Short-term rental not qualified for APRRE.

Letter Ruling (TAM) 9505002 presents a very interesting situation in which a rental activity was not considered rental real estate because of the short duration of the rental, and because the lack of significant services performed did not rise to the level of an active trade or business.

A husband and wife owned several weeks of use of a timeshare condominium in a resort location. They rented out the timeshare to third parties for some or all of the weeks available to them. The average rental period for the timeshare was seven days or less. Although some rentals may have been more than seven days in length, on average they were not. Through the payment of association dues, cleaning and maintenance of the condiominium unit was provided before and after renters came and left the condominium. Otherwise, no other services were provided. The IRS determined that there were no significant services provided to renters of this condominium.

The taxpayers filed their tax return, claiming a rental loss on Schedule E; because their adjusted gross income was less than $150,000, they claimed all or a portion of the rental loss as active participation rental real estate (APRRE) loss under Sec. 469(i). On audit, the Service disallowed the rental loss; the taxpayers then requested this ruling.

The IRS ruled that because the average rental period was seven days or less, under the regulations, this activity was not considered a rental activity at all. Temp. Regs. Sec. 1.469-1T(e)(3)(ii)(A) states that when the average rental period is seven days or less, the activity is not a rental activity; instead, it is treated as a trade or business. However, because no significant services are provided, the activity is treated as passive. Presumably, if towels, laundry service, room service or other such hotel/motel amenities were provided, these losses could be taken as active trade or business losses. The taxpayers in this case were required to show the income or loss from this activity on Schedule C, had to treat it as passive, were not entitled to the $25,000 APRRE loss deduction and could only use these passive losses either against income from passive activities or, in the event the activity was disposed of, treat them as ordinary losses in the year of disposition.

The ruling raises some interesting issues and planning opportunities. First, if the APRRE loss allowance is important to taxpayers, they will need to structure their rental activities such that the average rental period is greater than seven days. It is sufficient that the average period be greater than seven days, even though a preponderance of the renters may use the condominium for less than seven days. If the taxpayers are successful in doing so, the losses would be deductible as APRRE losses. On the other hand, if the taxpayers would like to get active trade or business losses, they would need to keep the average rental period under eight days and provide significant services in the nature of those provided by a hotel/motel. How much additional activity is required is not clear; each set of circumstances will be different. The condominium in the ruling did have a swimming pool and other hotel-type amenities, but otherwise the renters were on their own. Presumably, if it was important enough, taxpayers could provide more than just cleaning and maintenance services. Converting this to an active trade or business loss could have many benefits, including the reduction of self-employment income. If this activity shows income, presumably there would be no difference between rental income and passive trade or business income. But if it made a difference to a taxpayer, structuring the rental periods for an average of seven days or less without providing additional services would provide passive trade or business income.