Rental Property not owned but leased (net lease), goes on Sch E?

[John of PA]

Taxpayer has a rental property they do not own, they lease it (net lease), taxpayer collects rents and pays all expenses. Would this still go on Sch E, even though the property is not owned by the taxpayer?

[appelman]

Look at "Rent Expense" in Pub. 535.

I would think this might apply. If so, the lease payments would be a Schedule E expense. Presumably you couldn't claim depreciation.

[Gary2]

Taxpayer has a rental property they do not own, they lease it (net lease), taxpayer collects rents and pays all expenses. Would this still go on Sch E, even though the property is not owned by the taxpayer?

I always have trouble parsing these sorts of statements, because "lease" is ambiguous. If I lease a car, that almost always means I get to drive it, but someone else is on the title. But if I lease an office building, it's not clear if that means I'm the landlord or the tenant - both usages (lease to someone and lease from someone) are correct.

So what exactly is the situation here? If they don't own it, then why is anyone paying them rent? Are they leasing it from the owner, and then subleasing it to the actual occupants? Or are they just getting paid to manage it, by collecting the rents, paying the bills, paying the owner their share and keeping their share? The latter is pretty firmly in Sch. C territory; I'm not sure about the former, though it does feel like Sch. E.

[John of PA]

Thank you for your input. It is the former, they sub lease the property, then mangage it and lease it out. (known as a net lease) Sch E or Sch C? A bank who is looking at the tax return for a Refi, is telling my client it should not be on Sch E, I disagree with the banker, I interpret Sch E as reporting of rental activity without a requirement that the property being rented be owned.

[RitaB]

Love those refi guys

Thank you for your input. It is the former, they sub lease the property, then mangage it and lease it out. (known as a net lease) Sch E or Sch C? A bank who is looking at the tax return for a Refi, is telling my client it should not be on Sch E, I disagree with the banker, I interpret Sch E as reporting of rental activity without a requirement that the property being rented be owned.

You are correct. Here is an excerpt from Pub 527:

http://www.irs.gov/publications/p527/ch01.html

And the first line on Instructions for Sch E: "Use Schedule E (Form 1040) to report income or loss from rental real estate, royalties..."

[Gary2]

Thank you for your input. It is the former, they sub lease the property, then mangage it and lease it out. (known as a net lease) Sch E or Sch C? A bank who is looking at the tax return for a Refi, is telling my client it should not be on Sch E, I disagree with the banker, I interpret Sch E as reporting of rental activity without a requirement that the property being rented be owned.

First, the easy part: "net lease" (or in this case, triple net lease) only means that the lessee has agreed to pay some of the lessor's expenses, but doesn't say anything about subleasing. That may be where some of my confusion was from. It's entirely possible to have a net lease with no subleasing permitted.

In terms of reporting, I believe you're correct. Pub. 527 even mentions rental expenses as a deduction, for properties leased from owners and then rented to third parties.

However, one can't help but wonder if someone has figured out how to make a tidy living as a property manager without paying SE tax. I don't recall ever seeing this situation discussed. I'd hope that they're arms length from the actual owner, and that they're really liable to make their lease payments to the owner even if portions of the property are vacant.

[John of PA]

Good point about the possiblilty of incurring SE tax liability. They are liable for the net lease pmts, even if the property is vacant. What they have in thier defense on this is they spend very little time (hours) on the property because it's a 30 unit apartment house and it is managed by one of the tennants in exchange for free rent.

[Burke]

I had this situation for years. We issued a 1099MISC for the management expenses (the part he kept), and it went on his Sche C with his other real estate sales income. The owner did a Sche E for the rental income received, less the rental expenses -- including the management income paid -- as well as the depreciation.