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Regarding the passive versus active income, Phil followed up with a question upon which I would really like an answer, if you know.

Here is Phil's question: "But back to OP's question. Clearly, if she uses the management company to do everything, she's not actively participating. But how about her other scenario; is that active enough? I've never been clear on this."

My question was.....if I get a management company to only screen tenants and collect the rents, while I actively manage the property otherwise, would it be active or passive income?

Here's the relevant text from IRS Pub. 527:

Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions.

There are two somewhat conflicting sentences found in the IRS Audit Technique Guide for Passive Activity Losses (2005) regarding active participation in real estate rentals: "However, the taxpayer must be exercising independent judgment and not simply ratifying decisions made by a manager." (page 2-2) "To be actively participating, the taxpayer must be making management decisions in a bona fide sense, not merely ratifying an on-site manager's decisions." (page 2-17)

All of the above leads me to believe that the active vs. passive participation determination is a "facts and circumstances" decision. My personal inclination would be to claim active participation if you make the final decision to accept/reject a pre-screened tenant (on the basis that your management company isn't an on-site manager). If the management company makes the accept/reject decision I might want to do further research into relevant tsx court decisions before claiming active participation.

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