Am I a "Business" or "Investor" for Tax Purposes?

Question

Hello,

According to NOLO's Tax Deduction Guide, the waters are somewhat murky when determining whether a rental property owner is a "business" or "investor."  I own one out-of-state single family residence that has tenants and I pay a property management company 10% of the monthly rent.

Which one am I for tax purposes?

On a side note, can I depreciate a stove, refrigerator and washing machine if the previous owner installed it a couple of years ago?

Thank you,

Philip

Michael Plaks · Answer

@Philip C.

Four very different issues are at play here. Which is why RE taxation is so confusing for y'all and so profitable for us accountants. :)

Warning: I'm taking some liberties with the terminology, for the sake of clarity.

1. Active business v. Passive renting/landlording. This issue is about which schedule to use (Sch C or Sch E) and whether the income is subject to the self-employment tax, aka Social Security and Medicare tax. The answer for a rental property in 99% of the cases is the latter: passive renting and no SE tax.

2. Trade or Business v. Investment activity. This issue is about deductibility of general business expenses and the new 20% deduction on net income. The answer for a rental property in 99% of the cases is the former: Trade or Business, meaning all deductions are available.

3. Active participation in the activity. This issue is about your ability to deduct your rental losses, including depreciation, against your "normal" income, such as W2 salary. The answer is probably yes in your case, but I would need more information.

4. Passive activity v. Non-passive activity, aka Real Estate Professional status. This issue is about your ability to immediately deduct all your rental losses, regardless of your income level. The answer requires additional information from you, but it is probably the former: Passive activity, meaning that deductions for your losses can be limited if either your losses are too high or your income is too high.

Finally, on the appliances - yes, you can depreciate or even write them off completely the current value of the appliances. The key is: current value, not their original price paid by the previous owner.

Account Closed · Answer

I vote for tax writes offs even if it's long and messy, every time. Tax planning is 1/3 of my strategy. It isn't how much you make, it's how much you keep.

Joshua Thompson · Answer

Nope, that's not something I need, just some clarifications. If there are easier ways to get things done without sacrificing quality I'm all ears. Thanks for your responses!

Michael Plaks · Answer

You hope to become a CPA and also hope to avoid long and messy? Maybe not too late to rethink your career aspirations. :)

Joshua Thompson · Answer

@Philip C. This is the second time this book has been mentioned. I'll be adding it to the collection that much sooner. Thank you!

@Michael Plaks Thank you for the feedback. I ask because I'm hoping to become a CPA after I graduate and looking for some material to reference.

Doesn't adding all these personal items make the depreciation schedule long and messy? Or is that just the nature of the beast.

Michael Plaks · Answer

Yes, it does. Where can you find out? From your personal tax accountant. :)

There is no definitive list, but generally it's all removable items that can be (at least in theory) re-used and are not structural components. Examples:

• appliances
• carpets
• floating laminate
• hang-on cabinets
• some shelving
• some countertops
• furniture
• electronics

The non-structural part means that doors are NOT personal property even though easily removed.

The best, but often not economically feasible, answer could come from cost segregation studies.

Michael Plaks · Answer

@Philip C.

Using my familiar tune, there're three, not one, ways to write off appliances:

• de minimis safe harbor
• 100% bonus depreciation
• Section 179

All three allow an immediate deduction, but these methods can still produce different overall results. Ain't taxation of real estate elegant and straightforward?

Philip C. · Answer

Thank you @Carl Fischer  @Christopher Smith  @Todd Rasmussen @Michael Plaks  Yes @Michael Plaks, it's point # 3 that I was asking about.

@Joshua Thompson, According to this book here: https://store.nolo.com/products/every-landlords-ta...

personal property that can be deducted over 5-7 years includes things like stove, refrigerator, washer, etc. Based on Michael's suggestion, I think I would need to find out what the current value of each item is and either depreciate them over time or write them off all at once, I think using the De Minimis Safe Harbor Rule: https://www.nolo.com/legal-encyclopedia/new-irs-de...

Joshua Thompson · Answer

In response to the appliances, does that mean the majority of personal property can be written off at its current value? If so how can we know or where can we find what the IRS considers personal property vs real property?

Todd Rasmussen · Answer

Hi Philip,

I haven't read that guide and am not a tax professional but I do file taxes as often as once per year. Try IRS Publication 527 for your primary question. I think you'll find that you are a passive investor and will need to file schedule E with your return.

Your side note is a little more confusing. Since depreciation is used to recover the cost of income producing property, your ability to deduct it requires that it cost you something. I assume that you purchased the appliances in the property transaction and indicated their value at zero at the time. If so, their value is zero and cannot be depreciated or their value is already buried in the cost basis of the home and will be deducted over the next couple decades that way. Either way, probably best to let that one go this year. Even if you did reduce your cost basis in your property to give the appliances some value to depreciate faster, the capital gains you would pay against that difference on the back end is probably higher than your effective tax rate.

Am I a "Business" or "Investor" for Tax Purposes?

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