I have some questions about running STR as active vs. passive.

[Andrew Angell]

We are under contract on a property that we'll be operating as a STR and managing it ourselves.

We have paper losses on our books from a syndication that generated bonus depreciation last year.  

We also have an S-corp that is our primary business and generates the majority of our household income.  It puts us in a relatively high tax bracket.

My wife and I are both on our s-corp payroll, so I don't think we'd be able to qualify ourselves as REPS.

I was reviewing some info about running the STR as active and taking advantage of bonus depreciation via cost seg. to drive up our paper losses which could then offset our active s-corp income.

However, with the passive losses on our books it seems to make more sense to just run it as passive and let the income be offset by our paper losses.

But then I got thinking - we are going to manage this property ourselves, and we likely will have an avg. stay of fewer than 7 days, which seem to be the qualifiers for a STR being treated as active instead of passive.

They're going to force us to treat it as active anyway aren't they?  

I guess I would need the same type of documentation (ie. time logs) showing that we are not a "material participant"..??  Or would being the property manager automatically make you a material participant?

Is that why people use a separate LLC to act as the property manager even when managing it themselves? So your rental LLC pays a management fee to your property manager LLC. Now the property manager LLC has a little bit of active income you have to book, but the rest is left as passive inside the rental LLC..??

As you can see if you made it here I'm a bit all over the place with this.  Any general feedback, thoughts, or info would be greatly appreciated.  Thanks!

[John Malone]

@Andrew Angell happy to chime in.  I'm a tax attorney and owner of a tax strategy & accounting firm that specialized in real estate and deal with this all the time.  A few notes here to answer your questions:

1) If you check all of the boxes as a material participant, rent avg 7 days or less, will you be forced to treat this as "nonpassive"?  - YES - you don't elect your participation.  Think of it this way...you can't just choose to be a passive S Corp owner even if you materially participate.  It works both ways under IRC 469. 

2) Documentation - yes, this is key.  I posted yesterday about a recent tax court case where frankly the judge laughed at the taxpayers as they had no records then tried to make them up after the fact.  We have some clients where we need to prove they do NOT materially participate in their business' which is actually quite tricky and the IRS approaches this with skepticism. 

3) No, a MGMT LLC would not help you here.

Overall, let the facts dictate the outcome as you might be in a win/win here. If you are passive, it appears you have PALS that could be soaked up. If you cross the barrier into material participation, you could likely work with your team to take advantage of the STR strategies to offset S Corp income.

If you have any other questions feel free to post!