In most cases, earnings from rental property is considered passive income.
Passive income is money earned from business activities where the individual is not active in the day-to-day operations. However, income from rental properties is almost always considered passive, even if the owner is involved in the management of the property.
Is Your Rental Income Passive or Earned?
As explained above, income from rental properties is almost always considered passive income, but there are a few exceptions. In the below scenarios, the IRS might consider income from a rental property active instead of passive.
- If the owner of the rental property is classified as a real estate professional. To qualify as a real estate professional, at least half of the individuals’ work must be in real estate, and they must work a minimum of 750 hours in the real estate profession within the calendar year.
- Some short-term rentals might not be considered rental activity. To qualify, the average rental term for the property must be 7 days or less for the year.
- If the rental term is an average of 30 days or fewer and the owner provides significant services that are not required by law. There must be proof of the services.
- Rentals that are secondary to the running of a business. For example, dormitories rented to students at a university or hospital rooms. In these cases, the rental is incidental to the primary purpose of the business.
- If a business is only available during set business hours with non-exclusive use, like a golf course, and the business is not an S corp whose primary business activity is rentals.
- If a person rents the property but occupies it as a personal residence for over 14 days or 10% of the days the home is rented out.
These are just some general guidelines to determine if a rental property income is considered passive or active; it is best to consult with a financial or tax professional.
How Do Losses Work With Passive Income?
Losses in rental property can be common because of things like depreciation. However, a loss on a passive income activity is considered a suspended loss. The capital loss cannot be realized until a tax year where there is a positive passive income. The loss can be carried over as long as it takes to make a positive income.
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