Material Participation Rules

By Jason Watson, CPA
Posted Sunday, May 25, 2025

Material participation is one the most scrutinized and talked about topics among real estate investors and rental property owners. The two most common conversations is either about real estate professional status (REPS) or the short-term rental (STR) loophole. When we get into the meat of Temporary Treasury Regulations 1.469-5T, we will add some light commentary about each test. We dig a bit further in our respective sections on real estate professionals and short-term rentals.

Active Participation

Let’s discuss active participation first. For rental properties, the issue is nearly moot since active participation relates only to rental real estate activities and is a less stringent standard than material participation. As long as a taxpayer owns at least 10% and participates in management decisions in a bona fide sense, they actively participated in the real estate rental activity. Activities include new tenant approval, rental terms, repair authorizations, capital expenditures, etc. WCG CPAs & Advisors has a client whose brother handles all the rental property matters for a condo in San Francisco- in this example, his participation did not reach the level of active participation. Said differently, if you forget that you own a rental property because others are handling the business, you likely do not actively participate.

According to the IRS Audit Techniques Guide on Passive Activities there is not a specific hour requirement. Even if you use a management company, you will be considered active if you are involved with the operation of your rental. However, you must be exercising independent judgment and not simply ratifying decisions made by a manager or management company.

In addition, you must have at least a 10% interest in the rental activity (which we casually mentioned earlier). Here is the code from IRC Section 469(i)(6)(A)–

(A) In general
An individual shall not be treated as actively participating with respect to any interest in any rental real estate activity for any period if, at any time during such period, such interest (including any interest of the spouse of the individual) is less than 10 percent (by value) of all interests in such activity.

It is rare that this gets in the way.

Passive Activity Loss Limits

To recap for married taxpayers, passive activities such a rentals or investment partnerships with active participation have a loss limit of $25,000 in offsetting non-passive income such as W-2 wages or other earnings. This is reduced by $1 for every $2 over $100,000 in modified adjusted gross income (MAGI). Any disallowed passive loss is carried forward until you have offsetting passive income, or you sell the rental property. For example, you make $120,000 at your regular job and have $30,000 in rental losses. Your passive loss deduction is $15,000 ($25,000 minus $10,000) and the remaining $15,000 is carried forward.

Here is a summary table to kick this passive, active and material participation topic off-

What is even more confusing is that the tax code deems rental properties to be inherently passive and as such participation is deemed to be passive unless proven otherwise. Yet, and as stated earlier, most rental property owners are automatically deemed to be active since the bar is low and it is nearly impossible to have a rental property and not do the things to be considered active. Having said that, and as a reminder, there are times when participation is so low, you are deemed purely passive (see San Francisco condo example above).

People also confuse active as material in conversation. “Oh no, he’s not a passive investor, he’s active.” What they usually mean is that the person is engaged in some way, such as visiting the property, talking to the property manager, and making decisions about tenants or repairs. In everyday conversation, people frequently use terms like “active investor” or “passive investor” informally. Keep in mind that passive, active and material are terms of art in the tax code and they have specific meaning within the context of rental properties.

Also, please don’t go running around saying you have active income unless you are referring to W-2 income and self-employment income which are also commonly referred to as earned income. In other words, your active participation doesn’t make your rental income active income. Sorry to sound like Sister Sue from catholic school.

Moving on… Since we all want to be considered materially participating because it opens the doors to reducing taxes and other fun planning moments, let’s turn our attention to the good stuff. Here we go!