What are the tax consequences of hiring a property manager? It’s my understanding that doing so makes your rental a “passive investment” and therefore deductions cannot be taken. Is this correct?
First off, for anything having to do with taxes I always run things by my CPA before I take any action. I strongly suggest not making important tax decisions solely based on advice found on the Internet. What I can provided is some guidance to start the conversation with your CPA.
Passive and Active Activity Rules
The rules on passive and active activity can be complicated, but here are some basics per some of my favorite sources (Nolo.com, Property Management Kit for Dummies, and the IRS), as I understand them (and let me reiterate – I’m no tax expert!):
- Generally, real estate activities, including rental property, are passive activities, unless you qualify as a real estate professional or as an “active investor” who “materially participates” in the rental real estate. (IRS.gov)
- Real estate losses for passive investors are limited, but you may still use passive losses to offset passive income. However, you can’t deduct them from income from your job or investments. (nolo.com)
- You can still be actively involved in your property, even if you hire a property manager, if you “materially participate” in each rental activity. “Material participation” may be hard to show if a property management company is managing your rental property, but not impossible. Check with your CPA about what is required to show material participation. (Property Management Kit for Dummies).
- As with many other IRS rules, there are exceptions to passive loss rules. Again, check in with your CPA.
My best advice is that the tax consequences of active losses versus passive losses can be complicated, so I’ll write it again: check with your CPA.
And remember that even if your rental is considered a passive investment, you may still be able to take some deductions, and the benefits of hiring a property management company may outweigh other considerations. So if you don’t want the 3 a.m. emergency maintenance calls, or deal with tenant screening, paperwork, and evictions, among other things, a property manager may make sense for you.
Many people, myself included, have rental property as a passive investment, and still consider it a good investment.
As always, don’t consider this legal or tax advice. Before taking any action, consult with a professional lawyer or CPA licensed in your state.
Author of the Landlord Chronicles blog, Tracey March provides stories and “lessons learned” from her experience as a self-managed rental property owner. She helps owners decide if partnering with a property management company is beneficial.
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