When a taxpayer owns and materially participates* in an operating business AND alsoowns the accompanying real estate rented to that operating company, that isdefined as a “Self-Rental” per IRC, Sec. §469. There are complex regulations around reporting income and losses of self-rental property and taxpayers should be well-versed in the rules.
Tax consequences of income and losses for self-rental property
In many instances, an operating business (tenant) and a rental real estate entity (landlord), are separate entities but both owned by the same taxpayer. In this case, therental income is deemed to be “Self-Rental”.
- Net rental income from a self-rental property is treated as non-passive** income.
- Net rental losses from self-rental property are treated as passive** losses.
The result is that self-rental income, for the landlord, is essentially reported on a “stand alone” basis. The income derived from this self-rental cannot be used to offset any other rental losses, even if the losses are from other, commonly owned self-rental properties. This is true even if there are self-rental losses originating from other businesses that also have material participation by the same taxpayer.
Self-rental losses, on the other hand, are passive losses. Passive activity losses can only be used to offset other passive income. The current year self-rental losses, absent any other passive income for the year, will be suspended (“trapped”). If there is rental income in future years from this self-rental activity, the prior year(s) trapped losses can be used against this future income. Thus; prior years’ suspended passive losses from this activity can be carried forward and used to offset the current and future year rental income.
Sale of Operating-Lessee Company with Real Estate Retained
If there is a sale of the operating company/lessee but the taxpayer/landlord continues to own the property and leases it to a new (unrelated) purchaser, there are still more restrictions:
- The future rental income generated from the rental of this property, per the self-rental rules, would still be considered non-passive (active), if the taxpayer had materially participated in this business activity for five out of the past 10 years. To say it in simple terms; the taxpayer/landlord could still be considered as actively participating in a business that has been sold, for the subsequent five years after the sale if the taxpayer had run the business for five years prior to the sale.
Self-Rentals and Net Investment Income Tax
Net Investment Income Tax (NIIT) is a 3.8% tax on passive income. A trade or business is not a passive activity. Self-rental income, if treated as a non-passive activity per the rules previously noted, is not subject to NIIT.
Self-rental is a common tax situation that has very complicated rules. The best way to manage this tax structure is to be aware of these rules, and plan accordingly. Landlords, for self-rental tax planning, should make sure that the rent they are charging is reasonable and is competitive with current market rates. Self-rental income is usually more tax-efficient than self-rental losses.
For more information on properly reporting self-rental income, contact a ShindelRock tax professional.
*Material participation, in any operating business, requires that the taxpayer participate on a regular, continuous, and substantial basis.
**Passive activity is any trade or business in which the taxpayer does not materially participate. IRC 469(c)(2) states that passive activity includes almost any rental activity.
FAQs
In many instances, an operating business (tenant) and a rental real estate entity (landlord), are separate entities but both owned by the same taxpayer. In this case, the rental income is deemed to be “Self-Rental”. Net rental income from a self-rental property is treated as non-passive** income.
What is the IRS self rental rule? ›
Self-rental is an arrangement in which a business and property that it rents are both owned by the same person(s). It is common for a taxpayer to own an operating business and also own the accompanying real estate. That person has to materially participate in the operating company for the self rental rules to apply.
How does the IRS know if you have a rental property? ›
Rental property comes with a paper trail. IRS agents can check real estate paperwork and public records to verify the information reported on your return. Some states require rental property owners to have licenses.
At what point does the IRS consider a residence is rented? ›
Rental property / Personal use
You're considered to use a dwelling unit as a residence if you use it for personal purposes during the tax year for a number of days that's more than the greater of: 14 days, or. 10% of the total days you rent it to others at a fair rental price.
How does the IRS define personal use of property? ›
Personal use property is a type of asset or other property that an individual does not use for business purposes or as an investment. Quite simply, individuals use personal use property primarily for their individual purposes and for their own enjoyment.
What is a self-rental trap? ›
This treatment means that any income produced by a rental entity to which the self-rental rules apply cannot be netted against passive losses from other rental entities to utilize those losses. Ultimately, it often results in more passive losses being trapped by the Sec.
What are the passive rental income rules? ›
In most scenarios, the IRS classifies rental income as passive income, but there are exceptions. If the rental property owner qualifies as a real estate professional by dedicating at least 750 hours yearly to real estate work, with over 50% of their overall work in real estate.
Is it better to claim rental income or not? ›
All rental income must be reported on your tax return, and in general the associated expenses can be deducted from your rental income. If you are a cash basis taxpayer, you report rental income on your return for the year you receive it, regardless of when it was earned.
What expenses can you deduct from rental income? ›
The nine most common rental property tax deductions are:
- Mortgage Interest. ...
- Property Taxes. ...
- Travel and Transportation Expenses. ...
- Real Estate Depreciation. ...
- Maintenance and Repairs. ...
- Utilities. ...
- Legal and Professional Fees. ...
- Insurance Premiums.
You must pay tax on any profit from renting out property. For California, rental income and losses are always considered a passive activity. Visit our Instructions for Form FTB 3801, Passive Activity Loss Limitations for more information.
If market rate rent is not received, then this lost income and associated time is not deductible against rental earnings. Expenses for improvements and upgrades to the property also generally cannot be deducted and instead must be capitalized. This includes things like: Adding or renovating rooms.
What happens if I don't depreciate my rental property? ›
Some investors may be tempted to skip claiming depreciation to avoid the risk of depreciation recapture tax, but this generally won't succeed. The IRS assumes that you have taken a depreciation deduction. You will owe 25 percent of what you could have deducted as a “depreciation recapture” when you sell the property.
Is roommate rent taxable income? ›
Lots of people are trying to earn a few extra bucks by renting out a room in their home. As far as taxes go, this comes with bad news and good news. The bad news is that the rent you receive is taxable income that you must report to the IRS.
Can I deduct a mortgage payment from rental income? ›
As a rental property owner, you can claim deductions to offset rental income and lower taxes. Broadly, you can deduct qualified rental expenses (e.g., mortgage interest, property taxes, interest, and utilities), operating expenses, and repair costs.
What is the 14 day rule for the IRS? ›
The 14-Day Rule is a provision in the U.S. tax code that allows homeowners to rent out their primary residence for up to 14 days each year without paying any federal income tax on the rental income they receive.
What happens if my expenses are more than my rental income? ›
Since rental property activities are passive, there is a limit to the amount of the passive losses that can offset your income. If you are an active participant in your rental activity you can deduct up to $25,000 of your rental loss.
Is self-rental qualified business income? ›
199A qualified business income deduction, a taxpayer must establish that he or she is engaged in a trade or business. The rental of real estate will be a trade or business if a taxpayer engages in regular and continuous activity with respect to the property rented, even if only one property is rented.
Is self-rental subject to net investment tax? ›
Self-Rentals and Net Investment Income Tax
Net Investment Income Tax (NIIT) is a 3.8% tax on passive income. A trade or business is not a passive activity. Self-rental income, if treated as a non-passive activity per the rules previously noted, is not subject to NIIT.
What is self-rental per IRC section 469? ›
The self-rental rule in IRC Section 469 applies when you rent property to a business in which you or your spouse materially participates. Under the rule, any rental losses are still considered passive, but the rental income is deemed nonpassive.
Do I have to report rental income to IRS? ›
All rental income must be reported on your tax return, and in general the associated expenses can be deducted from your rental income. If you are a cash basis taxpayer, you report rental income on your return for the year you receive it, regardless of when it was earned.
When a taxpayer owns and materially participates* in an operating business AND alsoowns the accompanying real estate rented to that operating company, that isdefined as a “Self-Rental” per IRC, Sec. §469. There are complex regulations around reporting income and losses of self-rental property and taxpayers should be well-versed in the rules.