The Explanation

“The rental of personal property is deemed to be a business under the Internal Revenue Code. Section 1402(a) of the Code which defines income from Self Employment defines any earned income as income from self-employment except income from rentals of REAL PROPERTY, not income from the leasing of tangible personal property unless leased with real property. Since your LLC is a disregarded entity, this is self-employment income. You’ll have to pay self-employment tax on the income. Now we can argue that its a passive activity and thus not subject to these rules. The one factor that you have in your favor of all things is that the lease is a triple net lease. In other words, the lessee pays all taxes and insurance on the property. Generally, a triple net lease is presumed to be a passive investment instead of an active business under Section 469. The problem for you is that those losses should then have been suspended and not deducted on your Schedule E as an active business. So by making this argument you may be worse off than by paying the small amount you would owe under the self-employment rules”, the lawyer concluded. “What should I do then?”. Send me to the audit said the lawyer.

The bad news

Mr. Beaumont looked at the good doctor and said, you took salary of $50,000 which while a little low is not going to be a problem, but the leasing income should have been reported on Schedule C of his 1040. “What difference does that make?” asked the Doctor. “Let’s see in 2008 you had leasing income of $50,000. In 2009 you had leasing income of $60,000. You’ll owe self employment taxes on a portion of that”, said Beaumont. “What does that mean?” asked the doctor. “About 15% of $40,000 and 3% of the rest” replied the lawyer. “Wait a minute, could you explain that to me”, asked the Doctor.