By Jason Watson, CPA
Posted Tuesday, March 24, 2026

You can elect to group all your rental properties into one activity so the material participation test is less onerous. If you had three rentals and were needing to use the 500 hours test for material participation (test #1), you would need to spend 3 x 500 or 1,500 hours total at a minimum.

Mechanics of the Election

The 1.469-9(g) election is a formal election on the tax return that endures each year unless revoked. Here is Treasury Regulations 1.469-9(g) which we broke up into bite size phrases-

(g) Election to treat all interests in rental real estate as a single rental real estate activity

(1) In general.

A qualifying taxpayer may make an election to treat all of the taxpayer’s interests in rental real estate as a single rental real estate activity.

This election is binding for the taxable year in which it is made and for all future years in which the taxpayer is a qualifying taxpayer under paragraph (c) of this section, even if there are intervening years in which the taxpayer is not a qualifying taxpayer.

The election may be made in any year in which the taxpayer is a qualifying taxpayer, and the failure to make the election in one year does not preclude the taxpayer from making the election in a subsequent year.

In years in which the taxpayer is not a qualifying taxpayer, the election will not have effect and the taxpayer’s activities will be those determined under § 1.469-4.

If there is a material change in the taxpayer’s facts and circumstances, the taxpayer may revoke the election using the procedure described in paragraph (g)(3) of this section.

Keep in mind the phrase “qualifying taxpayer” is synonymous with real estate professional. In other words, the 1.469-9(g) election is only for REPS.

What if you forgot to make this election? The IRS has provided relief allowing certain qualifying real estate professionals to make late elections to group all interests in rental real estate. IRS Revenue Procedure 2011-34 applies to a rental property owner who failed to file a timely election to aggregate but who has filed tax returns consistent with having made the election for all the tax years in question.

Is it an election to group or aggregate? A lot of subject matter material out there will use the word “group” but the IRS in their late election relief uses the word “aggregate.” Perhaps we can all agree to group real estate trades or business together for the 750 hours test and aggregate rental properties into a single activity.

Downsides to the 1.469-9(g) Election

Are there downsides to the election? Yes there are. The most impactful problem is the need for a material change before you can revoke the aggregation. If you cannot revoke the election, any combined suspended passive losses allocable to the rental real estate activities cannot be used to minimize capital gains. Piggybacking on the language from Treasury Regulations 1.469-9(g), the verbiage continues with-

(2) Certain changes not material.
The fact that an election is less advantageous to the taxpayer in a particular taxable year is not, of itself, a material change in the taxpayer’s facts and circumstances. Similarly, a break in the taxpayer’s status as a qualifying taxpayer is not, of itself, a material change in the taxpayer’s facts and circumstances.

Is selling one rental out of three material? How about two out of three as Meatloaf sings? Yes, since you no longer have a group, right? How about three out of five? Makes you wonder. There are other issues as well, but the material change requirement for revocation is the most prominent. This becomes problematic when you have unallowed losses being carried over on Form 8582, and you want to use them upon sale of a rental property.

Having said that, most real estate investors will worry about next time, next time, and will elect to aggregate to ensure material participation is met.

You cannot pick and choose which rental properties to group for material participation. The verbiage under 1.469-9(g)(1) above should be enough, but the Treasury Regulations 1.469-9(g)(3) continues with-

(3) Filing a statement to make or revoke the election.
A qualifying taxpayer makes the election to treat all interests in rental real estate as a single rental real estate activity by filing a statement with the taxpayer’s original income tax return for the taxable year.

Read the “treat all interests in rental real estate” part again. If you cannot get enough, IRS Revenue Procedure 2011-34, which outlines how to make a late 1.469-9(g) election as described previously, reiterates the “all interests” phrase again-

03 Relief for late election under § 1.469-9(g). The Service will notify the taxpayer upon receipt of a completed application requesting relief under this revenue procedure that satisfies the procedural requirements under section 4.02 of this revenue procedure. Any taxpayer receiving relief under this revenue procedure is treated as having made a timely election to treat all interests in rental real estate as a single rental real estate activity as of the taxable year for which the late election was requested.

In the span of two subparagraphs of tax code plus an IRS Revenue Procedure, the phrase “all interests in rental real estate” is used five times. There you have it- no pick and choose. All in, or nothing. It reminds you of My Cousin Vinnie- “You were serious about that?!” Yes, apparently.

Using the 500 Hours Material Participation Test with 1.469-9(g)

A lot of rental property owners cannot substantiate or even justify 500 hours spent on their rental property to meet material participation. As such, they revert to the thresholds of either a) 100 hours and more than anyone else, or b) substantially all hours. However, these are problematic because you must track other people’s time.

How do you know if your hours are more than anyone else’s? How do you know if your plumber had enough hours to make your substantially all hours moot or unavailable as you scramble to hit 100 hours?

The 500 hours material participation test is the hammer- it does not care about anything other than your time. If you have one rental, Yes, this is mostly unavailable even in a short-term rental situation (10 hours a week… every week… might be a stretch unless you have a project or something).

However, if you own two rentals, three rentals, or more, and you elect to aggregate them for material participation purposes, the 500 hours test cuts down on the chore of tracking everyone else’s time and time spent on each rental property. Less recordkeeping is good- as you know or will learn, a lot of taxpayers have a good tax position but cannot prove it with proper recordkeeping. Less recordkeeping burden is less risk.

Amending Tax Returns For REPS

Real estate investors often believe that if they missed claiming Real Estate Professional Status (REPS) on a previous tax return, the opportunity is lost forever. While you can technically file an amended tax return to claim the status, the real hurdle is the “aggregation election,” which allows you to treat multiple rental properties as a single activity.

Historically, the IRS required this election to be made on an original, timely filed tax return, with limited relief available only through specific procedures. This usually left those who missed it with a portfolio of separate activities that rarely meet material participation tests on their own. Fortunately, Revenue Procedure 2011-34 provides a path for investors to make a late aggregation election.

To qualify for this relief, the investor must have filed all required returns consistently with the requested treatment and must have a reasonable cause for the initial failure. Specifically, Section 4.02 of IRS Revenue Procedure 2011-34 reads-

The taxpayer must attach a statement to an amended return… stating that the taxpayer is making an election under § 1.469-9(g)(1) and identifying the taxable year for which the late election is to be effective.

From there the procedure details out five elements including reasonable cause. “I found a better tax strategy with a cost segregation study” is not a reasonable cause. “My tax professional made a mistake, and I relied on that advice” is more plausible.

While it can be difficult to determine what time counts toward material participation, there are some clear examples of time that do not count. At times defining things in the negative is helpful. Here we go-

Certain Sweat Equity Time Does Not Count

Wait! What? Hang in there… you’ll see that this is quite trivial, but you need to be aware just the same. IRS Publication 925 Passive Activity and At-Risk Rules, discusses work that is not normally performed by owners, as well as investor activities versus managerial activities. Here is another blurb from the lovely publication-

Work not usually performed by owners. You don’t treat the work you do in connection with an activity as participation in the activity if both of the following are true.

The work isn’t work that’s customarily done by the owner of that type of activity.

One of your main reasons for doing the work is to avoid the disallowance of any loss or credit from the activity under the passive activity rules.

That second component is your escape hatch, right? Do you cuff yourself to your desk as you admit to that? Sure, your 9-5 is anything but a home builder yet you are handy, and can lay down tile with the best of them. The IRS could contend that your tile work is not customarily done by a rental property owner (which is a stretch anyway) but to assert that you installed tile with the sole purpose of puffing up your hours is a virtually groundless assertion.

Said differently, sweat equity certainly counts unless your sole purpose of sweating is to increase participation time which rarely makes sense in the real world (and you would never admit to anyway). As such, this section is a bit silly since this rule is rarely triggered, but one to be aware of just the same.

Competence And Unrealistic Hours

What if you stink at home improvement? What if you are not a handy guy? In Lee v. Commissioner, Tax Court Memo. 2006-193, the real estate investor’s time log showed spending 24 hours to replace blinds, 56 hours to replace a kitchen faucet, and over 280 hours to wrap-up the financial statements for tax preparation. The Tax Court found the time entries to be unrealistic and not credible.

Yeah, no kidding. Can’t blame them.

Material Participation On Call Time

In Moss v. Commissioner, 135 Tax Court 365 (2010), the rental property owner argued that he should be permitted to include hours spent “on call,” when a tenant could contact him if necessary. The court denied the tax position because the taxpayer was not actually performing services during those hours

While Moss was specifically fighting to count these hours toward his 750-hour Real Estate Professional Status (REPS) requirement, the court’s logic applies broadly to material participation analysis as well. The overarching lesson here is that watching football while waiting for the phone to ring is not participation, whether you are trying to hit 100 hours or 750 hours.

To repeat ourselves, and to buttress the court’s contention in Moss, Treasury Regulations Section 1.469-9(b)(4) states-

(4) Personal services.
Personal services means any work performed by an individual in connection with a trade or business. However, personal services do not include any work performed by an individual in the individual’s capacity as an investor as described in § 1.469-5T(f)(2)(ii).

Keep that personal services threshold in mind. Dreaming of your rentals doesn’t cut it. We wonder if the IRS would adopt Mohammed Ali’s saying “if you dream of beating me, you’d better wake up and apologize.” We digress.

The next part of our material participation miniseries brings us to travel time. Once the rental property is running, you will inevitably spend time driving to check on it, grabbing supplies, or meeting contractors.

Does the drive count toward your hours?

The answer is incredibly squishy. Nailing Jello to the wall sort of thing. It largely comes down to the distinction between a personal commute and travel that is integral to performing services for the activity.

IRS Stance: Travel Time Not Integral

You might look at Treasury Regulation Section 1.469-5T(f) and think you are safe-

(f) Participation-

(1) In general.
Except as otherwise provided in this paragraph (f), any work done by an individual (without regard to the capacity in which the individual does the work) in connection with an activity in which the individual owns an interest at the time the work is done shall be treated for purposes of this section as participation of the individual in the activity.

It plainly states that “any work done by an individual… in connection with an activity” counts as participation. However, Treasury Regulations Section 1.469-9(b)(4) throws a wet blanket on the party like your spouse looking at their watch and then giving you “the look,” by stating that personal services do not include work performed in an investor capacity.

(4) Personal services.
Personal services means any work performed by an individual in connection with a trade or business. However, personal services do not include any work performed by an individual in the individual’s capacity as an investor as described in § 1.469-5T(f)(2)(ii).

So, is travel a valid personal service or just an investor checking on their asset? The IRS Passive Activity Loss Audit Techniques Guide gives away their playbook:

Travel time generally should not be considered in computing the hourly tests for material participation, particularly if other factors indicate the taxpayer is not participating in the activity on a regular, continuous and substantial basis. Legislative history provides that ‘services must be integral to operations.’ It is somewhat difficult to construe that travel constitutes ‘services’ or ‘participation’… travel is not integral to operations in most cases.

Read that last line again. Yuck. Immediate skepticism, right? In other words, the IRS inherently assumes your drive to the rental property is just a personal commute. And just like driving from your home to your W-2 job is a non-deductible commute, the IRS views driving from your home to your rental property the exact same way. Admittedly, this mixes deductible expense concepts with material participation hours, but the analogy helps illustrate the IRS position.

Need more? The IRS position on travel time is not just an audit preference. Rather, it traces back to the legislative history of the passive activity rules. The Joint Committee explanation (JCS-10-87, May 1987) of the Tax Reform Act of 1986 states that services counted toward material participation must be integral to the operations of the activity. The committee report notes that merely traveling to or from an activity generally does not qualify as participation because the services must be tied directly to the operational functions of the business.

The Court Cases: The Good, The Bad, And The Chocolate

When this goes to Tax Court, the results are a mixed bag.

There is case law saying No. In Truskowsky v. Commissioner, Tax Court Summary 2003-130, the court stated that unless a taxpayer can prove day-to-day managerial involvement, travel time is considered commuting, which is personal in nature, and therefore does not qualify. To be fair, Truskowsky’s travel was a bit self-serving since it was not solely for business since they mixed in some pleasure by visiting family.

There is also case law saying Yes. In Leyh v. Commissioner, Tax Court Summary Opinion 2015-27, the taxpayer had only 632.5 hours on her time log but explained during the audit that she had failed to record the time spent traveling among her 12 rental properties. The IRS countered that her log was already inclusive of travel time. Based on her testimony, the Tax Court found she had not included it, and surprisingly allowed her to restate the time log to add the travel hours. The Tax Court was certainly having a nice day and being taxpayer-friendly. Perhaps Leyh brought chocolate.

As you can see, the IRS starts from the assumption that travel is personal unless the taxpayer can demonstrate that the travel itself was integral to performing services for the activity.

How to Make Travel Time Count For Material Participation

While your mileage might vary (pun intended), a reasonable, audit-defensible tax position starts with proving you are traveling between two business locations.

In Truskowsky v. Commissioner, Tax Court Summary 2003-130, the taxpayer successfully asserted that travel time counts if you are also claiming a home office that is used regularly and exclusively for your real estate activities. In that case, the drive may be characterized as travel between business locations rather than a personal commute. That counts.

How many rental properties do you need to assert a home office? Three? Five? Who knows! Facts and circumstances, chocolate and luck. In other words, it is situational. Some rentals are a pain in the butt; others run like clockwork. In our opinion, day-to-day participation is a higher standard than regular, continuous and substantial.

Even without a home office, driving from rental A to rental B is business travel. Driving from the bank (a business task) to Home Depot, and then to the rental is business travel. Don’t just log “driving.” Log “Travel to Main Street to collect rent.” And if you do not have a qualified home office, be very careful about counting the drive from your personal driveway to the rental property.

Sidebar: Personal service is scattered throughout this section and is one of the pillars of testing your participation. How much personal service is being performed on your real estate investments while sitting on an airplane? Perhaps a lot if you are reviewing contracts and balancing your rental property checkbook. How much personal service is being done driving a car for three hours? Perhaps a lot if you are on the phone chatting about your partnership tax returns and 1031 like-kind exchange concerns with your real estate CPA at WCG CPAs & Advisors. Be reasonable but don’t skimp.

The Inflection Point: Commute Versus Route

You might be looking at the IRS rules versus the Tax Court cases and thinking, “This is entirely contradictory. The IRS says travel doesn’t count unless I’m performing a service, but the court in Leyh allowed it anyway. What gives?”

And you all wonder why CPAs drink.

The secret lies in volume and context. It is the difference between a commute and a route. If you have a W-2 job and own one or two rentals, driving to check on them looks exactly like a personal commute to an investment. The IRS will almost always throw those hours out unless you have a strict home office or are actively conducting business on the phone during the drive (and tread lightly how often you claim business calls during your drives).

However, if you manage 12 or 20 properties full-time like the taxpayers in our favorable tax court cases such as Leyh and Hailstock, the script flips. You are no longer commuting; you are running a daily route. Just like a pool cleaner or a FedEx driver, the travel between your scattered properties is the connective tissue of your day-to-day operations. The court recognizes that at a high volume, transit is an integral part of managing the business.

Deductible Miles Do Not Equal Participation Hours

We need to revisit a painful truth we discussed earlier: just because an expense is deductible does not mean the time associated with it counts toward material participation.

Many investors assume that if they can deduct the 50 miles they drove to their rental, or the airfare to fly across the country to check on a property, then the time spent traveling automatically counts toward their hourly threshold.

Let us burst that bubble right now. Time spent in connection with mileage and its eventual deduction does not equal material participation. Airfare does not equal material participation. Trains and boats?

You might legally and perfectly deduct a $500 flight to Florida as an ordinary and necessary business expense under IRC Section 162. But the four hours you spent sitting in coach eating Biscoff cookies and watching a movie? The IRS generally does not consider that “work in connection with an activity.” As we mentioned in our multitasking sidebar, unless you are actively balancing the books or reviewing leases on that flight, the travel time itself is just… travel time.

Sidebar: $500 for coach? Live a little. Remember, if you don’t fly first class, your kids will.

Passing the test to deduct the cost of the trip does not automatically grant you the hours for the trip. One does not get you the other.

The Smell Test (Proportionality)

Let’s also throw a dash of common sense into the mix. The IRS and Tax Court judges are human beings, and they have a pretty good radar for nonsense.

If you log 24 hours of round-trip driving to spend 45 minutes painting a single accent wall, that just doesn’t make sense. The travel time must be proportional to the actual work being performed. There isn’t a rule or a safe harbor or a ratio or anything mathematic- just a smell test.

If your travel hours vastly outweigh your operational hours, the IRS and court might argue that your trip was personal in nature. Don’t confuse personal with pleasure- personal is just a nice way of saying “no time, no deduction, no nothing nothing” in perfect English prose.

Be reasonable. If the juice isn’t worth the squeeze for the actual property, it certainly isn’t worth the squeeze for material participation.

Here’s some gray water to swim in- you could fly the family to your short-term rental for 3 days of maintenance and 1 day of personal use. The trip is predominantly business. Kids’ air fare is likely not deductible unless they do actual work. Travel time as material participation?

The Net-Net On Material Participation Travel Time

What is this section really telling us? Unlike other areas of the tax code, there are no bright lines here. There are no safe harbors where you can neatly dock your material participation boat. Counting travel time toward material participation is a pure “facts and circumstances” test.

It relies entirely on the specifics of your situation, the proportionality of your driving versus working, the strength of your home office position, and frankly whether the human being auditing your return or hearing your Tax Court case is having a good day.

Track your time meticulously, lean on the home office or “cluster” defense if you can, pass the smell test, and always remember to bring chocolate to the audit.

Let’s step back for a moment and look at the pattern that has developed across this material participation timeline. We have spent the last few sections talking about the zillion things that will trip you up and disqualify your time should some suits want to challenge your time log.

So, what is left? Here are the leftovers. The pattern of material participation really looks like this:

• The Acquisition Phase. Most of your time is classified as investor activity and therefore does not count.
• The Pre-Opening Phase. The Richmond doctrine drops the hammer and says the business hasn’t started yet, and therefore your hours do not count.
• The In-Service Date. The property is finally ready, available, and held out for rent. The activity legally and practically exists. Cue the confetti. Celebrate… briefly… because now you have a real business with guests and tenants who are tough to impress.

From the in-service date forward, the real material participation analysis begins whether you are renovating between guests, managing tenants, or performing routine maintenance.

Material Participation Time Tracking

If you are looking for a way to easily track time, WCG CPAs & Advisors has partnered with REPSLog and you can download their app here-

https://wcginc.com/time

Material Participation Hours That Count

We discussed a lot of the time that does not count. Let’s come full circle and discuss what time does count as a general concept. Generally speaking, any work you perform in connection with an activity in which you own an interest is treated as participation in that activity. Some of the activities that count towards your hourly requirements include collecting rent, bookkeeping advertising, maintaining legal compliance, safety reviews, inspections, decorating, tenant approval, contractor supervision, procuring insurance, paying taxes, and actual hands-on maintenance.

Here is a list from IRS Notice 2019-7 with respect to rental activities being considered a trade or business as applied to IRC Section 199A-

(i) advertising to rent or lease the real estate;

(ii) negotiating and executing leases;

(iii) verifying information contained in prospective tenant applications;

(iv) collection of rent;

(v) daily operation, maintenance, and repair of the property;

(vi) management of the real estate;

(vii) purchase of materials; and

(viii) supervision of employees and independent contractors.

See our material participation time examples section for a whole bunch of actual duties, tasks, chores, etc. to punch your MP clock.

Confusing Participation Percentages

There is no perfect place for this, so we will address it here. The tax code surrounding real estate is a tangled web of percentages. Because there are so many different thresholds for different tax benefits, it is incredibly easy to conflate them. Let’s quickly decode the percentage soup:

• 1% For Material Participation. Can you materially participate in a rental property if you only own 1% of it? Technically, yes. The Treasury Regulations simply require that you own some interest in the activity. There is no statutory minimum percentage for material participation. That said, if you log 500 hours of free labor on a 1% stake while your partners golf, it looks a bit silly.
• 5% For REPS. If you work a W-2 job in the real estate industry (like a property manager or leasing agent), those W-2 hours generally do not count toward your 750-hour Real Estate Professional Status threshold unless you own at least 5% of your employer’s business. This has nothing to do with material participation, but we list it here to avoid confusion.
• 10% For Active Participation. If you can’t meet the high hurdle of material participation but still want to deduct up to $25,000 in rental losses against your W-2 income (within the passive activity loss income limitations), you rely on the active participation standard. To qualify for this special allowance, you must own at least 10% of the rental property.

Here is a classic scenario. You close on October 1. You spend the entire month of October painting walls, assembling IKEA furniture until your fingers bleed, and staging the perfect living room. After long debates with your spouse over the rug, you finally list it for rent on November 1.

Can you count the 100 hours you spent sweating in October toward material participation?

The answer: Generally, no.

And the hours arguing over the rug? Still No.

The Trade or Business Myth

You might hear from your bartender, your brother-in-law, or a highly confident person on the internet that because short-term rentals are technically treated as a trade or business rather than a rental activity, the business magically starts the day you buy the property. They might even use the used copier business analogy we discussed earlier, arguing that the moment you buy the asset, you are in business and the clock starts.

Proceed with extreme caution.

The Richmond Pre-Opening Doctrine

The courts have long held that a business does not begin until it functions as a going concern. For a rental property, that means the asset must be ready and available for customers.

In Richmond Television Corp. v. United States, 345 F.2d 901, the court established what is widely known as the “pre-opening doctrine.” The ruling states:

The court explained that a taxpayer has not “engaged in carrying on any trade or business” within the intent of section 162(a) until such time as the business has begun to function as a going concern and performed those activities for which it was organized.

Courts often describe this as the moment the business becomes a going concern, meaning the activity is capable of serving customers and generating revenue. What does this mean for your timesheet in plain English?

• October (The Gap Month). The property was not performing the activity for which it was organized (hosting guests). Therefore, the business had not legally started. The hours you spent painting and assembling beds are classified as “pre-opening” or “start-up” hours. They generally do not count for material participation.
•  November 1 (Placed in Service). The property is listed, ready, and available for rent. The business is now a going concern. Your material participation clock officially starts.

Yes, we feel the “yeah, but” from over here. Give us a minute.

The Material Participation Pre-Opening Takeaway

Your participation clock starts when the rental property is placed in service. Period. Full stop.

Do not rely on pre-opening hours to save your tax return or help you hit your minimum hour thresholds. Get the property listed and available for rent as quickly as humanly possible, and then worry about sourcing the perfect throw pillows.

Ok, here is your “yeah, but.”

Reconciling Richmond With The Anticipation Rule

“Wait a minute,” you might be saying. “Didn’t you just tell me in the STR Acquisition Wrinkle section that I could count my operational setup time because of the ‘anticipation of a trade or business’ rule?”

Yes, we did. And this is where the tax code gets incredibly bifurcated. Confusing. Stupid. Conflicted. D, all the above.

The hard line of the Richmond doctrine (where zero hours count before the property is placed in service) applies flawlessly to traditional long-term rentals. Why? Because traditional rentals are legally classified as “rental activities.” They do not get the benefit of the Treasury Regulations Section 1.469-4 “anticipation” rule because that rule specifically applies to trade or business activities, not rental activities.

Short-term rentals (STRs), however, may be treated as trade or business activities under the passive activity rules. Therefore, they get to use the “anticipation” rule. For an STR, the logic effectively becomes, “Your business hasn’t officially opened under Section 162, but for the sake of tracking your material participation hours, we will let you count the time you spend anticipating the opening.”

But do not let this give you a false sense of security. Remember the Chicken or the Egg problem we discussed earlier.

If you try to use the STR anticipation rule to count your October furniture-assembly hours, you must get that property placed in service and host enough guests by December 31st to prove your average stay is 7 days or less.

If you fail to get guests in Year 1, your property defaults to a traditional rental activity. The moment it defaults to a traditional rental, the “anticipation” loophole slams shut, the Richmond doctrine drops like a hammer, and every single hour you spent working on the property including the rug argument before November 1st gets wiped off your timesheet.

The ultimate takeaway remains the same- whether it is a long-term rental or an STR, racing to get the property placed in service is the only way to bulletproof your tax return.

Sidebar: Scrambling to place a rental property in service with a one-day, bare-bones guest stay feels less like a marketing strategy and more like a hack check a box. To survive scrutiny, you need to show regular and continuous efforts, and not an engineered, form-over-substance game. Ok, a bit dramatic, but see our rental property in service defined section on page 96 anyway.

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

This material participation stuff can make your head spin. Here is an executive summary in table format. MPH? Any guess? Material Participation Hours.

But there is a wrinkle when we apply these acquisition rules to short-term rentals. Short-term rentals with an average guest stay of 7 days or less are not treated as “rental activities” under the passive activity rules. They are treated like hotels. Why does this matter? Please see our chapter on short-term rentals.

Because the passive activity rules treat very short-term rentals more like hotels than traditional rental properties, the operational side of the business begins to resemble a service business rather than a passive investment.

Let’s go to the regulations. Treasury Regulations Section 1.469-4 primarily deals with how activities are grouped under the passive activity rules. However, courts often rely on this regulation because it is one of the few places in the IRC Section 469 regulations that explains what an “activity” actually is. In doing so, the regulation notes that an activity can include work performed “in anticipation of the commencement of a trade or business.”

This means you are considered to have an activity by the mere anticipation of starting a trade or business that is not a traditional rental. This opens the door to an argument that certain operational setup activities for a short-term rental may occur within an existing trade or business activity even before the property is fully operational.

Think about selling used copiers as a new business, as we discussed in a previous section. The moment you start procuring inventory, negotiating contracts, creating marketing materials, buying office furniture, and deploying an accounting system, you are materially participating in your used copier activity.

Setting up your STR by signing up with a management company, launching a listing, and shopping for linens starts to look a lot like building the operational framework of a small hospitality business, right?

Here is the massive catch: The chicken or the egg.

To use this anticipation rule, your STR cannot be classified as a rental activity. To avoid being classified as a rental activity, the property must ultimately meet the exception requiring an average guest stay of 7 days or less.

But how do you prove an average guest stay of 7 days or less if the property hasn’t opened for business yet?

If you buy a property in November, spend December furnishing it, and don’t host your first guest until January, you have a Year 1 tax problem. The IRS can easily argue that because you had zero guests in Year 1, you cannot prove the 7-day exception. If you can’t prove the exception, the property defaults to a standard rental activity for that year. The moment it becomes a standard rental activity, the anticipation rule vanishes, and your setup hours are thrown out as pre-opening rental time.

As such, if you want to count your operational setup time (buying linens, building listings) under the anticipation rule, you desperately need to get that property placed in service and host actual guests in the same tax year. You need that 7-day average data on the books to prove the activity is a trade or business, and not a typical rental activity.

Even with the STR anticipation rule, we must still be mindful of the investor time trap. Setting up operations counts, but purely looking for an asset does not. The following items likely will never (yeah, sure, a bit dramatic) count for material participation, even for an STR:

• Reading market reports.
• Viewing real estate listings.
• Meeting with a broker or lender.
• Building out spreadsheets to analyze ROI or IRR or some other R.

Ah, the beauty of our tax code!

Sidebar: While this trade or business classification creates a frustrating Year 1 material participation hurdle, it can be a benefit for the 750-hour REPS test. Because your STR is a trade or business using real property, your operational hours drop right into your 750-hour bucket to help your overall tax strategy. See our REPS pitfalls with short-term rentals section.

Material participation in rental real estate follows a fairly predictable timeline. Investors typically move through four distinct phases: selection and acquisition, pre-opening setup, renovations, and normal operations. The tax code treats each of these phases very differently when counting material participation hours. Some activities clearly count, some clearly do not, and a few sit in a gray area. In the following sections, we walk through each phase of the timeline so you know exactly when your participation clock actually starts ticking.

Research Time Does Not Count

You spent 40 hours surfing Zillow, 10 hours touring duds, and 15 hours analyzing the ROI on a spreadsheet. Do these count toward your material participation hours?

Generally, no.

Whether you are chasing Real Estate Professional Status (REPS), utilizing the short-term rental loophole, or just trying to prove you actively run a side business, you need valid material participation hours. A lot of investors attempt to fill the holes in their timesheets by logging the hours they spend researching new investment properties. While this sounds legitimate to a highly motivated buyer, the IRS and Tax Court consistently deny this position. Find something else to put on your time sheet- cut some grass, hunt and peck your QuickBooks entries, but don’t log Zillow hours.

Investor Time Does Not Count

To understand why this time gets thrown out, we must look at Treasury Regulation Section 1.469-5T(f)(2)(ii) and IRS Publication 925 Passive Activity and At-Risk Rules. Both specifically address work done in an individual’s capacity as an investor.

The rules state that you cannot treat the work you do in an investor capacity as participation unless you are directly involved in the day-to-day management or operations of the activity. Here is a quick blurb-

Work you do as an investor includes:

Studying and reviewing financial statements or reports on operations of the activity,

Preparing or compiling summaries or analyses of the finances or operations of the activity for your own use, and (note the tag line of “for your own use” which might contrast to “tax return preparation use”),

Monitoring the finances or operations of the activity in a non-managerial capacity.

New Business Reality: Operations Versus Assets

If this is your first rental, you generally do not have a business yet. You are just a person with a checkbook and a dream. Because the rental activity generally does not begin until the property is placed in service, none of this initial acquisition and selection time counts toward your material participation.

We must determine when a rental activity starts especially as it relates to material participation. More rules!

Treasury Regulations Section 1.469-1T(e)(3) read-

(3) Rental activity
(i) In general. Except as otherwise provided in this paragraph (e)(3), an activity is a rental activity for a taxable year if—

(A) During such taxable year, tangible property held in connection with the activity is used by customers or held for use by customers; and

(B) The gross income attributable to the conduct of the activity during such taxable year represents (or, in the case of an activity in which property is held for use by customers, the expected gross income from the conduct of the activity will represent) amounts paid or to be paid principally for the use of such tangible property (without regard to whether the use of the property by customers is pursuant to a lease or pursuant to a service contract or other arrangement that is not denominated a lease).

Did you read each word? Ah, you’re better for it if you did. What all this nonsense is saying is that you must have a rental property “used by customers or held for use by customer” for your activity to be a rental activity. In other words, you need an asset, the rental property, to be placed in service. Treasury Regulations Section 1.167(a)-11(e)(1)(i) define “placed in service,” and can be summarized as ready and available for occupancy, and held out for rental use through advertising and related efforts.

But there is another wrinkle to all this. Short-term rentals with average guest stay of 7 days or less are not considered rental activities. Huh? Why does this matter?

Let’s go to the regulations! Treasury Regulations Section 1.469-4, titled “Definition of an activity,” reads in part-

(b) Definitions. The following definitions apply for purposes of this section—

(1) Trade or business activities. Trade or business activities are activities, other than rental activities or activities that are treated under § 1.469-1T(e)(3)(vi)(B) as incidental to an activity of holding property for investment, that—

(i) Involve the conduct of a trade or business (within the meaning of section 162);

(ii) Are conducted in anticipation of the commencement of a trade or business; or

(iii) Involve research or experimental expenditures that are deductible under section 174 (or would be deductible if the taxpayer adopted the method described in section 174(a)).

What does this mean? You are considered to have an activity by the mere anticipation of the commencement of a trade or business that is not a rental activity. Therefore, since a short-term rental is not considered a rental activity, you nonetheless have an activity that you can materially participate in without necessarily having the asset (e.g., the rental property) placed in service.

To understand why the IRS is so strict about this, it helps to compare real estate to a traditional business.

Imagine you wake up on a Monday and decide to start a business selling used copiers. Your bartender says there’s big money in that, and you drop your W-2 job and start thinking about toner.

You spend the next three months reading repair manuals, attending trade shows, designing business cards, building a website, procuring inventory, negotiating contracts, creating marketing materials, hiring a staff or support team of contractors, buying office furniture and equipment, deploying an accounting system, among the myriad of other things business owners do, you are materially participating in your used copier activity.

Assuming your marriage survives, and you actually open your doors and start selling copiers that same year, the time you spent building the framework of that business is generally viewed as active participation in your new trade or business. You are building an operation.

Real estate is different. When you buy a rental property, the asset is the activity. When you spend three months scrolling Zillow, driving through neighborhoods, and running ROI spreadsheets, you are not building an operation; you are shopping for an asset. The IRS views this through a completely different lens. They see you acting strictly as an investor looking for a place to park your capital.

Subtle difference. And one you unequivocally don’t like.

As we discussed earlier, the tax code explicitly excludes investor time from counting toward material participation unless you are involved in the day-to-day management. Since you don’t own the property yet, there is no day-to-day management to be had. In short:

• Traditional Business. Pre-opening work (like building a website or marketing) can often be tied to the active operational framework of the business once it launches.
• Rental Real Estate. Pre-purchase work (like Zillow surfing and running numbers) is almost always classified as excluded investor time.

Yes, there is a bit of a chicken or the egg conundrum with real estate and material participation during the early stages. Think of it this way- if the rental property is not placed in service (ready and available for rent), there is nothing to report on a tax return.

If we go back to the investor hours do not count issue, the IRS can have it both ways- they can say the activity hasn’t started yet, so your hours disappear into the ether, and if you argue the activity has started without a place in service asset, the IRS can call your hours investor hours.

Let’s pile on, shall we? Tax Court decisions tend to reinforce this same distinction. When evaluating material participation in rental real estate, courts consistently focus on operational work such as supervising repairs, dealing with tenants, advertising vacancies, negotiating leases, and coordinating maintenance. By contrast, time spent analyzing potential investments, reviewing market data, or searching for new properties is routinely treated as investor activity rather than participation in the rental operation.

Expense Deductions Versus Material Participation Hours

You might also notice another confusing overlap here: deductible expenses versus participation hours. Just because an expense is deductible does not mean the time associated with it counts toward material participation.

For example, if you already own a rental property in Austin and travel across town to evaluate another potential rental in the same market, you might be able to deduct certain travel costs as part of your existing rental activity. The expense may qualify as an ordinary and necessary business cost, or it might be capitalized as an acquisition cost if you ultimately purchase the property.

However, that does not mean the hours spent analyzing that potential purchase count toward material participation. Yeah, we know, it stinks.

The tax code treats these issues completely separately. Expense deductions and capitalization principles are governed by rules such as IRC Section 162 and Section 212, while material participation is governed by the passive activity rules under IRC Section 469. Passing one test does not automatically satisfy the other.

To make a long story even longer, an expense deduction does not magically convert investor time into participation hours. Sorry. The good news is that almost everyone conflates these two, so if you did too, you are not alone. Support group. Jackets. We got you.

The Hailstock Unicorn (A Rare Exception)

However, in Hailstock v. Commissioner, Tax Court Memo 2016-146, the rental property owner did not keep a log with specific hours. It might have actually helped since the Tax Court accepted her narrative testimony plus her massive array of rental properties as enough evidence to demonstrate 750 hours of participation for real estate professional status. The case reads in part-

We find petitioner’s narrative summary convincing because she owned numerous rental properties and conducted her business as a “one-man operation” without being otherwise employed. As previously discussed, petitioner spent well in excess of 40 hours each week doing work related to numerous rental properties (i.e., researching prospective properties, maintaining properties, supervising work orders, finding tenants, securing leases, and continuing education related to rental real estate).

This was a win, but it should not be construed as a green light to log research and continuing education hours. In Hailstock, the taxpayer had well over twenty properties, she was not otherwise employed, and real estate was the only thing she spent time on. Her sheer volume of activity and lack of a W-2 job saved her. Do not build a tax strategy around being the exception to the rule. See our discussion on time logs on page 277.

The Expansion Exception, 1.469-4 Grouping Election

If you are not a full-time real estate professional with 20 properties, there is one other way acquisition time might count: if you already own rentals and treat the new purchase as an expansion of an existing activity rather than the start-up of a new one.

To do this, you must legally group your rentals as a single “appropriate economic unit” on your tax return using Treasury Regulations Section 1.469-4 election. By default, the IRS treats every rental as a separate activity. If they aren’t grouped, the new property is a standalone venture, and its pre-opening clock is stuck at zero.

But be careful! The IRS looks closely at similarities in trade and geographic location. If you own a rental in Austin and buy another on the same street, managing the acquisition could reasonably be considered operational work for your existing Austin rental business.

But what if you own a rental in Austin and start shopping for one in Orlando? The IRS heavily presumes that real estate in a new geographic market is a completely new business venture, not an expansion. They argue that a new city means different market dynamics, local laws, and management teams. While you can sometimes fight this by proving you run everything through a centralized, master management structure, it is an uphill battle.

Even if you successfully use the expansion argument (and even if you group the properties) pure investor tasks like financial analysis still never count. Only the business tasks of the acquisition might sneak in under the expansion umbrella.

Real Estate Professional Status 750 Hours Exception

Time spent acquiring a rental property is generally suspect for material participation purposes, as we’ve discussed. However, some of that time might still count toward the 750-hour test for real estate professional status.

Let’s review IRC Section 469(c)(7)(C) again for fun-

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.

However, it is important to understand the broader umbrella of IRC Section 469. The section is titled “Passive activity losses and credits limited.” It is not primarily about material participation. Having said that, IRC Section 469 does discuss material participation to determine if an activity is passive or nonpassive. Specifically, IRC Section 469(h) reads-

(h) Material participation defined
For purposes of this section-

(1) In general a taxpayer shall be treated as materially participating in an activity only if the taxpayer is involved in the operations of the activity on a basis which is-

(A) regular,
(B) continuous, and
(C) substantial.

What are we getting at here? It is easy to throw all of this into a material participation, passive activity, and real estate professional status stew and assume that the word “acquisition” somehow connects directly to material participation. It does not.

Rather, your hours might count toward the 750-hour real estate professional test, but not toward material participation for a specific rental activity until that activity actually exists. In other words, the hours you spend building your 750-hour total do not automatically count toward material participation in a particular property.

In other words, the same hour might help you qualify as a real estate professional but still fail to count toward material participation in a specific rental property.

Sidebar: Even though we just discussed this a few paragraphs ago, it bears repeating to solve this acquisition conundrum. The tax code loves a good general rule followed by a narrow exception. While not needed for the 750 hours test, grouping elections can certainly help on material participation.

By Jason Watson, CPA
Posted Sunday, March 22, 2026

There is a ton of chatter about time logs. Spreadsheets with dropdowns, conditional formatting, and built-in pivot tables. Neat. So much effort is spent on the right data that people lose sight of four fundamentals-

Your time log must be done in real-time, or what the IRS considers contemporaneous. This is usually not a huge deal but it is surprising how many court cases mention that the records were not kept in real-time.

Next, your time log must highlight not just your time, what you did and the location, it must also contain the time spent by others on your rental activities. This demonstrates your exhaustiveness or completeness in recording all time spent, not just yours.

Next, your time log must appear credible. To support credibility, you will likely need to recall details surrounding the time or moments spent. You will also need to be reasonable. In Escalante v. Commissioner, Tax Court Summary Opinion 2015-47, the rental property owner listed hundreds of hours for writing checks and reviewing mortgage statements. The Tax Court considered how long it would take them to write their own checks based on their own experience of daily life.

Finally, your time log must be corroborated with other transactions or by disinterested third parties. You claim that you spent 6 hours replacing a toilet, and you also demonstrate two separate trips to Lowe’s with receipts. The first is the toilet. The second has all the crud that you forget to get the first time. Perfect! However, in Pourmirzaie v. Commissioner, Tax Court Memo 2018-26, the rental property owner’s time log showed her being at the rentals every single Saturday performing “weekly cleaning and repairing” work. Unfortunately, her bank and credit card statements showed purchases in other locations besides her rental properties. Oops.

Sidebar: Frankly, the fancier the design of your time log with colors and fancy charts the more likely it is fabricated. Sure, that is not fair, we get it, but adding a bunch of bells and whistle to an otherwise simple time log is like putting lipstick on a pig (pun intended for you passive income generator types). Keep it simple. Support your entries. Done.

This is akin to a mileage log. It is a common misconception that just a mileage log is all you need to defend your automobile expenses. Not true. You also need corroboration such as service receipts from your dealership or Jiffy Lube supporting beginning and ending odometer reads.

Is a time log always required? No. Treasury Regulations Section 1.469-5T(f)(4) reads-

(4) Methods of proof.
The extent of an individual’s participation in an activity may be established by any reasonable means. Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means for purposes of this paragraph may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries.

Is this suggesting that a written log is not needed if participation can be established by other means? Yes. But be careful!

Here is a win for the real estate investor. In Birdsong v. Commissioner, Tax Court Memo 2018-148, the taxpayers did not maintain contemporaneous records but testified credibly to their activities. Here is a blurb from the ruling-

Petitioners testified credibly and in detail about petitioner wife’s active and extensive management of their rental properties. Furthermore, petitioners presented detailed spreadsheets that reflected petitioner wife’s rental management activities exceeded the 750-hour requirement. We find petitioners’ narrative summary and thorough time logs convincing because petitioners owned numerous rental units that petitioner wife operated alone. See Hailstock v. Commissioner, (holding that the taxpayer’s credible testimony regarding time spent operating multiple properties alone satisfied the section 469(c)(2) requirements). Petitioners’ testimony is further buttressed by petitioner wife’s thorough time-keeping as well as the receipts and invoices petitioner wife produced to corroborate her time logs.

On the basis of petitioners’ testimony and the record as a whole, we conclude that petitioner wife, pursuant to section 469(c), materially participated and is a real estate professional. Accordingly, petitioners’ loss attributable to their rental real estate is not limited by the passive activity loss rules of section 469.

But the Tax Court also gave a little spanking in a footnote-

Although we caution petitioner wife to construct more strictly contemporaneous time logs for her future endeavors, we find her credible testimony and time logs to be a “reasonable means” of proof. See sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).

Take the win! At the risk of de-emphasizing time logs, recall that in Hailstock v. Commissioner, Tax Court Memo 2016-146, the rental property owner did not keep a log with specific hours. The Tax Court accepted her narrative and stated “we find petitioner’s narrative summary convincing because she owned numerous rental properties and conducted her business as a ‘one-man operation’ without being otherwise employed.”

Credibility Trap: Overwhelming With Volume

Kill the IRS with kindness and perhaps a good tax position, but don’t kill ’em with volume. The safest strategy is to outwork your contractors by tracking every legitimate minute. Did you count the drive to Home Depot? The time spent researching materials? The hour spent negotiating the contract? Rental property owners often under-count their own time while the contractor sends a precise, documented bill.

However, do not mistake volume for credibility.

We often see clients try to pad the stats to safely clear the 100-hour hurdle. They log 30 minutes for a ten-minute Amazon order for spa chemicals or an hour to review a single utility bill. This is a massive mistake. If you material participation time log is challenged, more is not always better.

If an IRS or state revenue agent finds even a handful of entries that are bloated or unrealistic, they often feel justified in disregarding the entire log as non-credible. A concise, realistic log showing 120 high-quality hours is infinitely stronger than a 340-hour log that looks like a “ballpark guesstimate.” Lofty, unreasonable hours are counterproductive. Keep it real, or don’t keep it at all.

The “Crew of 3” Strategy

This is a bit of a sidebar, but good information nonetheless. Hiring a cleaning crew of three people is smart money for two reasons. First, as we discussed earlier with the tile contractors as our example, the 100-hour rule compares you to any individual worker, not the total invoice. If a crew of three works 50 hours each (150 total), and you work 101 hours, you still win because you worked more than Worker A, Worker B, or Worker C individually.

Second, it’s simple risk mitigation. If one person gets sick or quits on a guest turn-around day, the machine keeps moving. The only downside? Speed. A large crew is in and out so fast that they can’t wait for the dryer. You’ll likely need a laundry service to handle the linens off-site, however.

Time Log Application And A Hack

Keep a time log please! If you are looking for a way to easily track time, WCG CPAs & Advisors has partnered with REPSLog and you can download their app here-

https://wcginc.com/time

Also, since you need to track other people’s time as well, many rental property owners will purchase a web-enabled cipher lock and assign discrete door codes to each participant. Each cleaner, repair person, property manager, listing agent, etc. would have a separate door code which can then be downloaded into a time log with time and date stamps. This is especially useful for the 100 hours and more than anyone else material participation test. It also shows your level of sophistication should your time tracking come into question.

Spouse Participation

There is a difference between the 750 hours requirement and material participation in each rental property or as a group if formally elected. For the 750 hours, you cannot combine your time with your spouse. At least one must qualify on their own.

However, and conversely, your material participation in an activity, such as a rental property, includes your spouse’s material participation. This applies even if your spouse did not own any interest in the activity, and you and your spouse do not file a joint tax return for the year.

What does this mean? Let’s say one spouse is a real estate agent, and the other spouse does all the work on the rental properties directly and satisfies the material participation tests. The real estate agent spouse is truly the qualified taxpayer, or what the industry calls the real estate professional, and materially participates in the rental activities vis-a-vis the other spouse.

Hotel-Like Services

We recently had a client who could not meet the material participation rules. She later claimed that she provided hotel-like services such as daily or within-stay linen changes, concierge service, tours and airport shuttle transportation. Since she could not meet the 100 hours and more than anyone else or substantially all hours as part of the material participation tests, we gently pressed for clarifications.

Aside from providing some brochures of local activities and a home-grown dining guide to check the concierge services box, it came down to the semantics of providing hotel-like services and offering hotel-like services. In other words, she offered daily linen changes, tours and airport transportation, but guests never closed the loop and used the services.

We were left with a rental property owner who could not substantiate material participation but claimed to be operating a hotel. Since the tax return would not be very defensible on merit and with our due diligence coming into question, WCG CPAs & Advisors declined to continue with the engagement. The more words needed to explain your tax position suggests your tax position is already a bit wobbly.

By Jason Watson, CPA
Posted Sunday, March 22, 2026

Bear with us as we dig into a small tidbit that could blow up your material participation world. As we’ve defined in several places, a short-term rental is any rental where the average guest stay is 30 days or less. Whether it is considered a rental activity hinges on either a) providing substantial personal services or b) if the average guest stay is 7 days or less.

As such, if you have a rental where the average guest stay is 20 days and you do not provide hotel-like services (daily or mid-stay linen changes, concierge services, transportation, on premise fitness or spa, etc.), you-

• have a short-term rental
• that is considered nonresidential
• but is still a rental activity (and would be more appropriate for the 1.469-9(g) grouping).

Generally, those activities that are similar can be considered an appropriate economic unit. Treasury Regulations 1.469-4(c) read-

(2) Facts and circumstances test. Except as otherwise provided in this section, whether activities constitute an appropriate economic unit and, therefore, may be treated as a single activity depends upon all the relevant facts and circumstances. A taxpayer may use any reasonable method of applying the relevant facts and circumstances in grouping activities. The factors listed below, not all of which are necessary for a taxpayer to treat more than one activity as a single activity, are given the greatest weight in determining whether activities constitute an appropriate economic unit for the measurement of gain or loss for purposes of section 469—

(i) Similarities and differences in types of trades or businesses;

(ii) The extent of common control;

(iii) The extent of common ownership;

(iv) Geographical location; and

(v) Interdependencies between or among the activities (for example, the extent to which the activities purchase or sell goods between or among themselves, involve products or services that are normally provided together, have the same customers, have the same employees, or are accounted for with a single set of books and records).

Let’s bring in a summary table to help navigate this madness-

Don’t shoot the messenger, but there is a subtle difference in the election as well. Treasury Regulations 1.469-9(g) is specific for real estate professional status (REPS) whereas Treasury Regulations 1.469-4 is used for general grouping of activities as one business activity with the same characteristics (appropriate economic unit) such as short-term rentals qualifying for the loophole.

So, the first line and the last two would be grouped under 1.469-4 and the second and third would be grouped under 1.469-9(g). We have a table coming up, but you need to wait a bit.

Another way to say this- group your short-term rentals with an average guest stay of 7 days or less under 1.469-4 and group all other rentals (excluding hotel like rentals) under 1.469-9(g).

What happens if a rental activity changes from short-term to long-term to mid-term with hotel-like services back to short-term? You are likely to get shot by your real estate tax professional. Not fatal, but painful.

Could your group your bed and breakfast with your short-term rental? Yes, and it is not a bad idea. Keep in mind that a bed and breakfast is considered a hotel since substantial personal services are provided. As such, this is not a rental activity. A short-term rental with an average guest stay of 7 days or less is also not a rental activity (it is viewed as a business yet reported on Schedule E or Form 8825, and not Schedule C). Therefore, these two activities may be grouped into one activity to assist with material participation hurdles.

Caution! Before you blast off with your 1.469-4 election, a quick reminder is in order that the regulations require the grouping to be an appropriate economic unit. As such, they must share common control or management, must be similar in nature and should be geographically aligned.

Sidebar To The Caution: Keep in mind that when these regulations were written, working and managing things from a distance were not well contemplated. The geographical provision was meant more as a barometer of your ability to manage the grouped activity as one versus a strict rule on geography itself.

Here is yet another table to visualize grouping elections-

Would you ever group your various rental activities, such as long-term rentals, into one activity under Treasury Regulations Section 1.469-4? There might be a super narrow and rare reason to, but generally, No.

Also, you cannot group your rental properties into one activity to harvest a loss. For example, you own two rental properties- Elm Street and Main Street. Elm has a bunch of passive activity loss carryovers. You want to sell Main but harvest your losses from Elm. Grouping them does not allow for this otherwise wonderful idea. “A” for effort though!

Here is the verbiage from Treasury Regulations 1.469-4(g)(1)(i)–

(g) Dispositions.

(1) General rule. If a taxpayer disposes of an activity (within the meaning of §1.469–4(f)) in a fully taxable transaction to an unrelated party, gain or loss from the disposition is not taken into account in determining the income or loss from any other activity. For this purpose—

(i) If a taxpayer has grouped activities under this section, a disposition of all or substantially all of those activities constitutes a disposition of an entire activity for purposes of section 469(g)(1)(A). A disposition of less than substantially all of the grouped activities does not constitute a disposition of an entire activity.

Our cannot group short-term rentals with other rentals section repeats a lot of this, but also adds some more insights and considerations.

The Geographic Outlier

Keep in mind that when these regulations were written, managing things from a distance was not well contemplated. No internets. Air travel was a luxury (and not a utility or commodity). “Grandpa, did they let people smoke on airplanes?” The geographical provision was meant more as a barometer of your ability to manage the grouped activity as one rather than a strict boundary.

So, how does grouping help if you have three short-term rentals in your backyard and one way the heck across the country? By electing to treat them as a single economic unit, your localized cluster essentially anchors the distant property. As long as they share common control, ownership, and interdependencies (like using the same centralized bookkeeping or management software), the geographic outlier is safely absorbed into the group.

This prevents the IRS from isolating the distant property and arguing that you couldn’t possibly materially participate in it from afar.

Grouping Your Business And Office Building

This is not relevant to material participation, but a good reminder nonetheless. As mentioned elsewhere, you may want to group your business with your office building. Huh? Let’s say you own an architectural firm, and for various reasons the business does not own the office building. Rather, you own it personally or in another entity, and lease it to your architectural firm at fair market rent, and blah blah blah.

The regulations allow you to group these two activities. Treasury Regulations 1.469-4(c) read-

(1) In general. Rental activities may not be grouped with any other activity unless the rental activity is insubstantial in relation to the trade or business activity or the trade or business activity is insubstantial in relation to the rental activity, or unless the activities are integrated in a manner that makes them interdependent.

Why would you want to do this? Self-rentals, as in the example above, are treated like any other rental property where losses are likely limited by passive activity loss limitations. If the building was owned by the architectural firm directly, then you could perform a cost segregation study and deduct a tidy loss against the business income.

Sidebar: We say fair market rent and blah blah blah above. However, be careful since self-rentals are considered nonpassive and therefore the profits from those activities cannot offset or absorb losses from traditional rental properties. So, before you crank up the lease amount because you have other rental losses to offset, keep this little rule in mind (and No, you cannot group them together either). Sorry.

Sidebar #2: What if your business has a business purpose to rent your short-term rental? If your short-term rental qualifies for the loophole by having average guest stays of 7 days or less, and you materially participate in the rental activity as we’ve drooled over in this chapter, then the rental taxable income or loss is considered nonpassive. Self-rental income is considered nonpassive as well. This works, and is a great way to create deductions at the business level and use that rental income to offset rental expenses. Check out our my business rents my short-term rental section for more information.

You split the business and building up, and yuck, you cannot deduct the rental losses. Smart people recognized this problem, and created the regulations above to resolve this conundrum. In other words, you can still perform a cost segregation study on your self-rental and create a tax deductible loss against your business profit using the 1.469-4 election.

We digressed a bit in a chapter on material participation. Ah, you’re better for it, right?

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.

By Jason Watson, CPA
Posted Friday, November 28, 2025

A common myth among newer real estate investors, especially short-term rental owners is that hiring a property manager (PM) automatically kills your chance at material participation. You might say, Doesn’t the PM’s company report hundreds of hours and beat me anyway?

This sounds plausible, and serves as a good warning sign, but it is not entirely true. Recall that the most used material participation test is 100 hours and no one did more than you.

As such you can materially participate when using a property manager provided you understand how hours work, how the “no one does more than you” test is actually applied, and what activities you can legitimately count toward your total (which we just discussed before).

The 100 Hours Material Participation Test Revisited

To reiterate, to materially participate two things matter with this test:

• You must personally hit at least 100 hours, and
• No single individual logs more hours than you.

This second requirement is where property managers create confusion. Rental property owners often assume that the PM entity in aggregate counts as a single participant. It does not. Under Treasury Regulations Section 1.469-5T hours are attributed to individuals, not entities. A property management company doesn’t “perform” hours. People do.

Paragraph (a) starts off with-

In general. Except as provided in paragraphs (e) and (h)(2) of this section, an individual shall be treated, for purposes of section 469 and the regulations thereunder, as materially participating in an activity for the taxable year if and only if-

The rest of the material participation regulations uses the word “individual” about a zillion times.

Therefore, if your PM has five different employees who collectively rack up 250 hours, that sounds intimidating, sure, but unless one of those humans exceeds your time, you haven’t lost the test. The listing agent at 68 hours, the assistant at 91, a cleaner at 86, a seasonal maintenance guy at 42- none of them individually beat you. Collective hours don’t matter. The rule is measured human-by-human. Divide and conquer, right?

This is why good PMs understand the need for time tracking. The ones worth their salt already have processes for logging hours because sophisticated investors ask for this routinely. Let’s not forget that some employees are paid hourly anyway, so the PM is already tracking this to bill your owner account.

How Do You Get 100 Hours With A Property Manager

The real challenge isn’t beating the PM’s hours. The real challenge is hitting 100 hours of your own work, consistently, in real life.

One hundred hours is roughly two hours a week, every week, which is achievable but not trivial, especially if the PM handles the bulk of the day-to-day work. While we’ve just discussed a bunch of tasks and duties that count towards material participation, let’s reiterate a few specific to coordination with a property manager-

• Even if the PM sources leads, the owner can still review bookings (or applications), evaluate rental criteria, approve or deny, etc.
• Anytime the PM says “We need approval for swapping out the refrigerator,” your evaluation time counts when reviewing quotes and price checking, researching materials or methods, comparing contractor options among related things.
• While closely related to investor activities (which do not count), reviewing repair logs, property reports and rent analysis, variances and related problems, rent comps, competitive analysis and pricing adjustments are common operational duties.

Also, let’s not forget DIY maintenance. Let the PM handle simple or quick items like a lock swap or accepting a refrigerator delivery, but you can pop in for a few days to paint, pressure wash and stain the deck, perform seasonal maintenance, etc. Just make sure this work is actually necessary and not manufactured for the sake of material participation hours (you would never!). Substance beats form every time, and pigs get fed while hogs get slaughtered.

Material Participation Travel Time

Travel time counts only if tied to an activity that itself counts. Flying or driving long distances is permissible but only if you actually perform operational work once you arrive.

For example, you drive 12 hours, spend a weekend painting and repairing, and drive 12 hours home. All 24 hours of travel count because the operational work anchors the trip. But if you hot lap it to the rental property and confirm that it hasn’t burned to the ground despite every home automation app reporting happy news, and you do nothing to the property itself, that’s a commuter-style trip and does not count.

Let’s not forget that the overall situation must be reasonable as well- to drive 30 hours one way to steam clean the carpets seem a bit nutty. In other words, this seems disproportionate to the economic value and may fail the economic substance doctrine test (meaningful change that has a substantial non-tax purpose).

Strategy For Using A Property Manager With Your Rental

A cleaning crew of three is better than a cleaning crew of one, not only because of risk mitigation through diversification but all their hours are separated. If each cleaner logs three hours, that’s nine total but no single individual (as the tax code refers to) has more than three hours. That leaves you ahead or at least comfortably competitive.

The same applies to maintenance teams, handymen (handypersons just doesn’t roll off the tongue), landscapers, and seasonal workers. More individuals performing small tasks means fewer hours per person, which makes the “no one does more than you” test a snap.

Also, if a cleaning crew gives you a January–December summary in mid-January for rental property tax return preparation, and one cleaner logged 120 hours to your 101 hours, it’s too late to fix anything. December is gone. You cannot Marty your butt in a DeLorean.

Instead, ask for monthly or quarterly time logs, electronically store them with your own logs, verify the hours by task, and reconcile them before year-end. Property managers already track this internally because they bill by time or tasks. They simply need to export or share the data more frequently.

Putting It All Together

Material participation with a property manager is absolutely attainable. The material participation treasury regulations are clear that hours are counted by individual, not by a business entity. The key is making sure that:

• you reach 100 hours (which can be a challenge in itself),
• no single human, person, individual, soul beats you, and
• you have contemporaneous records for everyone involved (of course you do!).

Rental property owners, especially those working the STR loophole angle and need property manager assistance, who combine operational decision-making, strategic maintenance work, periodic onsite labor (sweat equity), and proper travel-time documentation can confidently hurdle the material participation threshold even with a full-service property manager.

Keep in mind too that you can leverage this alongside the Significant Participation Activity (SPA) material participation test. If you have several rentals and only one or two are managed by a property manager whose employees (individuals) spend more time than you on those specific activities, that does not automatically sink your year. Under SPA rules, you can still combine all your significant participation activities and materially participate across the group as a whole.

By Jason Watson, CPA
Posted Saturday, November 1, 2025

Most rental property owners, and even a fair number of real estate CPAs, see material participation as a three-way game between-

• 500 hours,
• 100 hours and no one did more than you, or
• Substantially all hours.

We do too and it is peppered throughout our book. This trinity covers 95% of the material participation options. But…

Often overlooked is the Significant Participation Activity (SPA) test, found in Treasury Regulations Section 1.469-5T(a)(4). We will call this the “SPA test” since it sounds fun and rolls off the tongue- everyone also likes a good spa, right? We can also call this threshold or test #4 since it is fourth on the list of seven. The SPA test is halfway down the list, and conveniently also the middle lane or blended material participation test.

In a nutshell, the SPA test rewards people who genuinely work in multiple ventures, and at times without the laborious time tracking of others or the worry that someone is spending more time than you. Yay!

The SPA Test in Plain English

Here’s the regulation verbatim-

(4) The activity is a significant participation activity (within the meaning of paragraph (c) of this section) for the taxable year, and the individual’s aggregate participation in all significant participation activities during such year exceeds 500 hours.

And paragraph (c) of Treasury Regulations Section 1.469-5T(c) defines what significant participation means with-

Tilt, right?

In other words, a SPA lives in the sweet spot- more than 100 hours, less than 500, and not already material by some other test. Cross 100 hours, clear 500 hours in the aggregate, and you’re in business on getting those pesky passive losses to become active and therefore deductible against your high W-2 income or other income.

Why the SPA Test Exists

When legislators wrote IRC Section 469, they wanted to prevent passive investors from sheltering income, sure, but they also did not want to punish working owners who happen to spread their time across several smaller activities. How nice, right? Without this material participation provision, someone running four real businesses, each at 150 hours a year, could lose valuable tax deductions simply because of diversification. The SPA test fixes that inequity when your facts line up just right.

SPA Basics

Let’s say you run three ventures: a craft business (110 hours), a tutoring side gig (160 hours), and a self-managed short-term rental cabin (250 hours). No activity hits 500 hours, but all exceed 100 and your total is 520 hours.

Under Treasury Regulations Section 1.469-5T(a)(4), you materially participate in aggregate without the grouping election (which has its limitations), no paperwork, no heroic hour-padding (you wouldn’t dare), etc. Just genuine, hands-on time across several active pursuits.

Sidebar: To group activities under Treasury Regulations Section 1.469-4, an appropriate economic unit meet a facts-and-circumstances test considering factors like similarity of business type, common control and ownership, geographic location, and interdependencies. Right off the bat, grouping a rental property with a tutoring side gig fails the “similarity of business type” criterion, and perhaps others.

Who wants a cheesy tagline? SPA test is aggregation without grouping frustration. There are some devils in the details, so read on!

When Others Participate

Now let’s complicate your rental activity. Like most short-term rental property owner who have a lot going on, you hire a cleaner after each guest stay. Moreover, they spend more time on the rental than you do. Does that ruin your material-participation claim? No.

The SPA test counts only your hours; it doesn’t subtract or offset anyone else’s. The cleaners, handyman or lawn crew’s time neither helps nor hurts. The only requirement is that you exceed 100 hours for the rental activity and your aggregate SPA total exceeds 500 hours. Yay, right?

That distinction matters. Other material participation tests, such as “no one else did more” or “substantially all,” explicitly compare your hours to everyone else’s. The SPA test does not. As long as you personally coordinate bookings, guest communication, repairs, and maintenance decisions, you are the operator with continuous and regular managerial involvement.

Sidebar: Does this mean you can skip recording a time log? Nope. You must still support and defend the 100 hours of participation with specifics on what you did. The silver lining is that you don’t have to track other people’s time which you typically must do in the “100 hours and no one did more than me” material participation test. Test #3 if you are counting.

Here is a table to visualize this-

Why Bother With SPA If I Already Qualify

You might be asking- if I have two rental properties where I already participate at least 100 hours each and no one participated more than me, why do I need to aggregate under SPA? Don’t I already qualify as materially participating? The short answer, Yes, but the SPA test can still make your life easier. Under SPA, you don’t have to track or defend other people’s hours, only your own as we’ve shown above. Sure, the aggregate threshold is higher at 500 hours, but it’s often less paperwork, fewer gray areas, and a cleaner audit defense.

But here’s where SPA really helps. Let’s say you have 4 rentals where you spend 126 hours participating in their operations. However, in 3 of the rentals, others spend way more time than you such as 150 hours compared to your 126 hours. You could elect to group them under 1.469-4 and hit the grand-daddy threshold of 500 hours, but with SPA you don’t have to worry about the pitfalls with the grouping election, and you also don’t have to worry about other hours exceeding yours. Also, you might not be eligible for grouping since there are rules associated with the election.

Want another example? You still have 4 rental properties but each of your rentals has others who spend more time than you. However, when you aggregate them with your side hustle, where you have a very active partner, the SPA test works. You’re active enough to matter even if others rack up more time on individual properties. Here is a table to illustrate-

Separately, none of these activities would be considered material participation and you cannot elect to formally group them since they are disparate in business entity and management / operations. This is where SPA comes in. Sure, narrow example, but it underscores the usefulness with your unique set of facts.

When The SPA Stinks (or can’t be used)

Let’s say you log 150 hours in a consulting side gig, 340 hours managing an eBay resale project, and another 80 hours tutoring. Only the consulting and eBay gigs qualify as SPAs (over 100 hours). As such, the total hours are only 150+340 or 490 hours, just a bit shy of the 500 hours needed. This was the very problem in Brumbaugh v. Commissioner, T.C. Memo. 2018-40. The taxpayer claimed hundreds of hours in an aircraft LLC but couldn’t show the 500-hour aggregate across multiple SPAs. The Court summarized simply-

Petitioner has not shown that his aggregate participation in all significant participation activities during such year exceeds 500 hours. See sec. 1.469-5T(a)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988). In sum, petitioner has failed to meet his burden of proving that he ‘materially participated’ in N444SS during 2007.

The SPA test is a three-part test (the regulations say it is a two-prong test, but we want to tease out a subtle annoyance). First, the activity must qualify as a significant participation activity, which we will discuss in detail in a bit. From there, you need 100 hours in each activity for it to invited to the SPA aggregation party, and then the aggregated hours must exceed 500 hours across all eligible SPAs. Who doesn’t like party with a spa?

Qualifying The Activity As A SPA

Another subtle trap. Correction- the trap is not so subtle, but the application is. Here we go- once an activity already meets a different material participation test, it cannot be a SPA in the same year. Huh? Technical Advice Memorandum 202229036 reads in part-

Section 1.469-5T(c)(1)(ii) provides that an activity is a significant participation activity only if the activity would be an activity in which the individual does not materially participate for the taxable year if material participation for such year were determined without regard to paragraph (a)(4) of this section.

Did that help? Probably not. Here it is in plain English- if an activity qualifies for material participation under another test, it cannot be considered a SPA activity for the 100-hour and 500-hour aggregate tests. What’s the big deal?

The 100 hours and no one did more than me and the substantially all hours tests are easy to trip, and therefore those activities become ineligible for the SPA test.

What About W-2 Jobs?

Taxpayers often ask whether a W-2 job counts toward SPA hours, or worse, whether it ruins the test. The answer is easier than it looks. A W-2 job isn’t even in the IRC Section 469 world (no party invite). Section 469(c)(6) reads-

The term ‘passive activity’ does not include any activity performed as an employee.

That one line takes employment completely off the board. You can’t include your day job hours in the SPA total, which seems obvious, but those hours can’t disqualify you either.

The only time a W-2 job matters is for real estate-professional status (REPS), where you must spend more than half your personal service time in real property trades or businesses. Those 2,080 W-2 hours make REPS qualification difficult (which is to say impossible) but they don’t touch SPA eligibility.

The Tax Court’s Track Record

Few cases address SPA directly, but the ones that do show its boundaries clearly.

In Padda v. Commissioner, T.C. Memo. 2020-154, a physician with ownership in five restaurants and a brewery logged more than 100 hours in each and “well over 500 hours” total. The Court believed his testimony and travel records, holding he materially participated via the SPA test even without grouping the entities. This is Mia’s spiritual twin case: multiple mid-level ventures, credible documentation, no single 500-hour monster in the SPA gaggle.

In Scheiner v. Commissioner, T.C. Memo. 1996-554, the Court described a SPA as an activity in which the taxpayer “participated for more than 100 hours during the tax year, with the level of participation not qualifying as material.” That simple sentence has anchored a lot of other discussions and court decisions. In other words, the quote is saying that while your participation is not material as defined elsewhere, it certainly is significant and cannot be ignored when aggregating under the SPA test.

Scheiner is one of those fundamental underpinnings to SPA considerations.

In Gregg v. United States, 186 F. Supp. 2d 1123, the district court noted that once an activity already satisfies the 500-hour material participation test, it can’t also qualify as a SPA for that same year (which we already discussed, but wanted to drive home the point). That activity stands on its own as “material,” and the SPA test simply doesn’t apply.

Together, these authorities sketch a neat box-

• under 100 hours, too small
• 100 to 499 hours, SPA territory
• 500+ hours, already material and excluded from SPA aggregation.

This is sort of a goldilocks situation. Too soft, too hard, just right.

Grouping Still Matters, Just Differently

Treasury Regulations Section 1.469-4 allows taxpayers to group several activities into one “appropriate economic unit” as we side barred previously. That can help when operations truly function as a single business or activity and you are trying to support material participation across them all. However, this election comes with baggage. Once grouped, always grouped, unless facts materially change. That can be problematic in certain circumstances.

The SPA rule, by contrast, requires no election. You can keep your activities separate for tax reporting yet still aggregate your hours informally for the 500-hour SPA threshold. That flexibility can be helpful for real estate investors or rental property owners with a gaggle of unrelated ventures that don’t meet the “appropriate economic unit” standard or want to be boxed in with the 1.469-4 election.

Real Estate Professional Status Overlay

If you qualify as a real estate professional, the SPA test can help determine final leg which is material participation within your rentals. This is especially helpful if you have several smaller properties where each one alone doesn’t meet the other material participation thresholds. For example-

• You spend 750 hours or more on real estate activities,
• More than half of your personal service time is spent on your rental properties (not including short-term rentals, which are not “rental activities” under IRC Section 469 but rather businesses, like a hotel), and
• You have four long-term rentals, each requiring about 150 hours of your time (over 100 hours but less than 500 hours).

In this case, you can apply the SPA test across those rental properties to establish material participation without using the 1.469-9(g) election (which is unique to REPS and separate from the 1.469-4 grouping election).

If you have made the 1.469-9(g) election to treat all rentals as one activity, you then test that single grouped activity under the standard material participation rules such as the 500-hour, 100-hour and no else did more or substantially all hours tests. The SPA test itself becomes irrelevant because SPA requires multiple distinct activities to aggregate; once they’re grouped, you have just one activity. In other words, you need at least two activities to have a SPA discussion (and at least two people to have a spa party).

Could you instead group your long-term rentals under 1.469-4, and then combine that now single activity with your short-term rentals under the SPA test? Theoretically you could, but in practice it rarely works. Once an activity, even a grouped one, meets a material participation test, it is already material and no longer eligible for SPA treatment.

Quick sidebar-

1.469-4 The “Economic Unit” Grouping. Let’s you combine multiple businesses or rentals into one activity if they form an appropriate economic unit based on common ownership, control, geography, or interdependence. It’s available to anyone and applies to both rentals and trades or businesses.

1.469-9(g) The Real Estate-Professional Election. Exclusive to real-estate professionals under IRC Section 469(c)(7). It allows all rental real-estate interests to be treated as a single activity solely for material-participation testing. It doesn’t depend on economic factors. Keep in mind that short-term rentals are not rental real estate interests.

We discuss grouping elections in deeper detail in later sections.

Final Thoughts Sitting In The SPA

For taxpayers with multiple mid-size ventures or activities, the SPA test can be a practical material-participation entry point if you want to reduce paperwork and time tracking of others. So, if you can say, “I’m busy everywhere but not full-time anywhere,” the SPA test might prove useful. Sure, it might not blow your hair back either since you might materially participate in using the 100 hours test- however, and it bears repeating, if you spend 100 hours per activity and others do spend more time than you, then SPA is your friend.

In summary, two reasons to use the significant participation activity (SPA) test-

• You don’t want to track other people’s time, or
• You cannot formally group activities because they are ineligible to be grouped, and they separately don’t qualify for material participation, or
• You have several activities where others spend time than you (think 4 rentals plus side gig where others are blowing up your material participation with their hours).

Yes, these are narrow reasons. Yes, this is a lot reading to get through. Yes, you are better for it.

By Jason Watson, CPA
Posted Sunday, August 31, 2025

Many real estate investors utilize the 100 hours and more than anyone else material participation entry point or threshold. 100 hours is easy, and you just need to ensure the cleaner, as an individual, does not spend more hours than you. But what about your business partner? If your partner is your spouse, hours can be combined for material participation. However, if your partner is the brother-in-law mentioned above, this becomes problematic.

A literal reading of the tax code suggests that you and your business partner must each be over 100 hours but also that your hours are identical. Here is a snippet from Treasury Regulations 1.469-5T(a)(3)–

Let’s rewrite this, shall we-

(3) The individual participates in the activity for more than 100 hours and their participation is not less than any other individual (including individuals who are not owners);

If they are at 103, you need to be at 103. This way your time is not less than your business partner. At times tax professionals, including WCG CPAs & Advisors, will say, “100 hours and more than anyone else.” This is not wrong, but it is not precise either since if it were, then each of you at 103 hours would not qualify, right?

Another consideration- In all the material participation chatter, the 7th test, which is facts and circumstances, is often thought of as kryptonite. Don’t touch it. Don’t look at it. We disagree. Keep mind the underpinning of the material participation tests- they are bright lines to remove the need for a facts and circumstances based argument. “Hey, give us a credible and reasonable time log and we’ll check the box without further explanation.”

Yet, the facts and circumstances argument or defense remains very much available. It would be silly to think that if you had 103 hours, and your business partner had 107 hours, the IRS would consider your participation efforts to be not material. Having said that, if you have 103 hours and your co-owner had 210 hours, that might be viewed differently.

Also, you can think of it this way- material participation is a per human and per individual tax return (Form 1040) sort of thing, and you don’t file a Form 1040 tax return with your brother in-law. That’d be weird and likely illegal in most states. Thanksgiving would be super awkward.

Finally, don’t forget about your spouse! As mentioned elsewhere, under Treasury Regulations 1.469-5T(f)(3), your spouse’s hours count towards material participation. Similar to the “per tax return” concept above, a jointly filed tax return combines the hours of both spouses for material participation. Paint that wall together. Fix that deck in between sips of bourbon. Honey do lists becomes honeys do it together lists.

Furthermore, it does not matter if the K-1 from the partnership is only in one spouse’s name nor does community property versus common law property states come into play. Keep in mind, however, that spousal hours do not count towards the 750 hours needed for real estate professional status (REPS).

By Jason Watson, CPA
Posted Thursday, September 4, 2025

Here are some FAQs you might find helpful for material participation-

Why does material participation matter for real estate investors?
It determines whether your rental activity is passive or nonpassive, affecting your ability to deduct losses against other income. Keep in mind that material participation must be paired with real estate professional status (REPS) or short-term rental (STR) loophole to offset other income.

What is the 500-hour material participation test?
If you work more than 500 hours on a rental activity in a year, you are materially participating under Test #1. Consider that this is nearly 10 hours a week, every week.

What is the “100 hours and more than anyone else” test?
If you work over 100 hours and more than any other person, you meet the material participation standard (Test #3). This is the common one used among rental property investors and landlords.

What does “substantially all” participation mean?
You did all of the work, with others participation being negligible or extremely incidental (like a lawn service, and only a lawn service and not a gaggle of support).

Can time from both spouses count toward the material participation tests?
Yes. Spouses’ time can be combined for material participation but not for the 750-hour REPS requirement.

Does investor time count toward material participation?
No. Time spent on financial analysis, research, or reviewing reports is considered investor time and does not count. It would be a runaway train otherwise.

Does time spent acquiring a rental property count toward the 750-hour real estate professional requirement?
Yes, acquisition time can count toward the 750 hours for real estate professional status, but it does not count toward material participation for a rental activity. Acquiring a short-term rental will not count towards the 750-hour test, however.

When does material participation in a rental activity begin?
Material participation starts once the property is placed in service which means the rental is ready, available, and held out for rent. This applies to both long-term and short-term rentals. Acquisition or setup tasks for a short-term rental may count earlier because STRs are treated as a trade or business, but operational work still requires the property to be in service.

Can acquisition time for a short-term rental count toward material participation?
Yes, acquisition-phase work (analysis, due diligence, financing, closing, and business setup) can count because STRs are treated as a trade or business. But setup or property-preparation tasks like furnishing, stocking, or getting the space guest-ready only count after the property is placed in service. Yes, this is annoying. No, you can’t complain.

Does short-term rental time count toward the 750-hour real estate professional status requirement?
No, short-term rental time does not count toward the 750 hours because STRs are not considered rental activities or real estate activities for this purpose.

What activities likely do not count toward material participation, even for short-term rentals?
Activities such as reading market reports, viewing real estate listings, meeting with brokers or lenders, or creating ROI/IRR spreadsheets generally do not count toward material participation.

What about supervising contractors or maintenance workers?
Yes, as long as the property is in service and the supervision is active and direct, it may count toward participation time.

Is using a property manager a problem?
Not necessarily. But if their individuals (repair people, cleaners, managers) spend more time than you, as individuals, your hours may not satisfy the “more than anyone else” rule.

Does hiring a property manager kill my chance at material participation?
Nope. The tax code counts hours by human, not by company, so a property manager’s collective hours don’t beat you. As long as no single person logs more time than you, you’re still very much in the material participation game.

How do I hit 100 hours if my property manager does most of the work?
You focus on the stuff they don’t do such as approvals, pricing decisions, reviewing reports, planning repairs, and doing meaningful DIY projects.

Do the property manager’s employees’ hours wreck my “no one did more than me” test?
Only if one individual blows past your hours. The listing agent at 68 hours, the assistant at 91, a cleaner at 86, a seasonal maintenance guy at 42. You are in good shape since you did a 100 or more, and in this example, no one hit 100 individually (or beat you).

Can I pick and choose which rentals to aggregate?
No. Under 1.469-9(g), aggregation applies to all rental interests or none at all.

Do I need a time log?
Yes. Keep a detailed log of activities, hours, and proof (emails, receipts, calendar events) to support your participation claims.

Does renovation time count?
Yes even if the rental is offline as long as the property is in service.

What’s the short version of the Significant Participation Activity (SPA) Test?
It’s the “100-plus hours but not 500” test that lets you combine several moderate-effort activities to reach material participation without formal grouping elections.

If I already qualify under the 100-hour test, why bother with SPA?
SPA can still simplify recordkeeping because you only prove your own hours. It’s often easier than defending what everyone else did.

When is the SPA material participation test helpful?
When you have certain activities such as short-term rentals where others perform more hours than you, but when your hours are aggregated (not grouped) under the SPA test, other people’s hours are ignored.

How do the 100-hour material participation rules apply when I have a business partner?
Each partner must participate for more than 100 hours, and your hours cannot be less than any other individual involved, even non-owners. So, you and your business partner’s hours should be the same.

Can my spouse’s hours count toward material participation in a partnership?
Yes, under Treasury Regulations 1.469-5T(f)(3), a spouse’s hours combine on a joint tax return, regardless of whose name is on the K-1 or state property laws.

Is the facts and circumstances test ever useful for material participation?
Yes, while often avoided, it can support participation if both partners’ hours are close, such as 103 and 107, though large disparities might be viewed differently by the IRS.

What’s the purpose of the 1.469-9(g) election?
It allows you to treat all your rental properties as one activity, simplifying the hours test and reducing tracking complexity.

What is the difference between the 1.469-9(g) and 1.469-4 elections?
1.469-9(g) is exclusively for qualifying taxpayers, and more commonly known as real estate professionals. Whereas 1.469-4 is a general election to group activities that are an appropriate economic unit such as all short-term rentals, or your business and office building.

Do short-term rentals require material participation?
For the loophole, Yes, but they’re not considered rental activities under IRS rules, so you can qualify without REPS if you materially participate.

By Jason Watson, CPA
Posted Sunday, August 31, 2025

Here is a big list of tasks and efforts that count towards material participation and an equally big list that do not count. Sure, some of this is redundant since defining what time you cannot count towards material participation is easily converted into what you can count with a flip of some words, but you’ll get the idea.

Also, before we get into the big lists, keep in mind two things- improper corroboration and inadequate record keeping are the downfalls to most taxpayer arguments, and second, don’t stop counting hours once you hit your 500- or 100-hour marks (depending on which test you are shooting for).

Things That Count Towards Material Participation

As promised, here is a decent-sized list of things that count towards material participation hours-

• Collecting rent from tenants or guests
• Advertising rental property for lease
• Screening tenant or guest applications
• Negotiating and executing lease or rental agreements
• Directly managing or supervising repair contractors (this one is tricky)
• Performing repairs yourself
• Procuring and reviewing hazard insurance
• Bookkeeping for the rental property (but not reviewing financial statements, subtle)
• Decorating/staging the rental property
• Conducting safety inspections (but let’s not get carried away)
• Renovating an in-service property (the in-service part is critical)
• Meeting tenants and guests about issues
• Responding to maintenance calls (but simply being on-call does not count)
• Purchasing supplies (but let’s not dilly dally)
• Coordinating tenant move-in and guest check-in, including when they leave
• On-site management visits (same warning as safety inspections)
• Reviewing local compliance requirements including Airbnb and VRBO
• Filing permits for rental operations
• Supervising employees such as your children who are on payroll
• Communicating with city inspectors
• Managing utilities for rental property (negotiating internet service, for example)
• Paying HOA dues and managing HOA compliance
• Attending HOA meetings if they are specific to operations
• Attending zoning or city council hearings for rentals
• Preparing property for new tenants or guests (turnover cleaning)
• Filing property tax protests/appeals (which you should do every two years, always)
• Meeting with attorneys and tax professionals
• Coordinating landscaping or lawn care services, including pest control
• Reviewing and signing vendor contracts such as trash or pool service
• Tracking and reconciling rent payments
• Drafting and reviewing tenant or guest communications
• Inspecting property after storms or damages
• Preparing documentation for tax return (if directly rental-related)

As mentioned elsewhere, be careful of how thick your pencil is- in other words, logging 32 hours to replace a toilet or spending 12 hours shopping for towels seems unreasonable. Attending HOA meetings is a mixed bag- if the meeting is specific to operations such as short-term rental compliance, parking lot maintenance or guest rules for grills and fireplaces (for example), then this time counts. General HOA nonsense like budgets and community events probably do not count towards material participation.

Also, keep in mind that time spent performing tasks on short-term rental activities does not count towards the 750 hours for real estate professional status. This is generally because STRs are not rental activities- they are businesses, and to make things worse, they are not real estate businesses. However, time would still otherwise count towards material participation for REPS (recall that there is a 3 part test- 750 hours in real estate, more than 50% of your time spent across all activities including W-2 jobs is spent in real estate, and you materially participate in the rental property activity).

Things That Don’t Count

Another list for your groaning pleasure-

• Researching future investment or rental properties
• Reading market reports (yawn) or AirDNA (fun)
• Browsing Zillow or MLS listings (totally fun and addictive, right?)
• Building ROI spreadsheets for new acquisitions
• Meeting brokers for acquisition discussions
• Reviewing rental property financials for own analysis (but what about for a lender?)
• Continuing education courses including reading real estate blogs/newsletters
• Being “on call” without actual work performed (need to lift a finger at least)
• Renovating property before placed in service (again, this is a big gotcha)
• Travel time considered commuting (no home office or rental in your resident city)
• Travel with personal errands mixed in (you would never)
• Working as employee of real estate firm (<5% owner)
• Dreaming or thinking about rental properties
• Travel without evidence of being involved in day-to-day managerial operations
• Preparing financial summaries for your own portfolio or personal financial statement
• Attending real estate investment seminar
• Researching tax strategies (but talking to WCG CPAs & Advisors about them, sure!)
• Networking events not directly tied to your rental properties
• Meals (and drinks) with real estate professionals
• General investor club meetings
• Meeting with mortgage lenders for future loans
• Reviewing potential loan options for acquisitions (not in-service yet)
• Preparing hypothetical budgets for “maybe” deals
• Performing due diligence on a property not yet purchased (darn in-service thing again)
• Talking with other investors about their rentals
• Comparing financing structures theoretically

Some tasks and efforts that do not count towards material participation might still count towards the 750 hours for real estate professional status. Examples might include building ROI spreadsheets for new acquisitions, meeting with real estate brokers and lenders, and performing due diligence on real estate investments. Don’t forget about renovations before in-service where you work with architects, designers and contractors, and then supervise the work.

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

At the risk of repeating ourselves from a previous section, there are times when you want your participation to be passive- usually when you have passive income that is being taxed, and you want to use it to offset passive losses. Huh? You are a successful business owner, and you are sunsetting a bit, and therefore you would like to consider your participation passive since you have managers and other smart people running things.

This would allow you to take your taxable business profits and offset them with rental property losses without having to worry about using real estate professional status or short-term rental loophole as your escape hatches. Recall the passive, active and material participation levels we discussed in our material participation rules section on page 129 where passive losses can only offer passive income. Therefore, calling business income passive income might be a good thing, right?

In response, and as they see you coming a mile away, the IRS might use “5. You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years” above to consider your business income (profits) not passive. Therefore, your business income is a different color of money and cannot be offset by rental property losses.

See our your small business as a passive income activity section and passive income generators (PIGs) section for more information.

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

Ok. Here we go. This is where the IRS is starting to crack down on what they deem gaming the system by self- determined real estate professionals and short-term rental loopers (yeah, we just made up the word looper, but it has a nice ring). IRC Section 469(h)(1) reads-

(h) Material participation define
For purposes of this section-

(1) In general
A taxpayer shall be treated as materially participating in an activity only if the taxpayer is involved in the operations of the activity on a basis which is-

(A) regular,
(B) continuous, and
(C) substantial.

Keep in mind that this is the Internal Revenue Code or the IRC. Treasury Regulations attempt to take the IRC and provide context including examples.

What the heck is regular, continuous and substantial? Temporary Treasury Regulations 1.469-5T(a) gives us a hand. There are several requirements for material participation, and satisfaction of any one test will allow you to be considered materially participating. We’ll discuss each one in turn and refer to notes from the IRS Audit Techniques Guide (ATG) for each test including case law when applicable.

As you read these, also keep in mind that the IRC simple states “regular, continuous and substantial.” The seven tests for material participation (only six since the seventh is the catch-all facts and circumstances test) can be considered a safe harbor of sorts or a bright line. The IRS basically says, “hey, prove X and we won’t challenge the materiality of your participation. If not, bring all your data to us, pack a lunch and a snack, and let’s chat.”

1. You participated in the activity for more than 500 hours.

ATG Notes: If the taxpayer participates more than 500 hours during the year in a business, income or loss from the activity will be nonpassive. Participation of both spouses is counted, but not participation of the children or employees. Participation in operations must be regular, continuous, and substantial. The examiner should determine whether the quantity of time documented is reasonable in light of other obligations.

What exactly does “regular, continuous, and substantial” mean? No definition is provided in the Internal Revenue Code or other regulations. However, among Technical Advice Memorandums (TAMs) and tax court Cases, a general notion exists that for a taxpayer to materially participate, the taxpayer must be involved in the day-to-day management and operations of the rental activity (similar to a trade or business).

ATG Notes Specific to Real Estate Professionals: Rental activities, by nature, normally do not require significant day- to-day involvement, i.e. they are not time intensive. For many taxpayers using any kind of outside management, the only material participation test available is the 500 hour test- the other tests will not apply. In many circumstances, an individual rental activity will not require 500 hours of participation, nor will the taxpayer have sufficient time available to spend 500 hours on each individual rental real estate activity.

Examination Techniques: Review W-2s and other nonpassive activities. Does it seem likely that the taxpayer claiming to be a real estate professional could spend 500 hours on the activity in light of other employment obligations? Ask questions on taxpayer material participation activity time early in the examination. Establish the time the taxpayer spends on all activities during the initial interview if possible. Determine the location of each activity. If located far from the taxpayer’s residence, how likely is the taxpayer to have spent substantial time on the activity?

Tax Court: Despite the IRS’s ATG notes on passive activities, the tax court in Pohoksi v. Commissioner, Tax Court Memo 1998-17 implied that they would entertain proof that the taxpayer substantially participated as compared to the participation of a property management company. This is a satisfaction of test #2.

WCG Notes: This is basically 10 hours a week, every week. Even a short-term rental usually has down time between seasons or events. A normal work year is 2,080 hours and 500 hours is basically 25%. We are not saying 500 hours is inconceivable or indefensible, but adding some comparison data helps the perspective.

2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity.

ATG Notes: Stated simply, if the taxpayer does most of the work, income or loss will be nonpassive. The involvement in the activity of an employee or non-owner could cause the taxpayer to fail this test. There is no specific number of hours associated with this test. In addition, the term “substantially” is not defined in the regulations.

Tax Court: In Pohoski, the tax court noted that the taxpayer did not introduce evidence of the hours spent by a property management company. The tax court implied that they would entertain proof that the taxpayer substantially participated as compared to the participation of a third party (in this case a management company). Pohoski v. Commissioner, Tax Court Memo 1998-17 stated the second test was not satisfied when taxpayers failed “to put forth some indication of the actual time spent by” third-party non-owners in activities on the property.

WCG Notes: This test is critical for partial year rental property activities especially when considered accelerated depreciation deduction from a cost segregation study. If you buy a rental and place it into service on October 1, the hours in test #1 above and test #3 below are not pro-rated for the partial year. The hours threshold is strict.

3. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who did not own any interest in the activity) for the year.

ATG Notes: If a taxpayer participates in an activity for more than 100 hours and no other individual participates more than the taxpayer (including any employee or non-owner), income or losses from the activity are nonpassive.

Examination Techniques: Be alert to employees who are managing the activity, indicating the taxpayer deducting the losses may not be materially participating (particularly on Form 1040 Schedules C and F). When reviewing taxpayer hours, watch for “investor” activities (Internal Revenue Code Section 1.469-5T(f)(2)(ii)). The taxpayer must be involved in the activity’s day-to-day management or operations. Hours spent toward reviewing financial statements, preparing analysis for personal use, and monitoring the activity in a non-managerial capacity do not count.

WCG Notes: We will discuss what time counts in a bit. The ATG mentions investor activities, and this is a common area where real estate investors and rental property owners get tripped up. Test #3 is a class favorite for the short-term rental (STR) loophole. However, you must track the time of cleaners and maintenance personnel.

4. The activity is a significant participation activity (SPA), and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you did not materially participate under any of the material participation tests, other than this test.

ATG Notes: The term significant participation activity is unique to Internal Revenue Code 1.469-5T. If the sum of the taxpayer’s time in all SPAs is more than 500 hours for the year, then income or losses from the businesses are nonpassive and the taxpayer might be considered a real estate professional. For each SPA, the regulations require: The taxpayer to participate more than 100 hours during the year. The activity must be a business, i.e. it cannot be a rental or investment activity. The business must be a passive activity. Thus, if the taxpayer works more than 500 hours in the business, it is not a SPA as 500 hours is one of the qualifying tests for material participation. Similarly, if the taxpayer does most of the work in the business, it cannot be a SPA as Internal Revenue Code Section 1.469-5T(a)(2) holds that performing substantially all the work qualifies for material participation.

WCG Notes: Yawn.

5. You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.

ATG Notes: An activity is nonpassive if the taxpayer would have been treated as materially participating in any 5 of the previous 10 years (whether or not consecutive). This test usually applies when a taxpayer “retires from material participation” but maintains an ownership interest in the activity.

Examination Techniques: Even if the taxpayer performs no services for a business currently, the examiner should inquire about involvement in prior years and review the returns to see if income or losses were treated as nonpassive.

WCG Notes: We discussed this in an earlier section on considering your small business as a passive income activity. Test #5 is a pariah of sorts since it is what the IRS uses to deem your activity nonpassive when you are wanting passive activity income. Test #1, #2 and #3 are the common ones to prove the activity is non-passive. The sword cuts both ways.

6. The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital is not a material income-producing factor.

ATG Notes: None.

Examination Techniques: None.

Tax Court: As far as we can tell, this test has not been used in tax courts involving real estate professionals and rental properties.

WCG Notes: Some real estate investors and tax strategists have argued that operating rental properties is a personal service. We disagree. The personal services listed in this test are traditional service professions where you would have clients or patients. Of course, an argument could be made that tenants are clients, but the one hiccup is the rental property itself. The personal service would not exist if it wasn’t for the building, therefore capital is a material income-producing factor (income comes from rents, rents come from tenants, tenants live in buildings, buildings require capital for acquisition).

Said in another way, the personal service is being spent on the building (maintenance, approving who gets to use it, recording transactions regarding the building, etc.) rather than on a person. Therefore, it is not truly a personal service. Personal service has the word person in it to boot! Also, doesn’t #6 look eerily similar to the rules in Section 199A qualified business income deduction? We digress.

7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.

ATG Notes: The facts and circumstances test may apply if none of the other tests are met. This test does not apply unless the taxpayer worked more than 100 hours a year. Furthermore, the taxpayer’s time spent managing will not count if: Any person received compensation for managing the activity and any person spent more hours than the taxpayer managing the activity.

Examination Techniques: Taxpayers may argue the facts and circumstances test when they fail the others. However, due to the stringent limitations, few taxpayers can meet the facts and circumstances standard. If there is paid on-site management, the facts and circumstances test cannot be used.

WCG Notes: Recall that the IRC Section 469 is the actual law which reads “a taxpayer shall be treated as materially participating in an activity only if the taxpayer is involved in the operations of the activity on a basis which is (A) regular, (B) continuous, and (C) substantial.” As we’ve stated before, material participation tests #1 through #6 can be considered a safe harbor of sorts or a bright line. If you cannot easily fit into one of those, then you have to prove you case with data, solid recordkeeping and some luck.

LLC Members

If you owned an activity as a limited partner or member, you generally are not treated as materially participating in the activity. However, you are treated as materially participating in the activity if you met test #1, #5 or #6 described above. You can also see Chambers v. Commissioner, Tax Court Summary 2012-91 for some real snoozer material.

Fundamental Underpinnings of the Code

As a reminder, and as stated elsewhere, the Internal Revenue Code is trying to say that if you meet one of the material participation rules, then the activity is automagically deemed to be “business-like.” While so many people warn against the “facts and circumstances” argument, we must remind ourselves of the underpinnings of determining material participation- , is this some side-gig hobby-esque passive whatever whatever, or is this a real business with a real vision and commercial substance?

We dig a little deeper and apply material participation tests in our sections on real estate professional status (REPS) and short-term rental (STR) loophole.

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

Chapter 5 dives deep or double clicks or whatever is the latest phrase into one of the most critical and misunderstood concepts in rental real estate investment- material participation. Unlike active participation, material participation requires a higher level of engagement in the rental activity. We also explain how to move your rental activity from the IRS’s default classification of “passive,” where losses are limited, to “nonpassive,” where losses can offset W-2 income, capital gains, and other sources. The key? Proving that you materially participate in your rental business. Shocker, considering the chapter title.

The chapter clarifies the difference between material participation and real estate professional status (REPS), and how the two intersect (although we have a dedicated chapter to REPS later). Key topics include how to log qualifying hours, what time doesn’t count (like investor or research hours), and how using a property manager affects your eligibility. Aggregation elections under Treasury Regulation 1.469-9(g) are also covered as a strategic option to reduce the hours spent burden.

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 nonpassive 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!