Whether you are the landlord of a single-family rental or you own a share in a large apartment building, it’s essential to know how to classify this activity at tax time.
Are you an investor or a business owner?
In this article, we’ll examine the distinction between the two and how qualifying as a business owner can save you money in deductions.
Your rental activity qualifies as a business under the law if you can prove your rentals are “for-profit” and that you work at this business “regularly and continuously.”
Landlords can hire managers and contractors to do most of the work on their property, but they still must be engaged in running the rentals, according to the law. Also, if a rental unit is vacant, it doesn’t preclude you from qualifying as a business owner -- as long as you are marketing the space for rent.
Here are other factors the IRS uses to determine if your rental activity is a business:
Here are some other ways you can prove you are operating a business with your rental property:
If, as a landlord, you have earned a profit in three of the past five years, the IRS sees you as a business. If you cannot meet this requirement, you must pass the “behavior” test.
You can operate rentals at a loss every year and still qualify as a business owner if you meet the behavior test criteria. Here are the factors an IRS auditor will use in this case:
In order to pass the behavior test, you need to maintain excellent records, including a time log of all your real estate activities. You can establish your expertise through references, blogs, speeches, and podcasts.
Landlords often do not qualify as business owners when they do one or more of the following:
For tax purposes, it’s always better for your rental activity to be a business rather than an investment. As a real estate business owner, you can deduct the following:
Landlords who meet the criteria of being business owners may qualify for the pass-through income tax deduction of up to 20% of their net rental income from 2018 through 2025.
This deduction—which is also called the Safe Harbor Rule—is part of the Tax Cuts and Jobs Act (TCJA), the tax reform package that became law in 2018. The deduction will end on January 1, 2026, unless Congress votes to extend it.
Use of the safe harbor rule is optional. To qualify for this deduction, a landlord must:
Landlords who use their rental property as their residence for more than 14 days during the year are not eligible for the Safe Harbor Rule. This requirement means that most short-term rental hosts may not apply for the deduction.
Finally, we cannot emphasize enough the importance of record-keeping as a landlord. Accurate, well-organized records will help you manage your rental property, prepare your financial statements, keep track of your expenses, prepare your tax returns, and support the items you report on your tax returns.
Find out about the tax savings strategies that you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation. TAKE THE TAX DISCOVERY QUIZ
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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