Can rental income be counted toward the business income limitation for Section 179 expense purposes?
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Yes, rental income can be counted toward the business income limitation for Section 179 expense purposes, but only if the rental activity rises to the level of an "active trade or business" as defined under Section 162 and the applicable Treasury Regulations.
1. Legal Framework
Section 179(b)(3)(A) limits the amount of Section 179 deduction to the aggregate amount of taxable income derived from the active conduct by the taxpayer of any trade or business during the taxable year. The regulations clarify that "trade or business" has the same meaning as in Section 162, and that the taxpayer must "meaningfully participate in the management or operations of the trade or business" to be considered actively conducting it. A mere passive investor does not meet this standard.
2. Application to Rental Real Estate
1. Rental Real Estate as a Trade or Business
- The rental of real estate can qualify as a trade or business if the taxpayer engages in regular and continuous activity with respect to the property, even if only one property is rented.
- Courts have held that the rental of real estate is a trade or business if the taxpayer-lessor (or their agent) engages in regular and continuous activity in relation to the property (see Alvary v. United States, Gilford v. Commissioner).
- The IRS and courts have recognized that even a single rental property can constitute a trade or business if the activity is sufficiently regular and continuous.
2. Active Conduct Requirement
- The taxpayer must "meaningfully participate" in the management or operations of the rental activity. This is a facts-and-circumstances test and is a lower threshold than the "material participation" standard under the passive activity rules.
- Activities such as overseeing a property manager, making management decisions, and being involved in the operations can be sufficient to meet the active conduct requirement.
3. Noncorporate Lessors—Special Rules
- For noncorporate lessors, additional requirements apply: the lessor must have manufactured or produced the leased property, or the lease term must be less than 50% of the class life of the property and, during the first 12 months, the lessor must have Section 162 deductions (other than interest, taxes, and depreciation) exceeding 15% of the rental income.
4. Partnerships and S Corporations
- For partnerships and S corporations, the Section 179 business income limitation applies at both the entity and owner level. The partner or shareholder must be actively engaged in the trade or business to count their share of the entity’s income toward their own Section 179 business income limitation.
3. Practical Example
If a taxpayer owns and manages an apartment building, regularly makes management decisions, and oversees operations (either directly or through an agent), the rental income from that property is considered income from the active conduct of a trade or business. Therefore, it is included in the Section 179 business income limitation calculation.
If, however, the taxpayer is a passive investor with no meaningful participation, the rental income would not count toward the Section 179 business income limitation.
4. Summary
- Rental income can be counted toward the Section 179 business income limitation if the rental activity constitutes an active trade or business under Section 162 and the taxpayer meaningfully participates in its management or operations.
- Passive rental activities do not qualify.
- Noncorporate lessors must also meet additional requirements regarding the nature of the lease and expenses.
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