Ninth Circuit says Nice Try on Passive Rental Activities


The U.S. Court of Appeals for the Ninth Circuit recently affirmed a District Court’s ruling against a married couple who claimed their losses related to three vacation properties were not limited under the passive activity loss rules of IRC § 469.[1] The couple argued that the management company responsible for renting the property to individuals was the customer under the IRC § 469 regulations. The Court disagreed.


IRC § 469 generally only allows passive activity losses to be deducted to the extent a taxpayer has passive activity gains.[2] A passive activity is any activity involving the conduct of a trade or business in which the taxpayer does not “materially participate.”[3] Rental activity is presumed to be a passive activity,[4] but this presumption can be overcome if the individual is engaged in a real estate trade or business and:

  1. More than one-half of the taxpayer’s total trade or business services for any given taxable year were related to real property trades or businesses in which the taxpayer materially participates; and[5]
  2. The taxpayer performed more than 750 hours of services in real estate trade or businesses in which he materially participates.[6]

Rental activity is defined in Treas. Reg. § 1.469-1T(e)(3)(i) as an activity involving tangible property held in connection with the activity which is used by or available for use by customers, if the income from the activity represents amounts paid by customers for the use of the property. The regulations also specifically exclude certain activities from the definition of rental activity.[7] One such exclusion is when the average period of customer use for the property is seven days or less.[8]

Taxpayers are able to make an election to group all of their interests in rental real estate, and thereby treat the group as a single real estate activity.[9] Taxpayers are prohibited from grouping real estate activities with any other sort of activity.[10]


Greg and Julie Eger owned thirty-three properties, which they elected to be treated as a single real estate activity. Since Mr. Eger was a real estate professional, his material participation permitted him to deduct his rental activity losses against non-passive income under IRC §469(c)(7). Three of these properties, being the properties at issue, were vacation rental properties for which the Egers employed separate management companies to handle marketing and rental of each of these vacation rental properties. The average period of rental of these three properties for end users was for less than seven days a year during the 2007, 2008, and 2009 tax years. The Egers retained significant rights to occupy the three properties under the management agreements but did not exercise those rights during the years in question.

The management agreements were not discussed by the Court, however they were a key issue to the District Court’s opinion. The management agreements stated that the management companies were to provide marking and rental services to rent out the properties on the Egers behalf. The District Court found that the management companies had only the right to attempt to rent out the properties for the taxpayers, not the right to use the properties, including the right to sublease them and that the Egers’ retained rights (even if not exercised) to use the property got in the way of being able to show the right to use the property for more than seven days.


The IRS argued that since the three specific properties were not rented by end-user customers for an average of at least seven days, they were not rental activities and therefore could not be grouped with the remainder of the rental properties in testing for material participation. If the IRS won on that argument, the result would be that Mr. Eger would not materially participate in the management of those properties. As such, the Egers would be unable to claim the losses related to those properties against their active income, including the other thirty three grouped properties for which Mr. Eger could satisfy the material participation standard.

The Egers made the argument that the management company was in fact the “customer” referred to by the regulations, and that it had continuous or recurring use of the properties because the Egers never used them in the years in question. Therefore, the property was rented for over seven days.


In its decision, the Court stated “When deciding who is a customer between individuals paying to stay in a property and the company responsible for marketing the property and managing payments, few people who are not creative tax lawyers would argue it is the latter,” before ruling that the word “customer” did in fact refer to end-user renters and not management companies. The Court did not address the management agreements, finding sufficient grounds to rule against the Egers based solely on the definition of “customer.”

It is important to note that the wording of the management agreements which allowed the Egers significant use of the properties could have been drafted differently. If the Egers had known they were not going to use the properties themselves, restricting their rights to use the property under the management agreements could have resulted in a much more favorable outcome for the Egers. The takeaway here is when you actively participate in real estate, don’t retain the right to use your properties if you have no intention of using them, else you might end up unable to utilize the losses associated with those properties.

[1] Eger, et. al. v. U.S., 126 AFTR 2d ¶2020-5181

[2] § 469(a)(1)

[3] § 469(c)(1)

[4] § 469(c)(2)

[5] § 469(c)(7)(i)

[6] § 469(c)(7)(ii)

[7] Treas. Reg. § 1.469-1T(e)(3)(ii)

[8] Treas. Reg. § 1.469-1T(e)(3)(ii)(A)

[9] Treas. Reg § 1.469-9(g)

[10] Treas. Reg § 1.469-9(e)(3)


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