Footnotes · for the preparer’s desk
Rental losses are passive. That is the rule.
The exception is a two-part test, a separate test for each property, an election that is permanent, and a log.
Most of the people who claim it don’t have the log.
Rental real estate is passive by definition (§469(c)(2)), which means losses offset only passive income, with the $25,000 allowance for active participants that phases out between $100,000 and $150,000 of income. Above that, a landlord with $80,000 of rental losses and $300,000 of wages deducts nothing this year. Section 469(c)(7) is the exception: a taxpayer who qualifies as a real estate professional and materially participates in the rental can deduct the losses against anything.
It is also the most-litigated provision in the passive loss rules, because the proof is hours, and the hours are the taxpayer’s own records. The Tax Court has decided well over a hundred of these cases and the taxpayer loses most of them, almost always on the log. This page is the test, the election that trips people, and what a record that survives looks like.
§469(c)(7)(B). Both parts, every year, by one spouse alone.
Qualifying as a real estate professional does not make the rentals nonpassive. It makes them eligible to be nonpassive if the taxpayer materially participates in them. And the default rule is that each rental property is a separate activity (Reg. §1.469-9(e)(1)), so material participation (the seven tests of Reg. §1.469-5T(a), applied to the rentals) must be met for each property separately. A taxpayer with six rentals who spends 100 hours a year on each one has 600 hours in rentals and materially participates in none of them under test 1 (500 hours), and probably none under test 3 (100 hours and more than anyone else, if a property manager is involved). Hence the election.
For the material participation test in the rentals (not the qualification test), a spouse’s participation counts (§469(h)(5)); the non-qualifying W-2 spouse who shows the units and handles repairs contributes hours here.
↑ Back to top| Counts | Does not count |
|---|---|
| Showing units, screening tenants, negotiating leases, collecting rent, handling repairs or supervising contractors on site, bookkeeping for the rentals, purchasing supplies, advertising, dealing with the HOA, evictions | Reviewing financial statements, monitoring operations in a non-managerial capacity, planning or arranging financing (investor activities, Reg. §1.469-5T(f)(2)(ii)(B)), unless the taxpayer is directly involved in day-to-day management |
| Travel to and from the property for management purposes (the court is split; Leyh, T.C. Summ. Op. 2015-27, allowed it; others have not) | Travel that is primarily personal; time researching properties never bought; education and seminars |
| Work on a property under construction or renovation that the taxpayer is doing or supervising | Work by a spouse, for the qualification test (counts for material participation) |
| Self-employed brokerage, property management for others, development | Hours as a W-2 employee of a company the taxpayer owns 5% or less of |
| Hours of a more-than-5% owner-employee of a real estate company | Hours in a business that isn’t a real property trade or business (the plumbing company, even if it works on the rentals) |
Reg. §1.469-5T(f)(4) allows participation to be established “by any reasonable means,” including appointment books, calendars, or narrative summaries; contemporaneous daily logs are not required. The Tax Court has read that generously as to form and strictly as to credibility:
What the file should contain: a contemporaneous log (a calendar app with entries made the same week is fine) with date, property, task, and time; corroboration where it exists (contractor invoices with dates, tenant emails, mileage records, listing records); a year-end summary by property and by category; a comparison of real estate hours with all other work hours; and the aggregation election statement if made. The preparer should see the log before signing the return, not describe it afterward.
A rental with an average customer stay of seven days or less is not a “rental activity” under Reg. §1.469-1T(e)(3)(ii)(A), so §469(c)(2) and (c)(7) don’t apply at all. The owner needs only to materially participate in that property under the seven tests, with no 750-hour requirement and no more-than-half requirement. A full-time employee with one short-term rental she manages herself (test 2: substantially all the work, or test 3: more than 100 hours and more than anyone else) has a nonpassive activity. This is the route for the W-2 taxpayer who can’t qualify under §469(c)(7); it is covered on our page on your home as income. It doesn’t help with long-term rentals, and hiring a management company that does more work than the owner ends it.
↑ Back to topNet investment income under §1411 includes rental income unless it is derived in the ordinary course of a trade or business in which the taxpayer is not passive. A real estate professional whose rentals are nonpassive and rise to the level of a trade or business excludes the rental income from NIIT. Reg. §1.1411-4(g)(7) provides a safe harbor: a real estate professional who participates more than 500 hours in rental real estate activities in the year (or in five of the last ten) is treated as deriving the rental income in a trade or business. For a profitable portfolio, the 3.8% saving can exceed the loss benefit, and it continues in years of net rental income. The gain on sale of the rentals is also excluded if the safe harbor is met in the year of sale.
↑ Back to top2026 hours from her calendar: brokerage 1,100; rentals: A 160, B 140, C 210 (she self-manages; Rob handles 80 hours of repairs across the three). No other work. Rental losses after depreciation: A ($14,000), B ($9,000), C ($22,000). Joint AGI before the losses: $260,000.
Qualification (Teresa alone): real property trades or businesses in which she materially participates: brokerage (1,100 hours, test 1) plus rentals (510 hours). Total 1,610 of her 1,610 working hours: more than half (100%) and more than 750. Qualifies. Rob’s hours don’t enter this test.
Material participation in the rentals, no election: property by property, with Rob’s hours added: A 160 + ~27, B 140 + ~27, C 210 + ~27. No property reaches 500 (test 1). Test 3 (over 100 hours and more than anyone else): she uses no manager, so she participates more than anyone else in each; each property passes test 3. No election needed this year, and no election means a sale of property C alone releases C’s suspended losses.
If she hired a management company that logged 200 hours per property, test 3 fails for each; she would need the aggregation election (510 + 80 = 590 combined hours, test 1) and would accept the single-activity disposition rule.
Result for 2026: $45,000 of rental losses nonpassive, deducted against Rob’s wages and her commissions; about $12,000 of federal and Colorado tax. Without §469(c)(7), the $25,000 allowance is fully phased out at $260,000 and the deduction is zero. NIIT: 510 hours exceeds 500; in a future profitable year the rental income is outside the 3.8%.
File: her calendar export by property; Rob’s repair dates with receipts; the commission statements showing brokerage activity; a one-page summary. No election statement this year, with a note explaining why.
Colorado conforms to §469 through federal taxable income; a loss allowed federally is allowed for Colorado, and a loss suspended federally is suspended for Colorado. There is no Colorado election, no Colorado log requirement, and no Colorado NIIT. The only Colorado consideration is the usual one for rental owners who move: Colorado rental income is Colorado-source to a nonresident, and the released passive losses on a sale of Colorado property by a nonresident are allowed against the Colorado-source gain on the nonresident return.
↑ Back to topNo. One spouse must meet both parts of the qualification test alone: more than half of that spouse’s working time and more than 750 hours in real property businesses. Your spouse’s hours count only toward material participation in the rentals after you qualify on your own.
The brokerage hours count toward qualification, so most full-time agents qualify. But qualification is only half: you must also materially participate in each rental (or in all of them combined, with the aggregation election). Gragg was a licensed agent who lost because she hadn’t shown participation in the rentals themselves.
If you can meet material participation property by property (you self-manage and no one works more on any property than you), probably not: the election makes all rentals one activity, and selling one property then doesn’t release its suspended losses. If you use managers or have many properties, the election is usually the only way to meet the test. It is permanent, so decide with the exit plan in mind.
Anything made at or near the time that records date, property, task and hours and is consistent with other evidence: a calendar app, a notebook, a spreadsheet updated weekly. A reconstruction from memory at tax time, in round numbers, is what the Tax Court has rejected in most of the cases taxpayers lost.
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Written for the Tax Shop desk; figures are for the 2026 tax year as currently published. Items marked (verify) are to be confirmed against primary sources before the figures freeze in December. Last updated October 16, 2026.
