigfoot CPA Professionals”. Or maybe “Unicorn Tax Preparers”.

Christina Yoon · Answer

Dibs on the name if you haven't trademarked it yet :)

In all seriousness though, it seems that you aren't confident about your current CPA's level of expertise in an area you need an advisor.  That's the most dangerous part of everything mentioned.

Michael Plaks · Answer

@Michael Meegan

You love your CPA? Does she know? Dangerous game right there. :)

Love her all you want, but find someone else for tax work. The issues you're worried about are valid, and the issues previously mentioned by my colleagues are valid.

We have not discussed the elephant in the room though. You converted a part of your residence to an STR. You still live there, too. Chances are that your STR does not qualify as a separate "dwelling unit" and is subject to limitations imposed by a very tricky Section 280A. Meaning - you cannot take any loss on your STR, no matter what the other rules say, besides mortgage interest and taxes.

The other rules will be cancelled by 280A rules. It's a very complex situation requiring a specialist. For starters, to determine IF these 280A rules apply to you.

Jon Fletcher · Answer

@Michael Meegan needs to be rescued by @Greg O'Brien lol

Natalie Kolodij · Answer

Ooofffff ......It's like she's so wrong she almost has it right haha

So the ironic part is- you likely qualify for them to be non-passive becuase it's < 7 days, material participation is likely ect. But STR are 39 years-they don't meet the definition of a residential rental proeprty for 27.5 years.

And IRC 469 has the defining factors between passive an non passive losses for a reason. Just saying becuase your "business" is real estate doesn't make these losses deductible magically. That's why real estate professional status exists and has very strict defining factors to it. I would recommend working with someone who is real estate specialized. Based on how she is doing things this would NOT be defendable in audit. It's pretty critical the tax professional understand the actual strategies and legalities around what they're doing...and isn't just...going with a feeling.

Linda Weygant · Answer

Oh my.... that's certainly a whole lot of creative interpretations of the tax law.....

I appreciate your loyalty to her but ask yourself - when push comes to shove, is she going to cover your penalties and interest for if/when you need to correct these issues??  Does she even carry errors & omissions insurance?  Is she qualified/experienced to represent you if/when these issues come up for audit?

There's no need for you to be this person's guinea pig while she learns this side of taxation.  You deserve to be with somebody that not only will file things correctly (there are roughly 5 issues with everything you wrote above that need to be thought through and well considered), but will also be able to help you strategize and plan as you grow.

The answer is so much beyond just the 27.5 vs 39 year question you're asking.  You/she has not considered (or apparently does not understand) De Minimus Safe Harbor rules or the concept of In Service date for the proper treatment of remodeling expenses.

Please do yourself a favor and get to a real estate focused CPA.

My CPA is using my Passive Activity Losses to write off my non-passive income????????

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