Today Donna from California did some research. “I’m interested in starting a small business in real estate centering around purchasing the property and renting it to tenants.
But to my dismay I recently read that the IRS does not consider that a business. Is that true? I also read that this is a “gray” area. But if that is the case how can I get a definitive answer on this prospective business. ”
Dear Donna,
Actually, it’s kind of a good thing that IRS doesn’t regard rental real estate as a ‘business’..
You see, if renting real estate were a ‘business’ to IRS, you would have to pay 15.65% Self Employment Taxes (SS & Medicare) on all the profits.
However, you are certainly able to deduct all your operating expenses on the property, including depreciation.
There is a great deal of information about how it works in IRS Publication 527
https://www.irs.gov/publications/p527/index.html
There is NO a grey area.
If you ‘actively’ or ‘materially’ OPERATE your rental property, you may take deductions for the losses. (They define ‘active’ and ‘materially’ very specifically in the tax code.)
However, if your income is over $125,000, you would not be able to take any deduction for any losses. But you would be able to reduce all your rental income to zero for the year – and not pay any taxes on it. The losses you don’t use get carried to years when your income drops – or can be deducted in full when you sell the property.
The rules are quite complicated – but not gray.
And while IRS does commit many ‘sins,’ don’t blame them for the tax laws. Put the blame where it belongs – CONGRESS writes the laws – your elected officials.
IRS only tries to figure out how to define their mumbo-jumbo and implement CONGRESS’s rules.
If you really want to take this ‘business’ seriously and want to make money (not have headaches), please see both a tax pro and property manager expert BEFORE you start.
And this is an excellent association to join: Apartment Owners Association https://www.aoausa.com/
Their website provides some good tools and forms for you to use.
And Nolo Press, the folks who put out some of the best do-it-yourself legal books, has published this book you may want to read: Every Landlord’s Legal Guide
https://www.amazon.com/exec/obidos/ASIN/1413300723/ref=nosimmywishlistA
If you handle it wrong, property will bankrupt you. If you do it right, you can grow quite wealthy.
I spent about 15 years teaching people to manage property. And in a 30 minute discussion with a client recently, I taught her
a) how to snag a prospective tenant
b) how to raise the rent from $1200 to $1795 (when a tenant moved out)
c) and how to avoid getting stiffed by new tenants
(e.g. how to screen)
One little tip, Donna, don’t let the tenant know you own the building. Be the ‘manager.’ Then, you can always blame unpopular decisions on the ‘owner.’
Naturally, you’ll find answers to all kinds real estate & tax questions – and lots of tax resources – free, where? Where else? At TaxMama.com !
- Ask TaxMama :: Where taxes are fun and answers are free
- IRS Publication 527 :: Residential Rental Property
- Dotster :: Domain names for $7.95/year
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