Self-Employment Tax and Rental Property Owners
As of January 2024, 16.1 million people in the US are self-employed. But what exactly counts as self-employed? Do you qualify since you own rental property? Should you pay self-employment taxes? They’re significant questions, and the answers aren’t always clear cut.
That’s why the REI Hub team is here to help! Today, we’re tackling four questions: What is the self-employment tax? Which real estate investors count as self-employed? How do property owners open themselves up to self-employment taxes? How does paying self-employment taxes help rental owners? Let’s get started.
What is the self-employment tax?
With a typical nine-to-five job, your paycheck has taxes deducted from it. You and your employer split the cost of those taxes, so each of you pay 6.2 percent for Social Security and 1.45 percent for Medicare.
But when you’re self-employed, you cover the entire cost for Social Security and Medicare—the full 15.2 percent.
Which real estate investors count as self-employed?
According to the IRS, you are self-employed if you meet any of these criteria:
• You carry on a trade or business as a sole proprietor or an independent contractor.
• You’re a member of a partnership that carries on a trade or business.
• You are otherwise in business for yourself, including a part-time business or gig work.
When you’re self-employed, your net earnings qualify for self-employment taxes. The good news is that, in most cases, the IRS excludes real estate rentals from self-employment income.
The IRS usually considers rental income as passive income. The tax rate for your passive income is the same as the rate for your earned income (such as salary from a W-2 job). You don’t have to pay additional taxes for Social Security or Medicare.
However, there is an exception.
Exception: Real Estate Professionals
Are the rents received in the course of your trade or business?
If you count as a real estate professional, you spend 750 hours per year working in real estate and at least half your time on real estate activities. Your rental properties aren’t passive investments—they’re an active business. That shift from passive to active qualifies you for self-employment, so you’ll pay self-employment taxes.
Refer to our related article for more information on the real estate professional designation and requirements.
How do property owners unintentionally subject themselves to self-employment taxes?
Property owners often provide amenities or extra conveniences for their tenants. These extras help your renters and boost your ratings as a host. Seems like a win-win, right?
Not necessarily. This is where many property owners unknowingly open themselves up to self-employment taxes. These extras may shift your position. Instead of being part of the real estate industry, you’ve become part of the hospitality industry. Your income now counts as active instead of passive.
Necessary Services
Let’s start with necessary services. To rent your property, you must keep it in working order and fit for occupancy. Think about what it takes to make your property habitable. Those tasks and features are necessary.
• Elevator service
• Maintenance and cleaning for common areas
• Routine repairs
• Security
• Trash collection
• Utilities, like heat, plumbing, electricity, and Wi-Fi
If you only offer necessary services, you won’t need to worry about self-employment taxes.
Substantial Services
So what counts as a substantial service?
Substantial offerings go beyond keeping your property habitable. You provide necessary upkeep, but you also offer extra services for your tenants’ convenience. For example, if you run a bed-and-breakfast, you may prepare meals. You offer more than lodging. These services and amenities are common offerings for short-term rentals:
• Access to recreational equipment
• Concierge services
• Daily housekeeping
• Guided tours or experiences
• Information on local attractions or places of worship
• Laundry
• Mail delivery
• Prepared meals
• Satellite TV
• Transportation schedules or prepaid vouchers
• Vending machines
The line between necessary and substantial services can be blurry. The IRS considers each situation on a case-by-case basis when determining whether property owners owe self-employment taxes. If you aren’t certain if the amenities or services you offer are substantial, check with your CPA or legal counsel.
How does paying self-employment taxes help rental owners?
The bright side of paying self-employment taxes is that your active income allows you to deduct rental losses up to $25,000. With passive income, the amount of passive income you report becomes the limit for your losses for the year.
Takeaways
The IRS generally considers rental property income as passive income—meaning you won’t pay self-employment taxes. However, there are two scenarios when real estate investors qualify as self-employed: when you count as a real estate professional or when you offer substantial services to tenants. If either situation applies to you, talk with your CPA. They’ll review your circumstances and help determine if you are subject to self-employment taxes.
We designed REI Hub’s software for rental property owners—whether or not you’re self-employed. When you need help tracking your income and expenses, preparing for tax time, and keeping your portfolio organized, sign up for our free trial!
