The Internal Revenue Service recognizes two types of income: earned and passive. Earned income includes wages, salaries, commissions and any other type of income for which the taxpayer performs a service or conducts a business activity in return. Passive income comes from real estate, investments and rental activities. Land rent is not earned income, but passive income except where specific exceptions apply.
Reporting Rental Income of Land
Gross income includes any amounts a renter pays to a taxpayer for use of land. The Internal Revenue Service permits the deduction of any related expenses. The taxpayer reports the net amount, total income minus expenses, on Schedule E of Form 1040.
First Three Steps to Exceptions to Passive Categorization
The Internal Revenue Service recognizes six exceptions for classifying rental income as part of an active trade or business. This makes it earned income. These first three exceptions are: a customer uses the property less than seven days, such as with a hotel; the customer uses the property less than 30 days and the owner provides personal services to the user; or the owner provides extraordinary amounts of personal services, for which there are no time constraints.
Final Steps to Exceptions to Passive Categorization
The final three exceptions to the passive categorization, which renders the rental activity as an active trade, include: the property is incidental to a non-rental activity of the taxpayer, the nonexclusive use of the property by customers during business hours for a trade or business the taxpayer participates in, and provision of the property for use to a partnership, S Corporation, or joint venture, where the taxpayer is a participant in daily operations.
Individual Investor Exception
There is one final exception that the Internal Revenue Service recognizes activity losses, and are normally only applicable to earned income. This rule provides middle-income persons whom purchase land or real estate for investment the opportunity to deduct activity losses. To be eligible, the taxpayer must actively manage the land, own more than 10 percent and have adjusted gross income of $150,000 or less, as of 2011. Adjusted gross income is found on line 37 of Form 1040.
- IRS.gov: Topic 414 - Rental Income and Expenses
- "Income Tax Planning for Financial Planners"; Thomas Langdon, et al.; 2011