This is part 2 in our discussion of whether or not a landlord needs to issue 1099s.
In part 1, we determined that Section 6041 of the tax code says “trades or businesses” need to issue 1099s.
This seems to settle the issue, right? A rental property clearly isn’t a trade or business….
Well … not so fast on that.
Rental Trade or Business
Did you know: many rental properties probably could meet the definition of being a trade or business under Section 162 of the code. Courts have held — for 75+ years — that even one rental house can be a trade or business, as long as the activity is carried on with regularity and continuity, the taxpayer is involved in the operation of the property with regularity and continuity, and the activity is carried on with a profit motive.
Examples of rental situations that are probably NOT a trade or business would be things like triple-net leases, or any other situation where the landlord is simply collecting a rent check and doing nothing else with the property.
The problem here is that there’s no bright-line test. It’s based on the dreaded “facts and circumstances.”
A person with one rental house “might” have a trade or a business if they are involved in the management of that property on a regular and continuous basis. But it depends on the facts and circumstances. So please don’t read this as me saying one rental house “does” qualify as a trade or business; I’m saying it “could” — and many probably “do” — based on 75+ years of court cases.
If a property management company is used to help manage the properties, it gets grayer still, but even then the rental activity could still be a trade or business as long as the landlord is involved in making decisions, even if the decisions are ultimately carried out by the management company. Again, “facts and circumstances” with no bright-line test.
This Guy Is Nuts
Some of you are probably saying to yourself, “This guy is crazy, rental properties can’t be a trade or business because rentals go on Schedule E and are passive activities. I’m done with this guy.”
So let’s back up and do a quick refresher on rental property taxation so you can get an idea of what the issues here are.
Basics of Rental Properties and Taxes
- Rental property is either a trade or business under Section 162, or investment property under Section 212.
- Either way, it is always shown on Schedule E and is not subject to self-employment tax, even if it meets the definition of a trade or business.* (*-If the average rental period is 7 days or less, or in some cases 30 days or less, and “significant personal services” [i.e. maid services] are provided, the reporting is different. The discussion in this series of posts is focused on the typical rental situation which goes on Schedule E and is not subject to SE tax.)
- The same deductions are allowed either way.
- With one exception: a rental that is a trade or business could, theoretically, take a home-office deduction. I personally am always skeptical of home-office deductions even for a typical Schedule C business because of the rule that says the office area must be used 100% for business purposes — does your typical landlord plausibly have an area of their home that they use for rental purposes and NOTHING ELSE? If they do, they could take home-office deduction if the rental activity is a trade or business.
- Rental activity, by default, is always a passive activity under Section 469, even if a trade or business. Rental losses of up to $25,000 per year can be deducted, subject to AGI phaseouts.
- If a taxpayer meets the tests to be considered a “real estate professional” under Section 469, the loss limitations and AGI phaseouts do not apply. A real estate professional is someone who works a “day job” in certain fields related to real estate, and who owns rental properties, and who meets the hours of participation tests under Section 469. (Yes, this is an oversimplification of the real estate professional tests.)
Real Estate Pros and 1099s
You will see some people — mainly CPAs and mainly in online discussions — saying emphatically that ONLY real estate professionals need to issue 1099s because “only” real estate pros have a trade or a business. I have also been a participant in CPE courses where the instructor (a CPA) has said this same thing. Again, this is always said emphatically and is if there is no doubt about it.
We will dive into where these CPAs are getting their information from, in part 3.
Links to Other Parts in This Series
- Part 1 (Introduction)
- Part 3 (Net Investment Income Tax Regs)
- Part 4 (Cautions About Relying on NIIT Regs for 1099 Purposes)
- Part 5 (Miscellaneous Discussion: What Was the ACA Really Changing; How to Proceed)
- Part 6 (Why Isn’t There a Clear Answer on This?)
“This blog post, along with comments that may follow, should not be considered tax advice. Before you make final tax or financial decisions, please secure a professional tax advisor to give you advice about your unique situation. To secure Jason as your accountant, please click on the ‘Services’ link at the top of the page.”