When is a rental not a rental?

• Author: Greene, Jeffrey J.

All over the country, business owners rent property they own personally to their businesses. In addition, many thousands of other persons own condominiums and other dwellings which they rent to families on vacation or own as investments. All must beware, however, since certain "rental" activities are not exempt from self-employment taxation. Careful planning is required in order to avoid the potential for coming under the self-employment tax umbrella.

The key to deciding when a "rental" activity is subject to self-employment tax lies in Sec. 1402. Under Sec. 1402(a), net earnings from self-employment means "the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business." Sec. 1402(a)(1) specifically excludes from the definition of net earnings from self-employment "rentals from real estate and from personal prop with the real estate." Under Sec. 1402(c), the definition of trade or business is the same as that found in Sec. 162 (with certain exceptions). Sec. 162 requires that a trade or business involve a regular, continuous and substantial investment of time and resources on the owner's part. While on its face Sec. 1402 appears to contain a blanket exclusion of real estate rentals from the definition of net earnings from self-employment, further reading of the regulations yields a different answer. Regs. Sec. 1.1402(a)-4(c)(2), under the caption "Rentals from living quarters," provides:

Payments for the use or occupancy of room or other space where services are also rendered to the occupant, such as for the use or occupancy of rooms or other quarters in hotels.... do not constitute rentals from real estate; consequently, such payments are included in determining net earnings from self-employment. Generally, services are considered rendered to the occupant if they are primarily for his convenience and are other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only. The supplying of maid service, for example, constitutes such service; whereas the furnishing of heat and light, the cleaning of public entrances, exits, stairways and lobbies, the collection of trash, and so forth, are not considered as services rendered to the occupant.

Thus, rentals must be analyzed closely to determine whether the owner's involvement is of such significance that it rises...