The tax treatment, particularly the application of self-employment taxes, of rental income from real estate investment properties can depend on the nature of the property and how it's operated.
In most cases, the IRS considers rental income as passive income. Passive income isn’t subject to self-employment tax because it doesn’t involve active participation, like running a business or providing significant services.
However, certain real estate operations, such as hotels, vacation rentals, and bed and breakfasts, may be subject to self-employment tax because they involve providing substantial services alongside the rental of the property.
Rental activities that can trigger self-employment tax include:
1. Hotels and Bed and Breakfasts
If you own and operate a hotel or bed and breakfast, you're likely providing much more than just the space for guests. In these types of operations, you typically offer services such as:
- Daily cleaning or housekeeping
- Providing meals (breakfast or more)
- Front desk services
- Concierge services
- Laundry
These services go beyond what would be considered typical for a rental property, like a long-term residential lease. The IRS considers you to be running a business, not just earning passive income from property rentals. As a result, the income from a hotel or B&B is considered active business income and subject to self-employment tax.
2. Short-Term Vacation Rentals
The rise of short-term rental platforms such as Airbnb and VRBO has blurred the lines between traditional long-term rentals and active business operations. If you rent out your property for short stays (typically under seven days), the IRS may consider this more akin to running a business than simply leasing a property.
Like hotels, if you provide substantial services to guests—cleaning, concierge services, or even stocked kitchens—the income may be subject to self-employment tax. However, if you simply rent the space and provide no additional services beyond the occasional cleaning or minor upkeep, the income would more likely be considered passive and not subject to self-employment tax.
3. Mixed-Use Properties
If you own a property that is partly used for rentals and partly for another business (such as a retail store or office space), the tax treatment of the rental income can vary. If you provide substantial services to tenants, such as daily cleaning, security, or maintenance services, the IRS may classify that portion of your income as subject to self-employment tax.
If you hold rental properties and are unsure how to treat the rental income for tax purposes, contact a ShindelRock tax professional.
Written by: David Shindel
