Is Rental Property Considered an Investment or a Business?

Tax season is quickly approaching. If you are a new landlord, chances are, you have a lot of questions pertaining to how to handle those taxes. To make certain that you are receiving the right deductions, you must determine if the property that you rent out is considered an investment or considered to be a business. In this helpful guide, you will be introduced to the information that will allow you to determine what your rental property is and other relevant information. Continue reading to learn more.

How Does the IRS View Rental Property?

The IRS generally looks at rental property as an investment. In short, what distinguishes an investment property from a business property is the amount of time and energy that you put into working the responsibilities associated with the overall management of the rental property.

For example, if you have a rental property that you rent out only certain times of the year and it is not occupied the rest of the time and it does not require a lot of time and effort on your part, the IRS would consider that rental property an investment.

If you find a rental property and intend to directly handle most of the property management and other responsibilities associated with that property, the rental property would then be viewed upon as a business by the IRS.

You must be able to prove to the Internal Revenue Service that you spend enough time maintaining the rental property through the year in order to receive any and all associated tax deductions that are business-related.

Is Rental Property Considered a Business if Friends or Family Live There?

While rental property may be considered a business if you invest enough time and effort into it, if you have friends or relatives that live in the property, you may not be able to claim tax deductions for business purposes.

The tenants that you allow to live in or on your rental property should be third-party individuals that you do not normally associate with through friendship or as part of your family.

What are the 5 Business Structures Associated with Rental Property?

If you are going to claim that your rental property is a business due to investing a lot of time and effort into the management of it, it is important to understand that there are 5 different business structures associated with it. The following outlines the structures that you may utilize as a landlord:

1. Sole Proprietorship – This type of business is owned by an individual or a couple that is married. These have fewer controls and less taxes, but makes you liable for debt that is incurred by the tenants and/or your business, as a whole.
2. General Partnership – This is typically a business owned by at least two people that are not married. Each business owner has an equal responsibility. Everything is shared, be it financial obligations, expenses, or labor. If debts occur, each owner is liable.
3. Estate – This is a lot like sole proprietorship, but a rental property only becomes an estate when the owner of the property dies. This is granted to allow the business to continue to operate while all associated legal issues are being addressed.
4. Limited Liability Company (LLC) – This is a business structure created by one or more persons. It details all aspects of the business. All earnings are passed on to all members and each member files their own taxes through self-employment tax. If a lawsuit occurred from a tenant, for example, the LLC would experience the suit and all individuals part of the lawsuit would have their personal assets protected.
5. Tenants in Common – In this business structure, two or more people are allowed to occupy the property while ensuring that the property’s assets and liabilities remain separate.

What is an Investment Property?

An investment property is a type of real estate property that is purchased with the purpose and the intent of earning a type of return on the investment through rental income, the resale of the property in the future, or both of these situations. An investment property may be held or owned by one-person, multiple investors, or even a corporation of investors.

What are the Tax Implications of an Investment Property?

If you are an investor of a property and collect rent from a property that is considered an “investment property”, you will be required by the Internal Revenue Service (IRS) to report the rent money as an income. The good news is, you will also be allowed to subtract relevant-based expenses from the total income amount.

Let’s say you collect $60,000 a year in rent, but you paid $10,000 out in maintenance, lawn care, and other related expenses, you could report the difference of $50,000 as your self-employed income.

If you own an investment rental property and you sell it for more than you originally paid for it, you will then have what is called a “capital gain”. This must also be reported to the Internal Revenue Service.

For the year of 2022, the tax rates associated with capital gains that were held for over a year ranged from 0% to 15% to 20%. The capital gain on a rental investment property is the overall selling price minus how much it was purchased for and minus any type of major improvement that that performed on the property.

Should Landlords Want to be an Investor or a Business?

A business owner makes their profits by managing their business in an active manner. Investors are considered to be passive and make money only when the assets that they have increase in the overall value. Investors do not actively manage the holdings that are theirs.

If you are a landlord, you will want your rental property to qualify as a business with the Internal Revenue Service.

To qualify as a business with your rental property, you must work at it in a regular and consistent manner. You must do so in a systematic manner.

• You must also earn a profit.
• You may still hire and manage individuals to assist with the property – such as property managers and contractors.
• You must simply be engaged with your rentals to actively profit for that rental property to be considered a business.

When is a Landlord Considered an Investor?

Landlords that are considered investors typically do the following:

1. They passively invest in mortgage notes associated with properties
2. They invest as what is called an “LP” in syndications associated with real estate
3. They have a small portfolio associated with the rental properties that they own
4. They do not have to dedicate too much time to the management of the rental properties that they own
5. They own what is referred to as “triple net lease properties”
6. They buy land and hold onto that land for the purpose and intent of selling it in the future

Conclusion

If you are a landlord or have an interest in rental property investment, you will want to be considered a business and not an investor. This means that you will need to be actively involved in the rentals you own. The good news is, you can obtain a property management team to assist you. You just have to be active with the team in order to reap the rewards of being considered a business. To learn more or to hire a team, contact us here at Pioneer Property Management today by calling the following number: 720-839-7482