Chapter 4 Frequently Asked Questions

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

Here are some FAQs you might find helpful for our hodge-podge of tax rental property tax considerations-

What are passive activity loss (PAL) limits?
The IRS generally disallows losses from passive activities (like rentals) unless you have passive income to offset or qualify as a real estate professional.

Can I treat income from renting property to my own business as passive income?
No. Under Treasury Regulations Section 1.469-2(f)(6), income from a self-rental to a business in which you materially participate is treated as non-passive. This means you cannot use that income to offset passive losses from other rental properties.

Can I use a cost segregation study on a self-rental property?
Only if you group the rental and business activity under Treasury Regulations Section 1.469-4(c)(1) to form an economic unit. When grouped, losses from the rental (including accelerated depreciation) can offset business income, assuming the business and rental meet common ownership, control, and activity requirements.

Does self-rental income qualify for the Section 199A QBI deduction?
Typically no—unless the self-rental is aggregated with the operating business under the same grouping rules above. If the rental and operating business share common ownership and meet other criteria, then the qualified business income (QBI) deduction may apply.

How much loss can I deduct if I don’t qualify as a real estate professional?
Up to $25,000, phased out if your modified AGI exceeds $100,000 and fully eliminated at $150,000.

What is the real estate professional (REPS) exception?
If you qualify under IRS rules, your rental activities are treated as non-passive, allowing you to deduct all losses against other sources of income.

Does California recognize the REPS exception?
No. California does not conform to IRC Section 469(c)(7), meaning real estate professional status doesn’t apply for state tax purposes. Yuck.

Can I take accelerated depreciation in California?
Generally no. California disallows bonus depreciation and limits Section 179 deductions more than the federal code does.

How many states do not allow bonus depreciation (conform to the federal tax code)?
Lots. Around 20 or so.

Do states treat capital gains from rentals like the IRS does?
Not always. Many states don’t offer preferential rates for long-term capital gains from your rental property sale, taxing them at higher ordinary rates.

Am I required to file a state tax return if my rental has a loss?
Yes. Most states still require a return to be filed if you own income-producing assets in the state, even with a tax loss. There is also the non-conformity or decoupling from federal tax code issue as well.

How are vacation homes taxed differently?
If personal use exceeds certain thresholds, deductions are limited and must be prorated based on rental vs. personal use days.

What are the vacation home use thresholds?
14 days or 10% of the rental days, whichever is higher. Exceeding this day limit makes the property a “home,” limiting deductible expenses.

What’s the Tax Court Method for vacation homes?
It prorates mortgage interest and property taxes over the full year, often allowing more to be deducted on Schedule A. IRS was not thrilled.

Can I carry forward unused vacation home deductions?
Yes, but only to offset future rental income. They don’t carry forward like your PALs (passive activity losses) and don’t offset other income sources.

Are mortgage interest and taxes always deductible on a vacation rental?
Only the rental-use portion is deductible on Schedule E. The personal-use portion may be deductible on Schedule A, subject to limits.

When should I report rental income on Schedule C instead of Schedule E?
You should report rental income on Schedule C only if you provide substantial personal services to tenants similar to those provided by hotels, such as daily cleaning, meal service, concierge support, or valet parking. These services must go beyond what is typically offered in a standard rental.

Do short-term rentals automatically go on Schedule C if I materially participate?
No. Even if you materially participate or use the short-term rental loophole, the activity is still reported on Schedule E, not Schedule C, unless you provide substantial personal services as defined by IRS Publication 527.

What types of real estate income are usually reported on Schedule C?
Generally, only real estate brokers, property managers for other owners, or fix-and-flip operators report income on Schedule C. Regular rental activity, including STRs without hotel-like services, should remain on Schedule E or Form 8825 for partnerships.