Rental income: Passive or Earned?

[cusco88]

We have a rental and we are in CA. Since we are capped by the amount of deduction, which usually factoring in the property tax for rental and our own home, TurboTax just says it’s best we use standard deduction.

so how to know if TurboTax is showing my rental is passive income or earned income?  We are not actively managing it as our tenants don’t like to be bothered. So I’m not sure if rental income for us is considered as passive or earned in that case. How to check? Thanks

[Mike9241]

the easiest way to check if the rental activity is being treated as passive by Turbotax is to look at form 8582. That's the form where income/loss from every passive activity first flows.

the only time rental activity would be considered earned income is If the average use of the property by a customer is seven days or less. Therefore, most VRBO and AirBnB are not considered rental activities. however if such is the case the activity is reported on Schedule C, not Schedule E. 

[Carl]

Typically, rental income is reported on SCH E, which is passive. Whereas earned income not reported on a W-2 is self-employment income and gets reported on SCH C.

SCH E deductions have nothing to do with your standard or SCH A itemized deduction. SCH E expenses are deducted from your SCH E income. Whereas other deductions are a SCH A itemized deduction.

It is not common for long term residential rental property to actually show a taxable profit "on paper" at tax time anyway. When you add up the deductions of mortgage interest, property taxes and insurance along with the depreciation you're required to take, those four items alone will usually exceed the total rental income for the year. Include with that other rental deductions allowed, such as repairs, maintenance and other things, and you're practically guaranteed to show a loss on the SCH E every year.

Rental losses that exceed the rental income are just carried over to the next year. This includes deductions not allowed because of income thresholds if your overall income is to high. So the carry over losses will tend to increase with each passing year. Those losses can't be realized until the year you sell the property. Then those losses will help offset gains, as well as depreciation recapture sometimes too.

[tagteam]

In addition to @Mike9241's post, it is also important to know whether the income is passive or nonpassive (which is different from passive versus earned).

As @Mike9241 indicated, your income/loss would not be reported on Schedule C unless you provided substantial services to short-term renters or you were a real estate dealer.

Further, your income/loss would be passive unless you were considered to be a real estate professional who materially participates in your rental property(ies), which is clearly not the case since you indicated you do not even actively participate.

[tagteam]

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@Carl wrote:

Typically, rental income is reported on SCH E, which is passive. 

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Rental income reported on Schedule E is not automatically passive (nor are losses).

[cusco88]

i'm not actively managing it as tenant don't like to be bothered.  the rental is rented it on an annually basis, so its not use for AirBnB or anything like that.  

i do recall turbotax asked if i am actively involved or not and their definition was that if i am a decision maker or something, then that would be active?  can't recall exactly.  not sure if by that selection it changes my rental to be earned income instead of passive?

[tagteam]

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@cusco88 wrote:

.....can't recall exactly.  not sure if by that selection it changes my rental to be earned income instead of passive?

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No, active participation does not change your rental income from passive to earned income.

Rather, it simply is one of the factors that qualifies you to take advantage of the limited exception to the passive loss rule (you can deduct up to $25,000 ($12,500 or less if married filing separately)).

See https://www.irs.gov/instructions/i1040se#en_US_2021_publink24332td0e578