How Landlords Can Qualify as Business Owners This Tax Season

February 14, 2025 6 min read

How Landlords Can Qualify as Business Owners This Tax Season

Whether you’re a rental property business owner managing a single rental property or multiple complexes, being recognized as a business owner in the eyes of the IRS offers valuable advantages. Understanding the distinction between a rental investment property business and a rental business is key to unlocking significant tax benefits of the second status.

In this article, we’ll discuss why it’s so advantageous to be classified as a business and what you can do to obtain this status this tax season.

The Benefits of Qualifying as A Business Owner

When it comes to property owners, there are several different tax classifications you can be assigned by the IRS. For instance, property owners can be classified as investors, not-for-profit owners, or business owners.

The primary reason to seek an official business owner status is the considerable number of business-only tax deductions. These tax deductions are only available to landlords whose work qualifies them as a ‘business owner’ according to the IRS’s criteria. They are as follows:

Pass-through Income Deduction: Business owners can deduct up to 20% of the qualified business income their rental properties generate from their income tax through pass-through deduction.
Real Estate Loss Deduction: If a business owner has a net real estate loss, they are protected and can deduct the total loss amount instead of the capital gain rate. The same is not true for real estate investors.
Home Office Deduction: If real estate business owners work in a home office space, they are permitted to deduct home office expenses from their taxable rental income, including furniture, computers, and the rental cost for the space, among other things.
Section 179 Expensing: Section 179 of the internal revenue code allows for business owners to opt for an immediate expense deduction for depreciable business items rather than capitalizing and depreciating those items over a longer period of time. This includes assets like furniture and electronics.
Start-up Expense Deduction: New rental property investors establishing a rental business can deduct up to $5,000 from the cost of starting their businesses for the first year.

How to Qualify as a Business Owner

The baseline qualifications to be considered a business owner in the eyes of the IRS relate to behavior and motive. You or someone working under you must regularly and continuously engage in rental activities (behavior) with the end goal of making a profit (motive).

Note that you don’t necessarily have to actually make a profit to be considered to have a profit motive. That’s where your behavior comes into play. If you behave as if profit is your primary motive by regularly and continuously working towards a profitable business, then you can still claim tax deductions for rental business owners. However, if you only invest in rental property purchases and then immediately sell them to property managers, for instance, your behavior would not qualify you as a business owner.

‘Business’ is certainly the best tax classification for landlords, as you could save a significant amount of money with deductions when tax season comes around. Let’s take a look at some actionable steps that you can take to help demonstrate to the IRS that you are profit-motivated so that you can earn that classification.

Three of Five Test

For real estate endeavors that are more well-established, consider whether you’ve made a profit for three out of five consecutive tax years. No matter what the profit margin ultimately is, the IRS will assume a profit motive if you pass the three of five test and would have to prove that you are not profit-motivated to classify you as anything other than a business owner. The IRS rarely does this, making it an effective diagnostic for gaining business owner status.

Behavior Test

The behavior test considers your actions and asks whether they indicate a profit-driven business owner. Business-owner behavior involves several aspects, including keeping well-kept and organized records, being knowledge about the real estate industry, paying regular attention to your business or other business successes outside of real estate, and tracking appreciation.

If your properties are primarily used recreationally, you are not attempting to be competitive in your rental property market, or the properties’ income is not considered essential to you, then the IRS has less of a reason to consider you a business owner.

Other Tips for Qualifying

If you weren’t able to generate a profit in the last year, there are still ways that you can qualify as a business owner. Maybe it was a particularly hard year for your business—monthly rental fees weren't enough to cover property taxes and mortgage payments—but there are still strategies that can help you achieve the benefits of official qualifying status.

Keep Organized Records

One way to convince the IRS that you are profit-motivated is to keep diligent records, making note of every relevant payment through receipts and invoices and keeping track of every email or message you send to a tenant or worker. This is good practice no matter your motive and can actually come in handy if you are ever audited by the IRS. Online property management software is a great way to automate the production and organization of these kinds of records.

Establish a Growth Plan for Your Business

Creating growth-based plans for your rental business is one of the clearest ways to prove that you’re profit-driven. Future-minded profit motivation could still be enough to earn the qualification. A rental property business plan would entail specific expectations for costs, revenue streams, and take-home profit.

Track Your Work Time

Keeping a log of all of the time that you spent on your rental business in any capacity is an effective way to demonstrate that you are working continuously and are committed to the long-term success of your investments. You should also keep records of any work logged by employees that you hire to regularly help run your rental properties.

Open a Dedicated Checking Account

Keeping your rental property finances separate from personal or other business money is always a good idea, but it allows you and any other party to see a dedicated financial record of the business. This can make it a lot easier to prove that your investments are profit motivated.

Conclusion

If you’re a rental property owner dedicated to the success of your rental investments, the steps listed above can help you officially qualify as a business owner come April. The strategies in this article are worth making a habit if you want to grow as a landlord, but they will also provide protections and deductions that will allow you to navigate tax season in stride.