Material Participation- Renovations

By Jason Watson, CPA
Posted Saturday, March 21, 2026

Part 4 of our material participation miniseries brings us to renovations. This topic is quite simple, but complicated all the same. The golden rule of renovation hours all comes down to timing: has the rental property been placed in service yet? This is like being pregnant. Yes or no?

If your rental property has never been placed in service (ready and available for occupancy, and held out for rental use through advertising and related efforts), the time spent swinging a hammer or dripping paint during this period does not count toward material participation. Yeah, read that again.

Let’s run through some quick examples:

• The Bummer. You purchase a rental property on May 1 and immediately start gutting the kitchen. You spend the next 30 days managing contractors, picking up tile, and painting. Does this count for material participation? No. Because the primary asset was never placed in service, the activity does not practically exist yet according to the tax code. If there is no activity, you cannot materially participate in it. Bummer. Stupid code.
• The Winner. You purchase a rental property on May 1, immediately list it, and rent it to guests through Labor Day. Once the slow season hits in October, you take it offline to renovate the kitchen. Because the property has already met the in-service threshold, the renovation work is treated as work performed within an existing activity rather than pre-opening startup work. Your time managing the reno absolutely counts.

Sidebar: This is a super duper distinction when it comes to Qualified Improvement Property where you might have immediate expensing through bonus depreciation or Section 179 on interior improvements including HVAC and roof if your rental is considered non-residential (30 days or less average guest stay). See our qualified improvement property section.

The Bottom Line on Timing

Get that rental property ready and available for occupancy, and ensure it is being held out for rental use through advertising before taking it offline for renovations.

The REPS Silver Lining

Here is the silver lining we alluded to earlier: your time spent on the rental property during a pre-opening renovation might fail the material participation test, but it does count towards the 750-hour requirement for Real Estate Professional Status (REPS).

As a reminder, IRC Section 469(c)(7) defines a real property trade or business to include construction and reconstruction. The statute reads:

For purposes of this paragraph, the term “real property trade or business” means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.

Therefore, while time spent on a pre-in-service conversion does not count for material participation on the specific property, it does count toward your overall 750-hour REPS threshold. Feel better? Unlikely. We get it.

Tracking Contractor Hours During a Reno

It is a tale as old as time (or at least as old as the Tax Reform Act of 1986 when the Bangles were walking like Egyptians). You buy a rental property that is already in service, but it needs a major facelift between tenants. You hire a tile guy to handle the heavy lifting while you handle the management and some of the lighter work.

At the end of the year, you count up your hours comprised of inspecting the property, managing permits, ordering materials, paint touch-up and post-construction cleaning. You hit 125 hours. You feel good. Then, you hand your file to your real estate minded CPA, and they ask a question that ruins your day: “How many hours did the tile guy work?”

You might be thinking, “Who cares? He’s a contractor. I’m the owner.” Unfortunately, the IRS disagrees. If you aren’t tracking your contractor’s hours during a renovation, you are charging into one of the most common IRS traps in the passive loss rules.

The More Than Anyone Else Rule (Material Test #3)

Most investors who manage their own properties but don’t work in real estate full-time rely on test #3 to prove material participation. This test allows you to qualify with as few as 100 hours of work, provided one critical condition is met: no other individual spends more time on the activity than you.

This is where the math gets dangerous. Let’s say you spent 125 hours managing the project. Your tile contractor spent 150 hours laying the new floors. You’ve already done the “oh crud” math.

Yup, the IRS does not care that you own the deed and he owns a kneepad. They do not care that you paid him. They simply look at the time log. If a single individual spent more time physically working on the activity than you did (performing a service directly on the rental property), you generally cannot claim you materially participated under this test. You are passive. Your losses are suspended.

Debunking the Renovation Myths

A savvy investor might argue: “The tile guy’s work was a capital expenditure (CapEx). It wasn’t day-to-day rental operations. Therefore, his hours shouldn’t count against my ‘operational’ participation.”

It is a clever argument. It is also incorrect. You are conflating two different sections of the tax code. IRC Section 263 tells us that the cost of the tile work generally must be capitalized and depreciated. But IRC Section 469 defines participation as any work done in connection with an activity. Whether you are fixing a leaky faucet (expense) or gutting a bathroom (capital unless Qualified Improvement Property), it is all work. You cannot have it both ways.

The Supervision Trap (Put Down the Beer)

Faced with a deficit (125 hours vs. 150 hours), many investors try to bridge the gap by inflating their own time with supervision.

The IRS and Tax Courts are highly skeptical of owners who claim they needed to supervise competent professionals. If you hired a professional tile setter because he knows how to cut, set, grout and seal tile, why did you need to stand over his shoulder for three weeks? If your supervision consisted of drinking coffee (or beer) and watching him work, those hours are generally treated as observation rather than participation. To count supervision hours, you must be doing actual project management: correcting mistakes, coordinating logistics, hauling debris, or procuring materials.

Also, and this might come as a surprise, supervisory hours can be a runaway train and are challenging for the IRS and courts to investigate and believe. As such they are immediately met with a heavy dose of skepticism and usually just tossed out.

How to Survive the Renovation Math

So, does a major renovation automatically disqualify you from material participation? Not necessarily. Here is how you survive the math:

• The Crew Loophole. The rule requires you to work more hours than any other individual. It does not compare you to the total invoice. If the tile guy or tile gal was actually a crew of three people who worked 50 hours each (total 150), the math changes. You worked 125 hours; Worker A worked 50. You pass material participation test #3. This is why hiring a large crew is often safer for your tax status than hiring a solo “jack-of-all-trades.”
• The Spousal Rule. As a reminder, IRC Section 469 allows you to combine your hours with your spouse’s hours when determining material participation. If you worked 125 hours and your spouse pitched in for 30 hours to clean and stage, your household total is 155 hours. You beat the solo contractor’s 150 hours. You pass. Double down and do the rental thing with your spouse.
• Overwhelm with Volume. The safest strategy is simply to outwork the contractor by tracking everything. Did you count the drive to Home Depot? The time spent researching materials? Negotiating the contract? Investors often under-count their own time while the contractor sends a precise bill. Log every legitimate minute. Don’t get twisted- we talk about puffing up hours in another section. We’ll say it here too- lofty unreasonable hours are counterproductive compared to lower hours that are reasonable.

Sidebar: The crew of 3 is smart money for cleaners as well for two reasons. One you can guess knowing what you know about the tile people, but the other reason is simple risk mitigation should someone quit, get fired and be sick on a guest turn. The downside of large cleaning crews is laundry usually needs to be done by a service since the crew is in and out quickly and cannot wait for the dryer.

When you take a property offline for a major renovation, do not assume that because you are the boss, the contractor’s hours don’t matter. Track your contractor’s hours. Ask for itemized invoices that break down labor by person, not just by job. Yes it is a pain, and yes, it might not ever see the light of day at the IRS office. However, it is the snowplow theory- buying a nice snowplow almost guarantees no snow until next year.

Also, keep your records in good order to support the in-service assertion while the rental property is vacant or getting ready for its first guest or tenant. Put forth efforts to rent the property, and document those efforts.

See our idle property versus vacant rental property section for more information about vacant rentals and the deduction of expenses. Also, see our rental property in-service defined section for expanded comments on ready and available, and held out for rental use.