Understand that owning rental property is a form of business income. There are basically two types of business income. Passive income, and non-passive income.
Non-passive business income is that which you earn when you go out and "do something" on a recurring basis to actually "earn" it. Non-passive income is also referred to as "earned income". If self-employed, the income is reported on SCH C as a physical part of your personal 1040 tax return. In addition to regular taxes, this income is also subject to the additional 15.3% self-employment tax. The SE tax is basically the employer's side of your social security and Medicare tax. This type of income also counts when figuring your maximum allowed contribution to a tax deferred retirement account.
Passive business income is basically what a majority of rental property produces. That's because with rental income you generally don't "do" anything on a recurring basis to earn it. All you do is "sit there" (literally!) and collect the income every month, or every week, or whatever pay period is set up with the tenant. This income is reported on SCH E as a physical part of your personal 1040 tax return. Income reported on SCH E is *not* subject to the additional 15.3% self-employment tax. Additionally, this income does not count for anything when figuring your maximum allowed contribution to a tax deferred retirement account.
For rental income to be treated as non-passive (earned) income, you have to provide your tenants services that meet two conditions.
- The services are "directly beneficial" to the tenant.
- The services are provided on a recurring basis.
Examples of such services would be house cleaning services, laundry services, bad making services, etc. In other words, the same exact services as are provided by a hotel. Now this does not mean you are the one who has to actually "do" those services on a recurring basis. It means in your "provide" those services to your tenants on a recurring basis, and the cost of those services is included in the rent they pay you each month. So if you pay a third party to perform those services "on a recurring basis" the the fact is, 'you' are the one "providing" those services.
So if you are "in fact" providing your tenants services on a recurring basis, that makes the rental income, earned income and it would be reported on SCH C.
Since you and your wife own the LLC together, that means your have a multi-member LLC. Therefore all the business income and expenses gets reported on the IRS Form 1065-Partnership Return. The partnership will then issue each individual owner a K-1, and each owner will enter their K-1 on their personal 1040 tax return.
If the income reported on the K-1 is passive rental income, then it will end up on page 2 of the SCH E on your personal 1040 tax return.
If the income reported on the K-1 is non-passive income, then it will "NOT" appear anywhere on the SCH E of y our personal 1040 tax return. It will appear elsewhere on the tax return, depending on the explict type of business income it is. Could be earned income, or what's called "officer compensation" which is basically a guaranteed payment to the owners of the business.
Last year the account we hired put all of the rents received as Gross Receipt of Sales which after the deductions made the result Ordinary Business Income (K1 box1)
Just a guess based on assumptions, since I really don't have "the facts" of your situation to work with. But it sounds to me like your CPA took the lazy way out and incorrectly reported your rental income as earned business income, when in fact it was not. But then, if you did "in fact" operate the rental like a hotel, then the CPA was right and you are the one that messed up without realizing it. So if the CPA was right, let us know and we'll help you get it right on your 2019 taxes.
If the CPA was wrong, then you have a mess on your hands that will require professional help to make it right. I would suggest you not use the same CPA to fix this either.
