Rental Income

[jane123]

CAn Rental income be used as 'earned income' for a sole proprietir to establish and contribute to a SEP?

Thanks

Jane

[Gary Lesser]

In general, the term "earned income" means the net earnings from self-employment (as defined in IRC section 1402(a)), but such net earnings shall be determined--(i) only with respect to a trade or business in which personal services of the taxpayer are a material income-producing factor.....

Rental income is gerally viewed as passive income and reported on Schedule E. By treating the amount as Earned income (if it is such) it will also become subject to SE tax. Do you do the repairs? How much income is generated from your service versus capital. Arguably, a portion might be treated as EI, but not all.

Complicated area without a lot more facts. Matters of depreciation and other considerations should be discussed with your accountant.

[No Name]

Gary,

I can't quote from Derrin's book without his permission. But in section 1.10 of his book "Who's the Employer", he says incorporation and contributing the property to the corporation solves the problem. In fact, I have a client with five properties that has gone this route.

[Belgarath]

I'd be a little hesitant to portray Derrin's statement quite so definitively. Without going back and checking it, I believe his example where he states this has the individual spending 5 hours per day in active management. I'd strongly recommend that you get either a legal opinion from Derrin or another attorney before accepting this example as a blanket invitation to incorporate and therefore use rental income for plan purposes.

[Gary Lesser]

Yes, to the extent of compensation (generally W-2) that is the solution, but then there is still the Social Security tax issue. Will it still worth the deferral at these tax rates. For a Roth, possibly, but for a tax-qualified or tax-sanctioned plan, I'm not too sure it makes sense in most situations. Ignoring corporate deductions and federal income taxes, a person needs to earn 18 percnt more to absorb the 15.3 (combined) SS tax. With that type of an initial negative charge, an after-tax investment in a tax-deferred investment (e.g., an annuity or nondividend paying stocks) might yield better results. If there were deductions that couldn't otherwise taken against unearned income, that too would need to be considered. Gut feeling, it rarely pays; but your solution does work--Derrin's Law.

His book is also available on the Internet (by subscription) as well as book form, I believe: Derrin's Site