Typically, real estate investing is a passive activity. Profits are subject to income tax—not self employment tax. An active trade or business, on the other hand, is likely subject to the full 15.3% self-employment (SE) tax. Since a flipping or wholesaling business is considered an active business, house flippers may be subject to the full 15.3% self-employment tax, which can lead up to a $21,068 hit to your earnings. Same can be true for many Airbnb rentals.
Not every flipper or Airbnb landlord will benefit from an S Corp election taxation. However, enough do that you should consider it as an option. Let’s take a closer look.
Some real estate investors aren’t really investors (at least according to tax laws). They are property developers who renovate and rehab. In other words, they’re flippers. Profits from real estate flipping may be subject to both income tax and self-employment taxes. Flipping is an active business. That translates to ordinary income taxes at your marginal rate as well as self-employment tax and/or payroll taxes. This depends on how the deal is structured. Compare flipping to buy and hold investing, where investors are relying on passive income.
Just as with any other active trade or business, an S Corp election may be a good way to save self-employment (SE) taxes. There are a few things flippers should know about organizing and defending their real estate portfolios. Chief among these is how to construct an asset protection strategy that adequately defends against lawsuits:
It’s vital that those engaged in active real estate flipping find a way to limit inherent liabilities. For many flippers, the LLC with S Corp election helps square both the issue of liability and how to formalize the flipping business.
If you are renting part of your home as an Airbnb for 14 days or less, you do not have to report or pay taxes on that income at all. Nice, right? Of course, you cannot deduct related expenses either. If you have Airbnb properties, you may have an active trade on your hands (rather than a passive real estate investing business).
Normally, income reported on Schedule C is subject to the SE tax, but that’s not always the case for rental properties. When your average stay is less than seven days, it is considered a business and not a rental activity, and is reported on Schedule C.
Schedule C is the tax form filed by most sole proprietors. As you can tell from its title, “Profit or Loss From Business,” it is used to report both income and losses. Many times, Schedule C filers are self-employed taxpayers who are just getting their businesses started.
If you are renting out a property using Airbnb or a similar service, and want to completely avoid the SE tax, then it is important not to provide substantial services to your guests. As long as you are simply renting out your Airbnb and providing no additional services, you will avoid the 15.3% self-employment tax, even if it is reported on Schedule C.