IRS tax rules for self-rental properties
When a taxpayer both owns and materially participates in an operating business while also owning the real estate rented to that business, this scenario is defined as “Self-Rental” according to IRC, Section 469. The taxation of self-rental property involves intricate regulations, necessitating a thorough understanding from taxpayers.
Tax Treatment of Self-Rental Income and Losses
In the case where an operating business (tenant) and a rental real estate entity (landlord) are owned by the same taxpayer, the rental income is categorized as “Self-Rental.”
- Self-Rental Income: Net rental income from self-rental property is treated as non-passive income.
- Self-Rental Losses: Net rental losses from self-rental property are treated as passive losses.
This distinction means that self-rental income cannot offset other rental losses, even if they stem from other self-rental properties owned by the same taxpayer and regardless of material participation in those businesses.
Handling of Self-Rental Losses: Self-rental losses are classified as passive losses, which can only offset other passive income. Any current-year self-rental losses without other passive income are suspended and carried forward. These losses can be utilized in future years against rental income from the same self-rental activity.
Sale of Operating-Lessee Company with Retained Real Estate: If the operating company/lessee is sold while the taxpayer/landlord retains ownership of the property and leases it to an unrelated purchaser, further considerations apply:
- Rental income from the property remains non-passive if the taxpayer materially participated in the business activity for at least five of the past ten years before the sale.
Self-Rentals and Net Investment Income Tax (NIIT): Self-rental income, treated as non-passive as per the rules, is exempt from the 3.8% NIIT, which applies to passive income.
For detailed guidance on reporting self-rental income correctly, contact a ShindelRock tax professional.
Note: Material participation in any operating business requires regular, continuous, and substantial involvement by the taxpayer. Passive activity, as defined in IRC 469(c)(2), includes nearly all rental activities.