Use of management company prevents taxpayer from claiming active participation in rental property.

A recent Tax Court case cited the use of a rental agent in denying the taxpayers' claim that a condominium held for rental was not subject to the passive loss limitations of Sec. 469. In Chapin, TC Memo 1996-56, the taxpayers owned a beach condominium. It was rented to individuals for an average period of seven days or less during the summer rental season. All rental activities during the rental season were conducted by a rental agent hired by the taxpayers. At the end of each rental season the taxpayers performed an annual clean-up, involving various cleaning, maintenance, decorating and repair jobs.

From 1987 through 1991, the taxpayers reported this activity on Schedule C. They reported losses as from an activity in which they materially participated and deducted aggregate losses in excess of $100,000 during the five-year period. The IRS determined that the activity was passive and disallowed the claimed losses in accordance with Sec. 469.

Taxpayers' Claim of Material Participation

The taxpayers asserted that they spent in excess of 170 hours in each of the five years during the off season in the cleaning and maintenance of the condominium. Although they did not keep a log or other record of the hours devoted to cleaning, maintenance, decorating and repainting, they could establish their presence in the Ocean City area for seven to eight days annually through credit card receipts.

In deducting their losses on Schedule C, the taxpayers relied on Temp. Regs. Sec. 1.469-T(c)(3)(ii)(A) to treat the condominium as an activity that was not a rental activity for passive loss rule purposes. They reasoned that the average customer use of the unit during the rental season was seven days or less, so the activity was not a rental activity subject to Sec. 469(c)(2).

To support their claim of material participation, the taxpayers cited Temp. Regs. Sec. 1.469-5T(a)(2), which states that an individual materially participates in an activity for a tax year if his participation "constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity)." In addition, the taxpayers asserted that the "safe harbor" requirements in Temp. Regs. Sec. 1.469-5T(a)(3) were satisfied by establishing that their participation exceeded 100 hours per year, and that no other individual's participation during the year exceeded their participation.

Tax Court Agrees With Service

While agreeing with the taxpayers that the condominium was not a "rental activity," the court held the passive activity rules of Sec. 469 were still applicable because the taxpayers did not materially participate in the activity. The work performed by the taxpayers was not regular, continuous or substantial (as required by the regulations) in the court's opinion, even if the taxpayers' claimed hours of participation were accurate.

During the rental season the rental agent advertised, leased, collected and dispensed keys, and directed all the cleaning and maintenance activities. These activities were the regular and continuous participation in the activity, regardless of the participation claimed by the taxpayers. As to the safe harbor requirements and the taxpayers' greater-than-100-hours of participation, the court stated that these standards were necessary only to establish the minimum requirements for material participation. The taxpayers had to prove, in addition, that their participation was regular and continuous. The annual cleaning and maintenance, no matter how thorough, did not meet the standard of regular and continuous participation in light of the activities conducted by the rental agent.