Unless you have set up your rental business as a corporation, an LLC treated as a corporation, or one of the other standard business structures, your small but mighty rental business will be defined as a sole proprietorship for tax purposes. What exactly is a sole proprietorship, you ask?
A sole proprietorship is a business that is operated by an individual owner. In short, a sole proprietor draws no distinction between the small business owner (you, the landlord) and the business entity (your rentals) for tax purposes, so you will pay your business taxes through your own personal taxes. Here are a couple of other reasons sole proprietorships are unique:
- It’s the default business structure for any business.
- Sole proprietors don’t have to register their business with the state they’re located in.
Because there’s no distinction between you and your rental business, sole proprietorships are considered a “pass-through business,” meaning the business’s profits or losses pass through to the owner’s personal tax return.
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Sole Proprietorship Taxes Defined
As a sole proprietor landlord, it’s important to know which sole proprietorship taxes you’ll pay and how they might affect your rental business. Each type of tax has its own requirements for reporting and payment. The types of taxes are as follows:
- Federal income tax. This will include both personal and business income tax. You’ll fill out two different IRS tax forms to accurately pay your federal income tax for the year.
- State tax. If your state assesses state income tax, landlords will carry income numbers from their federal forms over to state forms to determine how much income tax is due.
- Self-employment tax. When you’re employed, the employer is responsible for deducting Social Security tax and Medicare tax out of your pay. But as a sole proprietor landlord who’s self-employed, you’re responsible for paying the self-employment tax yourself, based on the business’s income. Self-employment tax is included in Form 1040 for federal taxes and is calculated using Schedule SE. The self-employment tax rate is 15.3%, which is comprised of 12.4% for Social Security up to an annual income ceiling, above which no tax applies, and 2.9% for Medicare with no income limit or ceiling.
- Federal and state-estimated taxes. Income tax and self-employment tax would normally be withheld from your paycheck by your employer, but as a sole proprietor landlord, you’ll determine your tax liability yourself. When you pay estimated taxes, you’re actually paying money ahead toward what you think you’ll owe for your small business. The IRS requires that these taxes be paid throughout the year, not just at tax time in April. Federal and state-estimated taxes are due in January, April, June and September, typically on the 15th of the month. These taxes can be filed with Form 1040 ES. Use this guide to help you calculate your estimated tax payments.
- Sales tax. If you sell products or services in your rental business, such as cleaning services or other convenience services, you may have to collect and pay sales tax. How you pay and collect this tax will depend on your home state. Your rental’s state department of revenue can tell you if and when you pay and file taxes.
How Sole Proprietor Landlords Pay Income Tax
The main difference between reporting income from your sole proprietorship and reporting earnings from a job as an individual is that you must fill out two forms to successfully pay federal income tax for the year.
First, sole proprietors must fill out Form 1040, which is the standard individual tax return. This form reports personal income. But to report business income, landlords or sole proprietors will fill out an additional form known as Schedule C – which reports business profits and losses.
To complete the Schedule C form, calculate the taxable income of the rental business, including all income and business expenses. The outcome of this calculation (income minus expenses) is known as the net income (the amount of taxable business income).
This net income or loss of the rental business is entered on Line 31 of the Schedule C, along with the landlord’s other income or losses. If the business has a profit, then the figure is entered on Line 3 of the Form 1040. Losses may be used to reduce the landlord’s total adjusted gross income (the income before exemptions and deductions) on the tax return.
Sole proprietor landlords’ tax bracket and the amount of federal income tax owed will be based on your combined income from both forms – Form 1040 and Schedule C.
Tax Deductions For Sole Proprietor Landlords
There’s no need to beat around the proverbial bush – tax deductions are every small business’s favorite part of doing taxes. Thankfully, there are several major deductions sole proprietor landlords can write off that will help reduce net business income, and thus, taxable income, which could equate to owing less in taxes. So when you’re filling out your tax forms keep these deductions top of mind:
- Home office expenses
- Mileage and travel expenses
- Insurance costs
- Self-employed retirement plans or traditional individual retirement contributions
- Advertising and marketing expenses
- Legal and professional fees
- HOA dues
- Property taxes
- Property depreciation
- Mortgage interest
- Repairs and maintenance
- Employees (full-time, part-time, or independent contractors)
We recommend always speaking to a tax professional for advice about your specific tax situation.
FAQ for Sole Proprietor Landlords
Are sole proprietors taxed as individuals?
Yes, sole proprietor landlords are taxed at the individual tax rate, just like the owner was before starting their rental business. They report their business income and expenses on their personal income tax returns, rather than on a separate business tax return like a corporation or some of the other business structures would.
Does a sole proprietorship pay a business license fee?
No, sole proprietorships do not have to pay a business license fee, seeing that they do not register their business with the state they’re located in.
Does a sole proprietor pay taxes on their personal income or business income?
Sole proprietors pay taxes on both their personal income and business income. Because the business itself is not taxed separately, sole proprietors pay taxes on business income on their personal tax returns.
What are the advantages of a sole proprietorship?
Two of the top advantages of a sole proprietorship are minimal paperwork and no to low set-up costs. Additionally, sole proprietorships can be extremely easy to maintain as compared to other business structures.
What are the disadvantages of a sole proprietorship?
Some of the disadvantages of a sole proprietorship include no liability protection, financing and business credit is harder to procure, and potential lack of financial control and difficulty tracking expenses.