Rental income as business income?

Question

Hi all,

I have been growing my portfolio over the last 5 years and currently have a mixture of 5 rental properties, 1 flip in progress, and 1 single family house that I decided to cash out on the equity and sell. (under contract right now) The properties are all held in my own name.

I've been using the same CPA for a few years now and she has always put my rental income on my personal return.  With the sale of a flip in 2020, I owed a decent tax liability and also pay quarterly estimated taxes which probably won't cover the sale this year.  My CPA has been great and depreciates and takes all expenses I believe I'm eligible for.  However, last year's taxes got me looking at how to reduce my tax burden for 2021, specifically by purchasing a truck for only rental property use and using the Section 179 deduction.

Here's my question: shouldn't I be able to claim my rental income as business income? I am being told that "Your residential rental properties don’t qualify as a trade or business.  They are considered a passive activity."  From what I understand, to have my rentals considered a business instead of passive activity it would need to be shown that I regularly work for/at the properties.  I am almost always (for the last couple years) involved in a renovation on one of my properties that involves much of my own work, handle maintenance requests, and do most of the repairs myself that come up.  I also advertise, screen tenants, and turn over units.  Rental related tasks are often a daily occurrence; definitely at least weekly.  I don't typically rely on random websites for answers, but this link looks like it has some good cases referenced: https://www.nolo.com/legal-encyclopedia/is-your-rental-activity-business-investment.html

She then countered with some reasons why I don't qualify as a Real Estate Professional, which I do agree with.  I work a 40 hour full time W2 job so "more than 50% of your service hours must be performed in real property trade or business activities" kicks me out of that category.

Do you have to be classified as a Real Estate Professional to claim rental income as a business?

If you've made it this far, thank you.  Would appreciate any insight on this!

Dan

Jermaine Southern · Answer

Based on what you've said, as a CPA and Landlord myself, I agree with the advice your CPA has given you. As you grow your portfolio, forming a management company to oversee your properties may be something to consider. That management company could buy toys like trucks and tools and take those deductions. But you would be converting passive income to self employed income which as a general rule isn't smart/optimal, but there are scenarios which may make sense.

David M. · Answer

@Daniel Guest

Rental activities are categorically passive income by the IRS.  The tests for being an active business, e.g. material participation, don't really apply since the IRS already has ruled/law saying rental are passive activities.  In fact, passive income has generally a better tax treatment than active income.

Flip properties are considered the sale of "inventory" so you are a dealer of property.  As such, its not an investment and NOT subject to capital gains tax treatment.  Profit from a flip is consider active, ordinary income subject to "all taxes" such as self employment taxes and reported on SchC.  This is probably why your flip sale in 2020 cost you so much in taxes.

In fact, I do believe that having rental activities is still considered as runnig a business.  However, its categorized as passive (as discussed above) and thus reported on SchE.

Sorry, didn't bother looking at your link.  We literally just had another post with I THINK it was a nolo link where the first two paragraphs were completely wrong as agreed by basicllay every post (well, excep the OP who was aking).

i hope this helps.  I'm not entirely sure what you are trying to achieve.  I'm guessing saving on taxes...  If your rentals are reported on SchE then you should be fine.  You need to understand that flip income is active so subject all taxes at your ordinary rate.  This is probably where you got yourself twisted around.  the flip profit/income was reported as "business income" so you got hit "hard" on your taxes...

Good luck.

Ashish Acharya · Answer

You dont have to be a real estate professional to have your rental activities as a trade or business. The RE pro status is meant to convert the passive rental to nonpassive.

Just because your activity is passive doesn't mean your business activity is not a trade or business.  You can have a passive trade or business. There are more than one tax codes that are interconnected here and that is why you are confused. I don't blame you, it's complicated.

Rental activity is always passive even if you materially participate (unless you are a real estate professional). We are not talking about active participation either. Two different rules for two different provisions.

Do you mean to ask why are your rental losses limited? Why do you want to treat your rental as a trade or business?

Daniel Guest · Answer

I finally wrapped my head around this the other day and hadn't had a chance to reply on here yet.  I knew before this that I didn't qualify for "real estate professional" but didn't realize that business income could still be classified as passive, and that the section 179 deduction I was interested in only applied to active, not passive business income.

Alexander Szikla · Answer

Why would you want it classified as business income?

Then it is subject to self employment tax.

Basit Siddiqi · Answer

@Daniel Guest'passive activity' and 'trade or business' aren't mutually exclusive when discussing both items.You can have both a trade or business that is either active or passive.If you have a trade or business and your income is positive, you might be eligible for 199A qualified business income deduction.However, most rentals don't operate at positive taxable income because of depreciations.

Ashish Acharya · Answer

It might be doable but there are other limitation on sec 179 and it would be impossible to answer that

Rental income as business income?

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