Form 1099 Considerations for Landlords Who Hire Rental Property Contractors
Is Your Rental Property an Investment or Is It a Business?
If you own rental real estate, you need to address whether you are an investor or if you have a trade or business. The distinction between these two has very different and important tax consequences.
Landlords who are business owners are allowed certain tax deductions that investors are not. In pre-2018 tax years, business owners could deduct home office expenses and were entitled to section 179 expensing. Beginning with the 2018 tax year, in addition to the aforementioned pre-2018 expenses, business owners are entitled to the special 20% business deduction enacted by the 2017 Tax Cut and Jobs Act. So which are you, a real estate investor or a business owner?
Which Landlords are Business Owners?
Owning rental property qualifies as a business if you do it to earn a profit and work at it regularly, systematically, and continuously. The courts have held that a landlord who finds new tenants, supplies the furnishings, cleans the units, and prepares the units for new tenants is a business owner who has demonstrated that such activities were sufficiently systematic and continuous.
What If You Hire a Real Estate Property Manager?
If the activities described above were handled by a real estate manager, does such action disqualify the landlord as a business owner? Not necessarily. The landlord would need to satisfy the IRS that the property manager acted as the agent for the owner, that the agent was under the control of the owner, and hence the owner was in a business through the agent.
How Many Rental Units Does a Landlord Need to Manage to have a Business?
Several courts have ruled that a landlord who owns a single rental property can be engaged in a business. But, it is much easier to prove you have a business if you own multiple rental units. The risk of owning just one or a few rental units is having good tenants. While any prudent person would agree that it makes good business sense to have a good tenant, it may cost you from a tax perspective. If you have a stable tenant who causes few problems and makes little demand of your time, the IRS and the courts have found that the landlord’s activities were too minimal to rise to the level of having a business.
This lack of business activity can also be found if the rental property is vacant for long periods of time. Persons who are limited partners in limited partnerships, corporations, and REITS are also considered investors by the IRS.
Which Landlords are Investors?
While you still have a profit objective, you don’t work it regularly, systematically, and continuously. This can be a fine line. Courts have found that a farmer who rented his land to a tenant farmer was not an investor because all he did was pay the bills, deposit rental checks, keep the records and files for the farm, and occasionally talk to his tenant farmer. Again, the IRS prevailed simply because the landlord could not demonstrate that his activities were regular, systematic and continuous. In other words, the landlord who does his due diligence in finding a great tenant, which is a characteristic of a prudent business owner (landlord), may be penalized in the eyes of the IRS and courts.
TAX PLANNING TIP #1: If you engage vendors to provide a service related to your rental properties, be sure to have the vendors complete IRS form W-9. This form enables landlords to identify the type of entity that is providing the service. C and S Corporations, if properly identified on the Form W-9, are not required to receive a 1099-MISC.
TAX PLANNING TIP #2: Whether you are a business owner or an investor in the eyes of the IRS, we recommend that landlords provide all service-provider vendors with a Form 1099-MISC. There is no IRS penalty for sending a Form 1099-MISC to a person or entity for which you are not required to send the form. We will not discuss herein how the penalties for providing inaccurate information on the Form 1099-MISC or filing it late are computed by the IRS. You can discuss these penalties with your tax professional. These penalties pale in comparison for failure to send the form to contractors if the IRS finds that you intentionally disregarded the filing requirements. The penalty for failure to file Form 1099-MISC is the greater of $530 per form or 10 percent of the amount required to be reported on the return. There is no ceiling on the amount of this penalty.
TAX PLANNING TIP #3: If your rental activities constitute a business, or if you wish to convert your investment to a business activity to claim the 20 percent qualified business deduction, you need to issue Form 1099-MISC to your vendors (contractors, service providers, etc.).
TAX PLANNING TIP #4: Business owners need to pay self-employment taxes on the net earnings from their business activities (in addition to paying income taxes on the net profits). Investors need only pay income taxes on the net profits from the rental properties. This is an additional tax cost to business owners.
TAX PLANNING TIP #5: Before investing in real estate rentals, you need to discuss with your tax professional the IRS rules regarding at risk investments, active participation rules, passive investments, and electing to be a real estate professional.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.
