Is Rental Income Active Or Passive Income? How Much Labor Landlords Should Expect

The Big Picture on Is Rental Income Passive Or Active

• For tax purposes rental income can be defined as passive income so long as you do not qualify as a real estate professional. 
• In the truest sense of the word, rental income is not “passive” income, as it requires extensive legwork on the landlord’s part. 
• Being a landlord may require a lot of work. There are ways to alleviate these headaches, like SparkRental’s landlord software. 

Most people buy rental properties for passive income, which flows in while they vacation, play with their kids, cook, read, or relax by the fireplace. 

But is rental income passive? 

In its purest form, passive income requires no effort after the initial setup. Some investments, like income properties, require ongoing work, however. Even minimal effort is still effort. The phrase “passive activities” may sound like an oxymoron, but that’s how to tell if your rental real estate investment is considered passive—if you don’t do much work to keep it running. 

So, Is Rental Income Active Or Passive Income?

So, let’s differentiate the definitions first. 

In all practical sense, rental income isn’t passive. Regardless of how efficient you make your setup, you’ll always have tasks to do. Outsourcing still needs you to oversee the chosen parties. Even the process of finding rental properties takes effort. 

But it’s still far more passive than working or running another business. 

However, the law may have a different answer. 

How Rental Income Is Taxed

The IRS states that “rental real estate activities in which you materially participate aren’t passive activities if you qualify as a real estate professional. Also, there’s a limited exception from the passive activity rules for rental real estate activities in which you actively participate.” 

In essence, what’s being laid out here is that rental real estate income is passive if you are not a qualified real estate professional. If you are, though, it counts as active income. 

So, keep that in mind when paying for your income tax. 

For more information on passive real estate activities and active participation for tax purposes, you can read Publication 925. 

Remember that countries may have different definitions of passive rental activities that may vary every tax year, and any income received may be taxed differently. 

Types Of Passive Income

If you’re looking for true passive income from real estate, invest in real estate syndications, notes, or real estate crowdfunding platforms. 

In our real estate investment club, we get together every month to vet a new passive real estate investment. That often means syndications (group real estate investments), but it sometimes means notes. One you invest, you never have to lift a finger again.

Going beyond real estate, here’s a list of activities that are considered passive income streams:

How Rental Properties Vary

The first thing to note is that rental income varies. The details of the property you rent out will shape your experience as a landlord. Is it in a safe area? Does it attract professionals? How complicated is its construction? A basic build is easier to manage. The materials are easier to replace. The public spaces are easier to maintain and decorate.

Imagine renting out a simple apartment in a wealthy real estate market. The tenants would likely be polite and need minimal attention. Now imagine renting out an old house in an area with much crime. Plan on more repairs, property damage, crime, and tenant turnover rates.

The more you’re asked to do, the more time you’ll need to commit. Renting out several residential properties increases the challenge. Of course, you could hire a property manager to take on some headaches. But property management fees eat into your profits, and hiring and managing the manager takes work, too.

In short, rentals differ: each landlord has a unique set of responsibilities. Are rental properties passive income? Some are passive “enough,” while others require frequent attention. Instead, consider what challenges you’ll likely face as a landlord. When considering a property to invest in, consider these challenges to gauge your real estate investing workload.

Typical Landlord Labor

Some landlords and real estate investors must put in more labor than others, so much so that it can’t really be called “earning passive income.” The following list encompasses their main work-related activities:

Real estate investments? Awesome. Being a landlord? Less fun.

Learn how to earn 15-30% on passive real estate investments in one free class.

Finding Deals

Before a property can start earning as a passive income stream, you must buy it, which takes more work than you might think.

First, it takes work to find good real estate deals. You can, of course, use a real estate agent to find on-market deals or buy turnkey properties easily on Roofstock. Just don’t expect enormous cash flow returns.  

To find stellar deals earning 10% or more cash flow yield, you’ll probably need to find off-market deals. This could mean driving for dollars, mass mailing campaigns, buying foreclosures, and other active strategies. Try Propstream for software that helps you find off-market properties. 

Then there’s all the due diligence, securing investment property financing, and doing any initial repairs. It’s all work, and you can’t discount it.

Screening Tenants

While you can buy a property with a tenant in it already, most properties don’t come with existing tenants. You have to advertise vacant rentals and sometimes even get proactive on social media. 

This process takes time and effort, and then you must process each rental application as they come in. Also, the timing might not work: a prospective tenant may need to move in sooner or later than you’d prefer. Offers may vary: someone may be willing to pay more to secure their place.

What To Look For

Tenant screening takes labor and often patience on your part. Potential tenants may seem nice and friendly, but there’s no guarantee they’ll stay that way. You need a thorough vetting procedure. The following core tenant screening tasks are particularly worth carrying out:

• Validating financial stability. Knowing that someone can afford to pay their rent each month is vital. You may need payment to be consistent and prompt. Even if you don’t, letting tenants delay their payment sets a bad precedent. This validation process involves checking bank statements and credit ratings.

   

• Requesting and checking references. Your impression of a possible tenant is significant, but you need more information. Asking for references and following up on them will give you invaluable insight. What do their previous landlords say about them? You can also carry out a free tenant background check for identity verification.

   

• Getting sign-off on house rules. You may have certain rules you’d like your tenants to follow. You may live next door and want a low level of noise. You may be unwilling to have pets on your properties. These things are essential to cover before you accept a rental agreement. Leaving them will only result in discontentment.

Finally, you want to avoid tenants who have sued their landlords in the past, or who go around badmouthing their landlords online. Increasingly, landlords have to worry about reputation management in today’s world. 

Timely Rent Collection

When tenants default on the rent, landlords still have to make mortgage payments. And pay for insurance, property taxes, maintenance, repairs, property management fees, and eviction costs. 

But some tenants always test your boundaries. They feed you excuses and ask you to cut them some slack. If you give it to them, they’ll ask for more.

In other words, don’t expect to watch the rent flow each month just like clockwork.

Could you make this task passive? It depends on your tenants. Renting your property to people who pay on time and never cause problems is possible. With aggressive tenant screening, you can weed out most bad seeds. The more investment properties you rent out, the more likely you’ll encounter problems. 

Maintaining the Exterior

How a property looks from the outside might not matter to an incumbent tenant, but it always matters to their landlord. Tenants come and go and never treat your property as well as homeowners treat theirs. 

First impressions matter for potential tenants. The more they like the places they see, the more enthusiastic they’ll be when applying to rent them. Something as simple as a fresh coat of paint on an external wall can make a big difference. 

It bears noting that it’s not only the building that needs care. The grounds outside also need work to stay presentable. The location of the house will determine what issues arise. Areas with clay soil are challenging for gardeners, for instance, due to poor drainage.

Amending clay soils is possible, but knowing how to amend them won’t make it easy. Can you put in the necessary work? Can you keep the effort going month after month?

You could refuse to do any of this, but you don’t need to get your property ready if you keep it ready while it’s occupied. There’s a good chance you can tidy the outside without causing much disruption to the tenants. You can also ask them to help you with this, though there’s no guarantee they will. Whatever you do, it’ll cost you time and money.

Maintaining the Interior

Landlords usually end up paying for internal property damage. They can contend that the tenants caused the damage, but the tenants can dispute that. It’s often easiest for them to get things fixed. 

Some real estate investors opt to do the repairs themselves to save money. If you’re good with DIY, you can take this approach, but you’ll still need to commit your time. Read: not passive. But hiring the work out isn’t passive either, from negotiating with contractors to checking their work and keeping them on schedule. 

Could you make this task passive? You’d need to pay a property manager to handle your tasks. You’d also need to give them the budget to hire tradespeople as required. It’s doable, then, but would be expensive. You’d need considerable income from your rentals to cover it.

(article continues below)

Want to compare investment property loans?

What short-term fix-and-flip loan options are available nowadays?

How about long-term rental property loans?

We compare several buy-and-rehab lenders and several long-term landlord loans on LTV, interest rates, closing costs, income requirements and more.

Landlord Paperwork

Paperwork is the bane of every self-employed worker, regardless of their exact career. Landlords don’t escape it. 

Landlords must manage plenty of legal paperwork, including lease agreements, renewals, rent change notifications, and eviction notices. This does not include documents that must be submitted to regulatory bodies, such as rental registrations and permits. There’s a lot of work involved, regardless of how you mitigate it.

Many of these documents can be produced using online tools. For instance, you can use SparkRental’s free lease agreement as a template. 

But you still need to review everything to ensure that it’s ready to go. You also need to keep up with changes to the law and make relevant amends when required. It’s another task to add to your list of steady responsibilities.

Legal Paperwork

And then there’s the paperwork involved in legal issues. When there’s a disagreement between a tenant and their landlord, it can lead to legal action. The latter will have more resources but more responsibilities, too. This will limit their ability to fight their case. It’s also an impossible situation when it comes to PR. No matter who wins, the landlord will come across as the villain.

Can they correct that framing? Can they clear their name? It’s possible, yes. They can work hard through social media to explain the situation. They can lean on glowing references from other tenants. 

Stigma is hard to erase and will linger for a long time. And no matter what happens, there will be documents to complete.

Could you make this task passive? For the most part, yes. You can hire property managers if you rent out enough properties to bring in a lot of money. 

If you need help, you can outsource the world to a property management company. The quality of the results will depend on how much you spend.

Is Being A Landlord Worth It?

Would-be landlords might be wrestling with this question, and I can safely answer it with a resounding yes. 

More than 44 million units are rented in the US, and a significant portion of the renters are under 30 (48%). Furthermore, the average landlord earns $87,280 a year. 

Though, as I said, it might take a lot of work. Thankfully, you don’t have to do it alone. 

How Much Can Landlords Automate?

With landlord software like SparkRental, you can manage many tasks from afar. Communicate with tenants, schedule maintenance calls, and submit paperwork—it’s all doable from anywhere in the world. 

If you use a service developed for landlords, you can remain in control with a limited schedule. You can travel most of the time. If you want to handle the repairs, you can plan around them. If you want to outsource them, you can arrange that from afar. 

It’s about helping you cover your essential responsibilities so you don’t need to spend hours and hours each week.

Are there negatives? Of course. You’ll need to decide to trust your chosen system, convince tenants to go along with it, learn your limitations and those of the system, and contend with whatever fees you need to pay. But the positives far outweigh the negatives.

True Passive Rental Income For Real Estate Professionals

If you’re eager to make money while doing nothing, consider investing in the stock market. You can also invest in real estate investment trusts (REITs) on public stock exchanges or through real estate crowdfunding platforms like Fundrise and Streitwise. 

Real estate investing can work for you if you want to earn high returns with plenty of tax deductions. It all comes down to using available tools to make your responsibilities easier. If you can get comfortable doing that, you can expand your rental portfolio. And the more rental income you earn, the easier it gets to systematize or outsource. 

Semi-passive income streams are better than active income, any day of the week.♦

Do you consider rental properties passive income? Why do you consider rental income passive — or why don’t you?