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How can I make Schedule E to be non-passive income?

anguyen3010

I have an airbnb rental. My average rental days is less than 7 days and I actively participated in the business. I read up on airbnb reporting guidance that I should report my rental activities on Schedule E. However, when I use schedule E in FreeTaxUSA, it's default to be passive income. What do I need to do to make it non-passive?

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Henry

Hi anguyen3010! It sounds like your Airbnb keeps you pretty busy.

According to the IRS, rental income is generally considered passive income, even if you materially participate, unless you are a qualified real estate professional.

However, if the property was rented for an average of 7 days or less per guest, the rental isn’t a passive rental activity, and it should be reported on Schedule C instead.

Check out this great article in the Community for more information.

phaser

I respectfully disagree with the answer provided by Henry. This topic has been well researched by various tax professionals and attorneys. It's accepted by pretty much everybody that if the rental activity is for short-term rental (under 7 days) and if the partnership member is materially participating in the business, Schedule E losses are considered active and can be used to offset other active income such as W2 wages.

Here is the actual copy and paste from Publication 925.

"Exceptions. Your activity isn’t a rental activity if any of the following apply.
1. The average period of customer use of the property is 7 days or less."

I like FreeTaxUSA, but if it keeps this mistake unfixed, I will have no choice but to go back to another tax service. Please, FreeTaxUSA, please get your tax experts to review this and fix the software!!!

anguyen3010

Hi @Phaser, I am glad to hear that my understanding of rental income being non-passive is not completely incorrect.

phaser

@anguyen3010, unfortunately my opinion and your opinion don't mean anything.

I am in the same boat as you were last year — I need to take the rental loss (through material participation) to offset my W2 income, but FreeTaxUSA's software doesn't allow that.

By the way, FYI, you used the phrase "actively participated" in your post last year. Active Participation and Material Participation are 2 different definitions and lead to different tax treatment. Active Participation is easier to be eligible for, but it gives you a cap on how much passive loss can be used to offset against active income. That amount decreases if your AGI is above $100k and disappears if AGI is above $150k. Material Participation has a higher bar to meet, but if you meet it, there is no AGI threshold.

Diabeetus

I have the same issue as Phaser and anguyen3010. With a STR and stays less than 7 days on average, I want to select Schedule E losses as active.

@Phaser Perhaps one could simply mark themselves as a "real estate professional", so it switches from passive to active? However, in my case, I have two rental properties and do not want them both toggled to active as just one of them is an applicable STR…

ana

I am running into this same issue. I have a schedule E with 2 passive long term rentals and 1 active short term rental, but all are counted as passive by freetaxusa. Any suggestions on what to do? Is using other software really the only way?

BosProps4121

Did anyone figure out a way to fix this? I am surprised to see my STR expenses allow for almost no deductions despite my material participation. I don't want to incorrectly report my status as "real estate professional" but doing so reduces my tax liability by around $20k. I would not be investing my time and money into short-term rentals if it were not for the tax benefits and passthrough deductions. I'm about 80% done with filing my taxes through freetaxusa, it would be a shame to start over in another software.

Henry

https://community.freetaxusa.com/discussion/comment/4317#Comment_4317

You're right, Phaser. Short-term rentals are getting to be more and more common, and the IRS has provided better guidance on how this type of income should be reported.

If the property was rented for an average of 7 days or less per guest, the rental isn’t a passive rental activity, and it should be reported on Schedule C instead.

I have updated my previous answer to reflect this information. I appreciate your feedback!

PhillipB

Hi,

Phaser's disagreement with our pro led me to do some research on this matter. Here is what I found:

From Form 8582 instructions (read the linked Exceptions section):

An activity is not a rental activity if it is a short-term rental (each guest stays 7 days or less)
If the rental activity has a profit motive it is a trade or business that may either be a passive activity or an active trade or business depending on material participation (Taxpayers will need to evaluate their work in their rental activity)
- If the short term rental has material participation, it should be reported on Schedule C as an active trade or business (this FreeTaxUSA supports) This will be the only place where your losses will be deductible against all other income.
- If the short term rental doesn't have material participation, it remains a passive activity and (this is not clearly stated in the IRS Pubs) and it can be reported as a passive trade or business on Schedule C (which FreeTaxUSA software doesn't currently support). The pubs state that short term passive rental losses should be reported in Form 8582 Part V, and this is generally from passive Schedule Cs, passive rentals that don't meet the active participation allowance, and passive non real estate rental businesses.
  - Since the IRS is not exactly clear on this, you may just be able to continue using the rental section of Schedule E if the short-term rental is still a passive activity (marked NO for active participation) without complaint from the IRS.

In short, the only way to report a short term rental as a non-passive activity in FreeTaxUSA is on Business Income (Schedule C). If you want it done through Schedule E, you will need a tax professional with the versatility that professional software offers.

socallocal

Has there been any other updates in FreeTaxUSA on this matter for 2025 taxes?

KristineS

Hi socallocal,

At this time, the previous answer from my colleague PhillipB remains the most accurate answer for reporting rental activity with FreeTaxUSA.

Thank you for the question!

jake343

I was hoping to drop my 5k accounting fees this year by switching to FreeTaxUSA. Unfortunately, not allowing material participation on Schedule E makes this unusable for me. You should definitely reconsider the stance. That is how all the top tax professionals in STRs are preparing files. While one could technically use Schedule C instead of E, there are ramifications to doing so.

kiarab

Hello jake343,

Thank you for the feedback. We do strive to improve each year and add more forms and tax scenarios to our software. We'll keep this in mind as we consider what to add in the future.

BosProps4121

What's the downside of putting this on Schedule C to get the passthrough expenses? Does it have to be Schedule E or can it be either?

GeorgeM

Hello BosProps4121

I believe the prior posters indicated that because their participation with their short-term rental property(ies) was “material,” any losses from their short-term rentals were non-passive, and thus, those losses could be used to offset ordinary income, such as wages, dividends, interest, capital gains, etc. Currently, we don’t support short-term rentals where the property owner seeks to characterize their rental involvement as material participation.

Reporting rental income/losses on the correct tax form, whether a Schedule C or Schedule E, is tantamount to having an accurate tax return in all respects. Schedule C would be used in those instances where the property owner is seeking to earn a profit from their rental activities, and also provides substantial services to their tenants, such as daily cleaning, clean linen and sheets, meals, etc. You are correct that if the rental expenses reported on a Schedule C result in a loss, such loss is an ordinary loss and such loss will offset ordinary income.

In our Rental Property section of our software, we do ask whether the property owner considers their rental activity to be a trade or business for tax purposes. A “yes” response will NOT generate a Schedule C; however, the property owner should only respond “yes” if their rental activities are, in fact, a business.

Assuming the property owner’s rental activities do not rise to the level of a trade or business, then the proper way to report the rental income, and expenses, is on a Schedule E. Rental income reported on a Schedule E is considered passive income; however, losses are considered passive as well and are subject to the passive loss limitation rules. Arguably, a taxpayer is in a better position from a tax perspective if they can report rental property losses as non-passive; however, as noted herein, our software only allows such if the taxpayer reports their rental income/losses on a Schedule C, and then only if, they meet the trade or business requirements.

GeorgeM

Hello BosProps4121:

I need to modify my previous post to you, and specifically that section of my post that related to whether a rental property is a trade or business. In the Rental Income (Schedule E) section of our software—under the Income tab—we do ask whether the property owner considers their rental activity “to be a trade or business for tax purposes.” While the property owner has the option to respond with a “yes” or a “no;” a yes response will not prompt our software to generate a Schedule C as I had indicated in my previous post. Rather a yes response to the trade or business question relates to whether the taxpayer’s rental property is eligible for the Qualified Business Income deduction, Form 8995.

While a rental activity may be fairly characterized as a trade or business, that fact by itself does not mean the taxpayer should report their rental activities on a Schedule C. However, should the taxpayer offer “substantial services” to their tenants, as that term is defined under IRS rules and regulations, then such rental activity should be reported in our software as Business Income (Schedule C).

We have a great article that addresses whether a rental property, characterized as a trade or business, also qualifies for the qualified business income deduction. You can find that article here:

Does my rental income qualify for the qualified business income (QBI) deduction? - FreeTaxUSA Community | Tax Questions, Answers, and Help

prem

Is filing Schedule E as non-passive still not possible with FreeTaxUSA Deluxe or Pro Support plans?

onevolk

@prem also asking the same question. Super frustrated to have gone through my entire tax prep and the the STR reporting isn't handled correctly. Schedule E is not showing a loss (in my case 1st year, new build, with non-passive property) and Schedule C is not appropriate for me.

I've been using FreeTaxUSA for years but without this feature/fix, I can't continue using it…

Austyn

Hi prem,

Unfortunately, filing Schedule E as non-passive is not something our software currently supports, regardless of which plan you use, including Deluxe or Pro Support.

There is one exception: if you qualify as a real estate professional, our software will treat your Schedule E rental activity as non-passive. To qualify, you must meet both of the following criteria:

1. More than half of all personal services you performed during the year were in real property trades or businesses in which you materially participated.
2. You performed more than 750 hours of services during the year in real property trades or businesses in which you materially participated.

If you meet both of those tests, you can enter that information by going to Income > Real Estate Professional (near the bottom of the Income menu).

For those who don't qualify as a real estate professional, the only other way to report a short-term rental as non-passive in our software is through Business Income (Schedule C), and only if your rental activities meet the trade or business requirements, such as providing substantial services to tenants.

We do appreciate all the feedback in this thread and will continue to keep this scenario in mind as we improve our software each year.

prem

Thanks for confirming. That is sad! I had to go through other paid software just due to the lack of this support. I hope freetaxUSA at least fixes this for next tax year.

BosProps4121

I wouldn't bank on them fixing it. If you switch it to schedule C because short-term rentals with material participation are indeed business activities, you will get all the passthrough losses you would expect to see.

Mathematico

https://community.freetaxusa.com/discussion/comment/8043#Comment_8043

Hi Austyn,

Wife and I have been trying to use the real estate professional feature in FreeTaxUSA. We have been real estate professionals (REPs) since retiring from W-2 jobs in 2023, but in the years before we were REPs, we accumulated over $120,000 in suspended passive activity losses (PALs). As REPs, we don't aggregate activities, and instead let each house operate as it's own activity and we materially participate in all of them. We have 4 rental houses("activities") and we pass one or more of the 7 material participation tests for each activity. And of course I'm passing the overall 750 hour / more-than-half tests. Three of the four houses operate at a loss on schedule E. There's our background - below is the issue.

The Issue

We notice that when we "turn on" real estate professional, ALL of the previous years' suspended PALs that we enter for the particular house are taken against ordinary income irrespective of whether or not there was any gain on the the particular house in the current year. All the PALs seem to just add in on schedule E and flow right through to 1040 thereby wiping out all those suspended PALs and giving a huge loss wiping out a big chuck of taxable ordinary income. I don't think this is correct.

What I think is correct is that suspended losses from years we were not real estate professionals stay suspended. This is because the suspended losses were passive when they were generated and will retain that character. Being real estate professionals in 2025 can not re-characterize PALs that were passive in, say 2019, to active. (Although, I believe there is a special rule for REPs that if an activity does show a gain, suspended PALs from that activity can offset that actual gain — this wouldn't apply to us this year.)

Is there some place I can designate that the suspended PALs I enter for the houses were from a time when we were not real estate professionals?

rachels

Hi Mathematico,

You are correct that when an activity changes from a passive activity to a non-passive activity, the rules for the loss carryovers are different, as explained in Publication 925.

Our software does not currently do a good job tracking activities as they change from passive to non-passive. Since that is the case, you are correct--if you indicate on your 2025 tax return that you became a real estate professional, our software will not limit the carryover correctly.

What you could do is enter the carryover amount up to your income for each activity. If you do that, you would need to track whatever the leftover carryover amount is for the next year. This makes it a little trickier on your side. We are looking into changing this to be more user-friendly in the future, but for the 2025 tax return at least, you would need to handle it this way if you file on our website.

Mathematico

Thanks Rachels, it seems like this will be a solution.

I still want to file my 8582 every year and this method suppresses it. I think I could create the correct 8582 by putting in all the PAL for each rental and switching off REP. Make sense?

rachels

https://community.freetaxusa.com/discussion/comment/8232#Comment_8232

Yes, that makes sense Mathematico. Make sure that you go back and change your answer to correctly reflect your REP status after you get Form 8582, though. You will also want to double-check that Form 8582 is filled out correctly.

If you plan to submit Form 8582 to the IRS, you would need to choose the option to mail your returns, rather than e-file.