If I am a business owner and sublet rental space that I do not own, is this considered income? Will this put me into a different tax bracket?

[pls-76]

Does rental income carry me into a higher tax bracket?

[Critter]

If you file a sch C then the rent you collect is entered as other income and how it effects your tax brackets depends on the amount.

[Hal_Al · Accepted solution]

Because the sublet is part of your business, it is reported as business income on schedule C (not schedule E where regular rental income is reported). As Critter#2 indicated, the income is shown as other income (line 6 of schedule C) rather than included in  Gross receipts or sales (line 1).

The income will increase your profit (or reduce your loss), pushing you toward a higher tax rate. Whether you get to the higher bracket depends on the amount and where you were in the lower bracket before the income.

The extra profit will be subject to self employment tax as well as income tax.

Another way to look at it is: it is not so much income as a reduction in your rental deduction for the rent you pay

[sbookspan]

Rental income is subject to income tax after deducting all expenses related to the rental property. The sublet aspect does not affect the taxable impact of receiving the rental payment.

There is no way to answer your second question without having access to the specific information on your tax return. If the rental income is such that when added to your existing taxable income you are pushed to a higher tax bracket, then yes. If the rental income is such that you don't encroach your next tax bracket, then your tax rate will not change, but your total income taxes will increase by the amount of the net rental income received during the tax year.

Hope this is helpful!

Answers are simply - net income from property rental is taxable income to the holder of the lease and recipient of rental payments.

[fsteincpa]

Hal, do you have a cite for this. this has always been my understanding and I am having a disagreemnt with another tax pro on a forum and would love some backup. lol

[tagteam]

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@fsteincpa wrote:

....this has always been my understanding and I am having a disagreemnt with another tax pro on a forum and would love some backup. lol

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I  am, frankly, not surprised that there is a disagreement considering the following general principle:

If you are a real estate dealer who receives income from renting real property or an owner of a hotel, motel, etc., who provides services (maid services, etc.) for guests, report the rental income and expenses on Schedule C or C-EZ. If you are not a real estate dealer or the kind of owner described in the preceding sentence, report the rental income and expenses on Schedule E. 

I would be willing to bet that, at least in part, formed the basis for the other tax pro's position. I have yet to see anything in the Code or Regs that would contradict the italicized language. Except for those exceptions, rental income strictly for the use and occupancy of real property should be reported on Schedule E, at least that would be my position.

Therefore, I would also like a cite that supports the treatment outlined in the previous posts.

[fsteincpa]

I actually agree with the previous post.  To me, it is recovery/reduction of expenses and not truly rental income. I just want a cite to support my belief. lol

[tagteam]

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@fsteincpa wrote:

I actually agree with the previous post.  To me, it is recovery/reduction of expenses and not truly rental income. I just want a cite to support my belief. lol

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The business owner leases from the owner of the building, pays rent but does not utilize the entire space so the business owner sublets part of the space to an unrelated party (i.e, not connected with his/her business). There is no reduction if the business owner reports 100% of the rent paid as an expense and then reports 100% of the rental income received by the sublessee.

If the business owner pays $1000/month to the building owner and collects $500 from the sublessee, then the business owner has a $1000/month rent expense and reports $500 in rental income (in this case the entire transaction is a wash - between the method of reporting outlined and just reporting $500 as a rent expense). 

[Carl]

Generally when you are renting out property, be it real estate or something else such as construction equipment, you are required to depreciate that property on SCH E. However, you can't depreciate that which you did not pay for and therefore do not own. That's because *YOU* don't have a cost basis for the property that *YOU* paid, to take any depreciation from.

In your case since you are basically sub-letting, it's really your business that is sub-letting - not you. Neither you nor your business actually owns the property. Therefore you don't report it on SCH E. It gets reporting as other business income on the SCH C.

The actual owner of the property is already depreciating it. So *you* can't.

Now since rental income is passive, you'd "think" it would be a schedule E item. But it's not because your business is renting the "entire" building for an "active" (not passive) business. Therefore all income received by the business is active and reported on SCH C.

I see this stuff all the time and while it's been years since I've been asked to "cite" anything concerning it and did so years ago, I'm not willing to take the time to find it again. But it's a fact that this is the correct way to do it.

[tagteam]

The only reasonable conclusion here is that this is a "recovery/reduction of expenses and not truly rental income" or the sublease is actually rental income that is reported on Schedule E. 

There is no such thing as a "sublease of a business" as that defies the very definition of the terms "sublease" or "subletting" (which relate specifically to renting of property by a third party). A sublease merely grants the exclusive right to possession and use, to a third party, of a portion of the original tenant's real estate (or of the entirety but for a shorter period of time than specified in the original lease). 

Regardless, if a tenant leases real property from an owner thereof and grants a sublease to a third party, then by definition that tenant is renting out real property.

[fsteincpa]

I agree 100% with your synopsis. I was hoping the cite would be a simple one to find. I haven't been able to find one. So, was hoping some better researchers would have it handy. 

[tagteam]

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@fsteincpa wrote:

I agree 100% with your synopsis. I was hoping the cite would be a simple one to find. I haven't been able to find one. So, was hoping some better researchers would have it handy. 

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I doubt whether you are going to find a cite that is directly on point (verbatim) since I doubt whether one actually exists.

The closest I can get is Section 446 of the Code, and Regs thereunder, which, among other things, requires accounting methods and procedures be adopted that clearly reflect income. However, it is fairly clear there could be more than one interpretation with respect to the subject at hand.

[kmhwhite]

Actually had this situation come up with the IRS a couple years ago.  IRS required that we amend to report the sublease on Schedule E.  The IRS was alerted to the situation as the subletting business correctly filed a 1099misc to lessee (unincorporated business).  Lessee had reported the expense as a reduction in rent expense.  Maybe the difference was the 1099misc reporting, otherwise how would IRS know about it?  Either way, we didn't argue, just amended and reported on Schedule E as IRS requested.    

[ThomasM125]

Rental receipts are either income or reduction in rent expense. In either case they can increase your taxable income which could result in putting you into a higher tax bracket.

Rental income can be reported on schedule E, and that would shelter it from self-employment tax. That being so, why would you want to report it on schedule C?