Real Estate and Rental Properties as a Business

By Jason Watson, CPA
Posted Saturday, August 3, 2024

A lot of this chapter’s material is in reference to general business ventures. However, we consider rental property investments and other real estate activities to be a business in the purest sense. Why?

Let’s back up a bit since some real estate investments are not necessarily a business venture in themselves, but the decision to invest has a profit motive. We’ll casually define three buckets-

True Passive Real Estate

Investors might purchase tranches or interests in a real estate syndicate or entity. This is not just real estate investment trusts (REITS) but rather private groups that offer a piece of the pie through partial ownership. You send money, and they send reports plus an annual K-1 for your individual tax returns (Form 1040). You have no control, you do not actively participate in decisions, and at times you don’t have the ability to divest or exit without severe redemption penalties or discounts.

We talk more about these from a tax planning perspective, but for now know that these types of investments can be leveraged to offset other passive income and therefore they become a part of the overall business venture mindset. In other words, while real estate syndicates can exist in isolation within your portfolio, they can also be a smart business decision when coupled with other real estate investments.

Passive by Tax Law, Business by Mind

This bucket is your general rental property investment where you are running the venture like a business. Keep the property occupied. Try to push up rent. Keep expenses low. All the things a business owner does, but for various reasons that we will get into later, the activity is deemed passive yet rises to level of IRC Section 162. We define Section 162 later in a few moments.

Real Estate as a Straight-up Business

The low hanging fruit in this bucket are brokerage commissions, management fees, and fix and flip activities. Simple.

The next real estate investment that is deemed a straight-up business is a rental property where you materially participate in the activity (as defined by nutty IRS tax code), and you are either-

• a real estate professional (REPS) in doing so or

• the property qualifies as a short-term rental (STR) with average guest stays of 7 days or less, or

• both.

We will discuss material participation in nauseating detail in another chapter. However, if we take another step back and see what the IRS is suggesting with its material participation rules, we will find that it is simply trying to draw bright lines to determine if your real estate activities are investments or businesses.

Here are considerations to have a business-like mindset to your real estate investments regardless of the buckets above-

• The definition of a “trade or business” comes from common law, where the concepts have been developed and refined by the courts over time. The Supreme Court has interpreted “trade or business” for purposes of IRC Section 162 to mean an activity conducted with “continuity and regularity” and with the primary purpose of earning income or making a profit. We would argue that rentals and general real estate investments fall under this auspice otherwise you wouldn’t do it. Sure, we all want that short-term tax loss to offset other income, but ultimately you want to make money.

• Running your rental property or other real estate investments like a business whether they are short-term rentals, syndicates, fix and flips, etc. helps provide a basic profit vision to the overall venture including day to day decision-making.

• IRC Section 199A offers an additional tax deduction for rental properties with taxable income provided they “rise to the level of Section 162.”

So, as you read through this chapter and others, please wrap your rental property and real estate investment mindsight with that of a business owner.