IRS Rules for Reporting Car Rental Income and Deducting Expenses
Income earned by renting out cars and trucks is taxable
When you earn money from renting a car through peer-to-peer car-sharing services like JustShareIt, Getaround, or Turo, it's taxable income. But you can often deduct your related expenses, such as depreciation, commissions, and marketing expenses.
How the income and expenses are reported depends on whether the IRS considers your activity to be a business.
Rules Regarding Income
Income from renting your car is referred to as "rents from personal property" in IRS terms. It's ordinary income subject to federal and state income tax, and possibly to self-employment tax.
This income is categorized either as either business income or as non-business income. Business income is reported on Schedule C and is subject to self-employment tax—the self-employed equivalent of Medicare and Social Security tax.
Non-business income is reported on Schedule 1 and line 6 of the new 2018 Form 1040. It's sub-categorized as either a for-profit activity or a not-for-profit activity. Not-for-profit activity essentially means it's a hobby.
Rules for Deductions
Expenses can be deducted as business expenses if you're self-employed, netted directly against business income on Schedule C.
Non-business expenses can be deducted on Schedule 1 of the new 1040 subject to certain rules.
Hobby expenses are no longer deductible from 2018 through at least 2025. The Tax Cuts and Jobs Act (TCJA) has eliminated them.
You can generally deduct the following:
- Actual expenses: prorated for rental use or using the standard mileage rate
- Marketing expenses/commissions to the networks
- Car washes
Start With the Basics—3 Questions
First, determine if your car rental activity is a business. Second, if your rental activity is a business, determine whether you "materially participate" in the business. Finally, determine whether your car rental activity is conducted for profit if your rental activity is not a business.
If Your Operation Is a Trade or Business
Rental income is taxed just like other business income if renting out your personal vehicle is a trade or business. Report your gross rents on Schedule C, then deduct any expenses directly related to your car rental business directly on that form. The net income arrived at after taking deductions is then transferred to your 1040 and is subject to federal income tax, self-employment tax, and any applicable state taxes.
This is what the IRS has to say about it in Publication 17:
"In most cases, if your primary purpose is income or profit and you are involved in the rental activity with continuity and regularity, your rental activity is a business."
The IRS spells out nine factors for testing whether an activity is carried on for profit:
- "You carry on the activity in a businesslike manner
- The time and effort you put into the activity indicate you intend to make it profitable
- You depend on the income for your livelihood
- Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business)
- You change your methods of operation in an attempt to improve profitability
- You (or your advisors) have the knowledge needed to carry on the activity as a successful business
- You were successful in making a profit in similar activities in the past
- The activity makes a profit in some years, and
- You can expect to make a future profit from the appreciation of the assets used in the activity."
Did You Materially Participate?
The passive activity loss limitations control when and how much of your losses are allowed. Three rules apply here.
The general rule states, "A rental activity is a passive activity even if you materially participated in that activity," but two more rules that provide exceptions: five exceptions for rental activities, and the material participation test.
The material participation rule states that "you participated in the activity for more than 500 hours" during the tax year. Five hundred hours might be a pretty high target for people who are renting out their cars through a sharing economy platform, but this is just one test.
Another test asks if the taxpayer participated in an activity for more than 100 hours during the year and the taxpayer's level of participation was at least as much as any other person involved in the activity, including non-owners. This might be a more feasible target for people who are renting out their cars.
Yet another test asks if the taxpayer's participation in the activity for the year was substantially all of the participation in the activity by all individuals, including any non-owners, for the year. In other words, this test is asking if the taxpayer did substantially all the work of renting out the car. If so, the taxpayer materially participated in the business.
Is Your Business a Passive Activity?
If you don't materially participate in the car rental activity and the business incurs a loss for the year, that loss might be suspended under the passive activity loss limitation rules (PALL). These rules are spelled out in detail in Publication 925.
You've already determined that your car rental activity is a business and it's conducted for profit. You're reporting the income and deducting expenses on Schedule C. After deducting all expenses related to the car rental activity, you have negative net income—a loss. At this point, you need to ask yourself if this loss is limited by the passive activity rules.
If not, the full amount of the loss is carried to Form 1040, where the loss offsets any other income you've reported. If yes, the loss is suspended. The loss is not carried to your Form 1040. Instead, it's carried over to next year's tax return where it offsets any net positive income on next year's car rental Schedule C.
If It's Not a Business
Rental income is taxed as ordinary income if renting out a personal vehicle is not a business. Indicate that the income is from the rental of personal property so the IRS will know what type of income you're reporting there.
Non-business income is subject to federal income tax and any state taxes, but it isn't subject to the self-employment tax.
If your car rental activity is not a business and isn't conducted for profit, the rental income is still reported on Schedule 1, but expenses related to the rental activity aren't deductible.
Rule of Thumb: Are You Profitable in 3 out of 5 Years?
The IRS will presume that an activity is carried out for profit if the activity produces profits in at least three out of the last five years, including the current year. The IRS might wonder whether your car rental activity is actually a not-for-profit activity if it were to fail this three-out-of-five-year test. And remember, not-for-profit activities are treated like hobbies.
You can ask the IRS to hold off on making a determination about whether your car rental activity is conducted for profit. In technical jargon, this is called making an election and it's made by filing Form 5213 with your tax return. . You can ask the IRS to wait until you have five years of activity. Then you and the IRS can review the full five years to see whether your car rental activity has generated profits in at least three of those five years.
It's important to keep track of the number of hours that every person—owner, staff, and contractors—dedicates to the business. Keep track the number of days for each rental, and take the average to see if it might be less than seven days at the end of the year. If so, any losses for the car rental business are not limited by the passive activity loss limitations. That means the net loss from Schedule C would flow to Form 1040 where that loss can offset other types of income.
You'll also want to keep a log of your rentals, measuring the number of days the car is rented out. Measure the number of miles driven at the end of the year versus the total miles the car was driven.