Is passive rental income subject to Self Employment Tax

18 Replies

I am a passive real estate investor (no full time job) and own a few rental properties tru my LLCs. I just noticed that I pay Self Employment Tax on the total amount of net income? My return is prepared by my CPA. Is this correct? I will also start flipping and I am aware that that will be subject to capital gains. My questions:

1. Is rental income subject to SE tax?

2. Is capital gains also subject to SE tax?

@Yas Tahir Get a new CPA immediately. Passive rental income is not subject to self employment tax. When you sell the property, you will pay capital gains tax, but capital gains tax will not be subject to SE tax.

With that being said, the Tax Reform proposal might change the SE tax application for certain real estate investors - namely those that are considered in an active trade or business. Nonetheless, if you paid SE tax on your rental income in 2016 and earlier years, you might be able to amend your tax returns and get some money back.

Let me know if any questions.

SE Tax is not payable on passive income. Capital gains SE is not payable unless you're designated as a dealer.

Unless you hold your flip for more than a year it will be taxed at regular rates and not the capital gains rate.

If your average rental period is short (less than 30 days) and you provide significant services to your tenants, then your income from your rental properties is deemed to be not passive and would be subject to SE taxes. 

No, we rent for a minimum of 1 year, although they usually stay longer.  Any CPA recommendation experienced in real estate in Houston, TX?

@Yas Tahir , @Jim Shepard

Flip profit is always taxed as ordinary business income subject to self-employment income taxes, regardless of your holding period.  Capital gains tax treatment does not apply to flips

@Yas Tahir  

Did you ask your CPA about it? I'm curious to know what his/her reasoning was for the SE tax?

Yes, he said the company is pas tru entity and therefore have to pay SE tax. He suggested we file it to be C or S Corp Jan 2018 to avoid paying SE tax. I hope this is correct?

Yas,

I am a CPA and tax attorney in California. If your CPA is advising you to dissolve your LLC and instead own rental real estate through a corporation (C or S), he is giving you very bad advice. Go find another CPA immediately bad.

Moving property out of a Corp is a taxable event, while it isn’t necessarily for an LLC, so that’s not a good thing.

Also, if you are a S corporation if you want to take money out of the Corp you must first pay yourself a reasonable salary (and pay payroll taxes on that).

If you are a C corporation, you are subject to double taxation (all income is taxed at the corporate level, and then again when distributed to you).

If you are a real estate developer it makes sense to own property through a corporation, but not rental real estate.

I strongly suggest talking to someone else about you tax situation.

@Yas Tahir

Answer from a Houston accountant here. No SE tax on net rental income - that is not even debatable. If what you're saying about your tax return is accurate, then your CPA messed up.

You got some bad answers on this thread about flips though. If they are actual flips, the result is not capital gain but ordinary income PLUS SE tax. It does not matter how long you held the flip, even if more than a year. 

Sometimes, flips can be treated as investments with capital gains, but it is case-by-case and requires a longer discussion.

I agree.  New CPA immediately.  

Rentals with leases 30 days or greater are passive income.

Flips are subject to self employment tax and regular income tax.

Originally posted by @Jim Shepard :

Unless you hold your flip for more than a year it will be taxed at regular rates and not the capital gains rate.

Profit from a flip is always ordinary business income subject to self-employment income taxes regardless of the holding period.

He said rental income from property under my personal name is not subject to SE tax, but other properties all under LLC with pass tru entity selection are subject to SE tax. This is only for rental income, not flips. I have asked him again and waiting for his answer.

When you set up the LLC, how did you elect to be taxed? Did you elect to be taxed as an S Corp?


LLCs are pass trough entity.  No S corp election was made.

@Yas Tahir It doesn't matter whether the rentals are under your name or under an LLC - you get the same treatment of rental income:

 - true rental properties (long-term) - not subject to SE tax,

 - occasional & short-term rentals - potentially subject to SE tax,

 - fix & flips - subject to SE tax. 

When rental property is under an LLC, there is a possibility of rental income to be erroneously treated as subject to SE tax. That would happen if K-1 from the LLC incorrectly reports rental income as ordinary business income.

In either case, it sounds like your CPA might not be proficient with real estate investing, and you should think about looking for a new CPA. If you do that, BP is great place to look, as many of us work with clients remotely.

Feel free to reach out with any questions.

@Yas Tahir Do you have your copy of the K-1 from your LLC? Is it showing your rental income on Line 1 or Line 2?

I don't know if this is your situation, but this is a reason to not necessarily go with the cheapest tax preparer you can find.  When if comes to legal and accounting, I think your first consideration needs to be whether the person has expertise in the area, and only second consider price.  If you are getting bad advice, it can easily cost you a lot more than whatever you saved in fees.

In your CPA's case, he is flat out wrong about the rental income flowing through an LLC being subject to SE tax- it isn't. He also gave you very bad advice about reforming your business as a corporation. That is a horrible idea for holding rental properties. My concern now is whether or not there are additional mistakes he made that are costing you money.

Are lease options treated the same as rentals as far as taxation is considered?

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