Is Rental Property Income Considered Earned Income?

Rental property income is generally not considered earned income, though specific exceptions exist. This distinction carries significant implications for tax purposes, particularly concerning payroll taxes.

Defining Earned and Unearned Income

The IRS distinguishes between earned income and unearned income based on its source. Earned income typically results from active labor, such as wages, salaries, professional fees, or net earnings from self-employment. Unearned income, also known as passive income, comes from sources that do not require active participation or labor. Examples include interest from savings accounts, dividends from investments, capital gains, and generally, rental income from property.

Rental Income: The General Classification

Rental income is ordinarily categorized as unearned or passive income. This classification stems from the nature of the income, which is primarily derived from the ownership of property rather than active services provided by the owner. For instance, collecting rent from a long-term tenant, where the landlord’s involvement is minimal, typically generates passive income. Because it is largely considered passive, this type of rental income is generally not subject to self-employment taxes for Social Security and Medicare. This means that property owners usually do not pay the combined 15.3% self-employment tax rate on their net rental earnings, which covers 12.4% for Social Security and 2.9% for Medicare.

Exceptions: When Rental Income Qualifies as Earned Income

Rental income can be treated as earned income under specific conditions, primarily when the property owner’s involvement is substantial. This often occurs if the owner provides significant services to tenants beyond mere property upkeep, or if they qualify as a “real estate professional” under IRS rules. To qualify as a real estate professional, a taxpayer must meet two specific criteria outlined in IRS Publication 925: they must spend more than half of their personal services in real property trades or businesses in which they materially participate, and they must perform at least 750 hours of services during the tax year in those real property trades or businesses. Real property trades or businesses include development, construction, acquisition, conversion, rental, operation, management, or brokering of real property. When these strict criteria are met, the rental income and associated losses may be treated as non-passive, and thus potentially subject to self-employment taxes.

Reporting and General Tax Implications

Regardless of its classification as generally passive or as earned income under specific exceptions, rental income is typically reported to the IRS on Schedule E (Supplemental Income and Loss) of Form 1040. This form allows property owners to detail their income and expenses for each rental property. Rental income is generally taxed at ordinary income tax rates, consistent with other forms of income reported on Form 1040. Property owners can offset their rental income with various deductible expenses, including:
Mortgage interest
Property taxes
Insurance premiums
Maintenance
Repairs
Property management fees
Depreciation

The classification of rental income as earned or unearned directly impacts whether it is subject to the Social Security and Medicare components of self-employment tax.