Tax Essentials for Sole Proprietors: Understanding Your Tax Obligations

Unless you have set up your rental business as a corporation, an LLC treated as a corporation, or one of the other standard business structures, your small-but-mighty rental business will be defined as a sole proprietorship for tax purposes. What exactly is a sole proprietorship, you ask?

A sole proprietorship is a business that an individual owner operates. In short, a sole proprietor does not distinguish between the small-business owner (you, the landlord) and the business entity (your rentals) for tax purposes, so you will pay your business taxes through your own personal taxes. Sole proprietorships have a few unique aspects:

• It’s the default business structure for any business.
• Sole proprietorships have a more flexible management structure with fewer regulations compared to an LLC or corporation.

Because there’s no distinction between you and your rental business, sole proprietorships are considered a pass-through business, meaning the business’s profits or losses pass through to the owner’s personal tax return.

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Sole Proprietorship Taxes Defined

As a sole proprietor landlord, it’s important to know which taxes you’ll pay and how they might affect your rental business. Each type of tax has its own requirements for reporting and payment. Basic rental property businesses pay these taxes:

• • Federal income tax: This will include both personal and business income tax. You’ll fill out two different IRS tax forms to accurately pay your federal income tax for the year.
  • State tax: If your state assesses state income tax, landlords will carry income numbers from their federal forms over to state forms to determine how much state income tax is due.
  • Federal and state estimated taxes: Your employer would normally withhold your income tax from your paycheck, but as a sole proprietor landlord, you’ll determine your tax liability yourself. When you pay estimated taxes, you’re actually paying money ahead toward what you think you’ll owe for your small business. The IRS requires that these taxes be paid throughout the year, not just at tax time in April. Federal and state estimated taxes are due in January, April, June, and September, typically on the 15th of the month. These taxes can be filed with Form 1040-ES. Use this guide to help you calculate your estimated tax payments.
  • Property tax: When a business owns real estate, it is responsible for paying property taxes based on the property’s assessed value. We determine a property’s value by multiplying the property tax rate by the percentage of the property’s value that is taxed. All property sales are registered with the state or local government, so you’ll receive information about any changes in the assessed value of your property. The taxes due are based on that assessment.
  • Business personal property tax: Depending on your location, businesses must pay tax on their assets, such as furniture, computer equipment, and fixtures. Some states require you to pay this tax even when your assets are fully depreciated.

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Does your rental property business offer additional services, like catering, transportation, or concierge options? If so, you may qualify for these additional taxes:

• Self-employment tax: Income from rental or investment properties is considered passive income, which is exempt from self-employment tax. However, if you provide additional, substantial services or are a real estate professional, check with your tax preparer about self-employment taxes.

When employed, the employer is responsible for deducting Social Security and Medicare taxes from your pay. But when you’re self-employed, you’re responsible for paying the self-employment tax yourself, based on the business’s income. Self-employment tax is included in Form 1040 for federal taxes and is calculated using Schedule SE. The self-employment tax rate is 15.3%, which is composed of 12.4% for Social Security up to an annual income ceiling, above which no tax applies, and 2.9% for Medicare with no income limit or ceiling.

• Sales tax: You may have to collect and pay sales tax if you sell products or services in your rental business, such as cleaning or other convenience services. How you pay and collect this tax will depend on your home state. Your rental’s state department of revenue can tell you if and when you pay and file taxes.

And if you own short-term rental property, you may be subject to additional taxes:

• Transient occupancy tax: Short-term rentals — think 30 days or fewer — may qualify for a lodging tax. Your state or local government sets this, and you collect the tax from your renters and then submit it to your tax authority.
• Short-term rental taxes: Your local government decides what counts as a short-term rental for tax purposes. Some regulations allow short-term rentals to last as long as 92 consecutive days. In some areas, you’ll need a certification as a short-term rental company when you launch the business; then, you’ll renew your certification each year. Work with your lawyer and tax preparer to assess the requirements in your area and determine if this tax applies to your situation.

How Sole Proprietor Landlords Pay Income Tax

The main difference between reporting income from your sole proprietorship rental business and reporting earnings from a job as an individual is that you must fill out two forms to pay federal income tax for the year successfully.

First, sole proprietors must fill out Form 1040, which is the standard individual tax return. This form reports personal income. But to report business income, sole proprietor landlords will fill out an additional form, and which form you need depends on whether you’re reporting passive or active income.

Reporting Passive Income with Schedule E

Most real estate investors use Schedule E to report their net income or losses from rental properties. This is the form you’ll use if these situations apply to you:

• You own the investment property in your name, with your spouse, or through a single-member LLC.
• You are not a real estate professional, a special tax designation that allows you to count your rental activities as active business concerns.
• You do not offer your renters additional, substantial services like transportation, meals, or guided activities.

To complete Schedule E, you’ll need this information on hand:

• 1099 payments and forms
• Rental property type and address
• Fair rental and personal use days
• Qualified joint venture
• Income and expenses

Grab step-by-step instructions and the most recent version of the Schedule E here!

Reporting Active Income with Schedule C

If you offer your tenants additional substantial services like concierge services, daily cleaning, or tour options, then you’re more likely to need Schedule C—the form to report active income.

To complete Schedule C, calculate the taxable income of the rental business, including all income and business expenses. The outcome of this calculation (income minus expenses) is known as the net income (the amount of taxable business income).

The rental business’s net income or loss is entered on Line 31 of Schedule C, along with the landlord’s other income or losses. If the business has a profit, then the figure is entered on Line 3 of the Form 1040. Losses may be used to reduce the landlord’s total adjusted gross income (the income before exemptions and deductions) on the tax return.

Your tax bracket and the amount of federal income tax owed will be based on your combined income from both Form 1040 and Schedule C.

Tax Deductions for Sole Proprietor Landlords

There’s no need to beat around the proverbial bush — tax deductions are every small-business owner’s favorite part of doing taxes. Thankfully, there are several major deductions sole proprietor landlords can write off that will help reduce net business income, and thus, taxable income, which could equate to owing less in taxes. So when you’re filling out your tax forms, keep these deductions top of mind:

• Home office expenses
• Mileage and travel expenses
• Insurance costs
• Self-employed retirement plans or traditional individual retirement contributions
• Advertising and marketing expenses
• Legal and professional fees
• HOA dues
• Property taxes
• Property depreciation
• Mortgage interest
• Repairs and maintenance
• Employees (full- or part-time)
• Independent contractors

We recommend always speaking to a tax professional for advice about your specific tax situation.

FAQs for Sole Proprietor Landlords