1099 Contractor Question for Newbie

[Bruce Gardner]

Are the costs of a 1099 contractor fully tax-deductible in the process of doing business on rentals, BRRRR, or flips?

More specifically, I'm looking at entering into an agreement with a contractor where their fee will be 50% of the net income derived from the property.  For example, if I have a rental that collects $1,000/month, payout $500 in expenses, then another $250 to the contractor (keeping $250 as profit)...is the $250 paid to the contractor considered an expense and fully deductible as a write-off?

At what point does the IRS say that the contractor is not a contractor but instead is a partner, so their payment is not tax deductible as a business expense?

[Michael Plaks]

@Bruce Gardner

Short answer first. The IRS does not really care how much you pay the other person, as long as it is reported by you and him. It is always deductible for you, but it becomes taxable to him. In other words, you merely shift your income from you to him. The IRS still gets paid.

Now, a longer answer and caveats.

1. The payment has to have some business reason. You cannot simply shift income to someone not involved in your business. Otherwise, we all will be shifting income to some low-income relatives or friends. You need to have a reason why he deserves half of the income, and there could be many reasons.

2. Be careful treating him as a contractor. If you treat him as a contractor, he will owe Social Security and Medicare taxes. It is only fair if he provided actual work to earn his half. Otherwise, you will add taxes where they did not exist, because rental income is not normally subject to SS/Med taxes.

3. Additional reason to consult a tax accountant: you seemingly do not understand the difference between a 1099 contractor, a partner, and other ways to structure to it. Your best bet is probably to issue a 1099-MISC with Box 3 "other income" - but this advice may change if I knew more about your arrangement. That's why I say - ask a pro.

4. I suspect that you're not telling us the whole story. There's likely something else that you're trying to accomplish, and you decided that paying him half of the income solves that problem. There could be better ways if you disclose the full story.

5. Your deductions could be limited on your side, for various reasons. For example, high income.