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It seems that we can't take a Schedule E business deduction in this case even with active participation. Is this true?

Yes. At least as long as your AGI is over $150k. But all is not lost. The loss is simply deferred into the future. If your income drops below $150k, you will be able to use part or all of this deferred loss. And if you should dispose of the rental in a fully taxable transaction, you will also be able to use the loss in the year of disposition.

Someone said they thought we were using the wrong schedule since the cottage is an LLC. Would that make any difference?

Not if the only owner of the LLC is you and/or your wife. Schedule E would be the right place on the Federal return. States might have different issues. (Notably, California, where you'd need to file an additional return, form 568, to pay the required taxes on an LLC.)

Last year will be our last full year of owning the LLC because my wife is gifting it to her youngest son, but that is a different story.

Not so much a different story as a sequel. ;-)

A gift is not a fully taxable disposition, so you would continue carrying forward this loss, waiting for your AGI to drop enough to use it.

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