Is Rental Income Considered Earned Income?

Earned income is generally defined by the Internal Revenue Service (IRS) as money received for performing personal services. This includes wages, salaries, tips, and net earnings from self-employment. The classification of income as “earned” is important for various tax purposes, including eligibility for certain tax credits and the ability to contribute to retirement accounts. This distinction helps taxpayers accurately report income and claim benefits.

Understanding Rental Income Classification

Rental income typically falls into the category of passive income for tax purposes. This classification applies when the income is derived from merely owning property, collecting rent, and performing routine landlord duties. Such duties include basic maintenance, screening tenants, and managing finances.

The IRS generally considers that this income stems from the property itself, not from significant active labor or services provided by the owner. Most individuals who own residential or commercial rental properties and collect rent will find their income classified as passive.

Situations Where Rental Income Qualifies as Earned Income

While most rental income is passive, certain specific scenarios allow it to be considered earned income. This reclassification often hinges on the level of active involvement and services provided by the property owner.

One such scenario involves qualifying as a “real estate professional” for tax purposes. To meet this IRS designation, an individual must dedicate more than half of their personal services in all trades or businesses during the year to real property trades or businesses in which they materially participate. Additionally, they must perform over 750 hours of services annually in these real property trades or businesses.

Rental income can also be considered earned if it is part of an active trade or business where substantial services are provided to tenants beyond standard landlord duties. Examples include short-term rentals like hotels or bed and breakfasts, where services such as daily cleaning, concierge services, or meals are offered. If the average period of customer use for a property is seven days or less, and significant services are provided, the income may be classified as active business income.

If the rental activity rises to the level of a trade or business, the income generated might be subject to self-employment tax. This tax covers Social Security and Medicare contributions, typically at a rate of 15.3% on net earnings. Income subject to self-employment tax is considered earned income.

Why the Classification Matters

The distinction between earned and passive rental income has significant implications for a taxpayer’s financial planning and tax obligations. One major area affected is the ability to contribute to Individual Retirement Arrangements (IRAs). Contributions to traditional or Roth IRAs generally require the taxpayer to have earned income.

Passive rental income does not qualify as earned income for IRA contribution purposes, meaning it cannot be used as a basis for contributing to these retirement accounts. However, if rental income is properly classified as earned income, it can support IRA contributions up to the annual limits, which are $7,000 for those under age 50 and $8,000 for those age 50 or older in 2024 and 2025.

The classification also affects Social Security benefits. Earned income contributes to an individual’s Social Security earnings record, which determines future benefits. Passive rental income typically does not contribute to Social Security earnings.

Furthermore, various tax credits, such as the Earned Income Tax Credit (EITC), require earned income for eligibility. Passive rental income would not count towards the earned income thresholds necessary to qualify for these credits.