Is Rental Income Counted As Investment Income on Taxes?

The Internal Revenue Service recognizes numerous types of income, which all fall into three broad categories: active or ordinary income, portfolio income and passive income. Income from investments may fall under portfolio income or passive income depending on the type of investment. Real estate, however, is a passive income activity and subject to taxation based upon this fact unless the owner is a real estate professional. For real estate professionals, rental income is ordinary income.

Passive Income from Real Estate Rentals

A taxpayer reports income from real estate rentals on Form 1040 Schedule E. For tax purposes, the Internal Revenue Service considers this passive income, but there are exceptions. The owner of the property deducts expenses such as depreciation, operating expenses and repairs against income for a given tax year. Income includes rent, expenses paid by a tenant and any money paid to cancel a lease. Real estate rentals do not include vacation homes or personal residences of the taxpayer.

Exceptions to Passive Income

The IRS provides certain exceptions for which real estate is not a rental property. These include a limited average rental period of seven days or fewer, or 30 days or fewer with the provision of significant personal services, such as maintenance or cleaning. Use of a property for a trade or business provides other exceptions.

Other Exceptions

If the taxpayer is primarily holding the property for purposes of appreciation and capital gains and the rental income is minor in comparison to either what the buyer pays for the property on an unadjusted basis or the fair market value, whichever is less. In this case, income is incidental to a trade or business, meaning the taxpayer includes it with ordinary income. Using the property for other business activities for which the owner participates also renders the income as ordinary, or active, income.

Personal and Vacation Property

A taxpayer recognizes income from a personal or vacation property only in certain cases. Renting a property for more than 15 days qualifies it as a rental activity for which the IRS requires the owner to report income. However, if the owner uses the property for either 14 days or greater than 10 percent of the total rental days, he does not have to report income or deduct expenses.

Real Estate Professional

Earning income from rental properties as a real estate professional is not passive income in most cases. The IRS recognizes this type of activity as an ordinary trade or business activity; therefore, the income is ordinary, or active, income. The taxpayer still reports in on Form 1040 Schedule E.

References

• Internal Revenue Service: Tax Topic 414 Rental Income and Expenses
• Internal Revenue Service: Tax Topic 415 Renting Residential and Vacation Property
• Internal Revenue Service: Publication 925, Passive Activity and At-Risk Rules; 2010
• "Income Tax Planning for Financial Planners": Thomas Langdon, et al; 2011

Resources

• Internal Revenue Service: Form 1040 Schedule E