Car Rental Income

Income earned by renting out cars and trucks is taxable.

Rental car on a scenic road
Rental car on scenic road near Nevada's Valley of Fire state park. © photo75 / Getty Images

Income earned by renting out a car through peer-to-peer car-sharing services such as JustShareIt, Getaround, or Turo is taxable. The car owner can also deduct expenses related to renting out the car, such as depreciation, commissions, and marketing expenses. How the income and expenses are reported depends on whether this economic activity is considered a business.

This is a new and emerging way for people to make money, and the IRS has only a limited amount of information about this topic.

We review all available information related to generating income by renting out a personal vehicle.

The main points

  • Income is called rents from personal property:
    • It is ordinary income subject to the federal income tax and state income tax.
    • Possibly subject to the self-employment tax.
  • This income is categorized either as business income or as non-business income:
    • Business income is reported on Schedule C and is subject to the self-employment tax;
    • Non-business income is reported on Line 21 of Form 1040;
    • Non-business income is sub-categorized either as a for-profit activity or as a not-for-profit (hobby) activity 
  • Expenses are deducted:
    • As business expenses, netted directly against business income on Schedule C.
    • As non-business expenses, enter on Line 36 of Form 1040 and identify as "PPR."
    • Or as not-for-profit hobby expenses
      • on Schedule A miscellaneous itemized deduction subject to the 2% of AGI threshold
      • Limited: expenses cannot total more than the income you report.
    • What can you deduct?
      • Depreciation
      • Actual expenses: prorated for rental use
      • or the Standard Mileage Rate
      • Marketing expenses / commissions to the networks
      • Interest
      • Car washes
      • Repairs
  • Technical issues:
    • Is this a trade or business?
    • If the business incurs a loss, is this loss passive or non-passive?
    • If the rental activity incurs a loss, do you want to make a special election to get more time to determine if your activity is meets the for-profit test?

In IRS terminology, what we are dealing with is called rents from personal property.

Let's read what the IRS has to say on this topic, and then we'll flush out what it means.

Rents from Personal Property – an excerpt from Publication 17

   

"If you rent out personal property, such as equipment or vehicles, how you report your income and expenses is in most cases determined by:

  • Whether or not the rental activity is a business, and
  • Whether or not the rental activity is conducted for profit.

"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. See Publication 535, Business Expenses, for details on deducting expenses for both business and not-for-profit activities.

"Reporting business income and expenses.    If you are in the business of renting personal property, report your income and expenses on Schedule C or Schedule C-EZ (Form 1040). The form instructions have information on how to complete them.

"Reporting nonbusiness income.   If you are not in the business of renting personal property, report your rental income on Form 1040, line 21. List the type and amount of the income on the dotted line next to line 21.

"Reporting nonbusiness expenses.   If you rent personal property for profit, include your rental expenses in the total amount you enter on Form 1040, line 36, and see the instructions there.

"If you do not rent personal property for profit, your deductions are limited and you cannot report a loss to offset other income. See Activity not for profit, under Other Income, later."

   
IRS.gov, Your Federal Income Tax (Publication 17), Chapter 12 (Other Income), section on Rents from Personal Property; pages 91-92 in the PDF version.

 

The Basics

  • First, determine if your car rental activity is a business.
  • Second, if your rental activity is a business, then determine whether you materially participate in the business.
  • Third, if your rental activity is not a business, then determine whether your car rental activity is conducted for profit.

From these three questions, we can figure out how the income is taxed and reported on your tax return.

If renting out a personal vehicle is a trade or business, then the rental income is taxed just like other business income. You report the gross rents on Schedule C. You also deduct any expenses directly related to your car rental business; this also gets reported on Schedule C. The net income (after deductions) is subject to the federal income tax, self-employment tax, and any state taxes.

If you incur a loss in your rental business, we need to figure out when and how much of those losses can be deducted.

What's at work are the passive activity loss limitations. The passive activity loss limitations control when (in which tax year) and how much (to the extent of other passive income) losses are allowed. There are three rules in particular to which we need to pay attention. The general rule states, "A rental activity is a passive activity even if you materially participated in that activity" (Publication 925, Passive Activity and At-Risk Rules, section on passive activities; page 3 of the PDF version). However, there are two special rules that provide exceptions: the five exceptions for rental activities, and the material participation test. By working through these special rules, we determine how to handle any losses in a car rental business.

We have a two-fold way of determining when and to what extent losses of a rental business are deductible. The first way looks to the exceptions to the rental activity rules. The second way looks to whether you "materially participated" in the rental business.

If renting out a personal vehicle is not a business, however, then the rental income is taxed as ordinary income. You report the gross rents on Line 21 (Other Income) of Form 1040; expenses are reported on Line 36. Indicate that the income is from the rental of personal property, so the IRS will know what type of income you are reporting there. Indicate the expenses on the dotted line for Form 1040 Line 36. You'll notice that Line 36 is the line where we subtotal all adjustments to income. You will also notice that there is no line item from line 23 to 35 for these kinds of expenses. Accordingly, the IRS instructs us, "On the dotted line next to line 36, enter the amount of your deduction and identify it as indicated." And specifically, the IRS goes on to say, "Deductible expenses related to income reported on line 21 from the rental of personal property engaged in for profit. Identify as 'PPR.'" (Instructions for Form 1040, 2015 edition, page 38).

Non-business income is subject to the federal income tax and any state taxes; it is not subject to the self-employment tax.

If the car rental activity is not a business and is not conducted for profit, then the rental income and expenses are treated as a not-for-profit hobby. The rental income is reported on Line 21 (Other Income) of Form 1040. Expenses related to the rental activity are reported on Schedule A as miscellaneous deductions subject to the 2% of adjusted gross income limit. The amount of expenses you report cannot exceed the amount of rental income you reported. Furthermore, the rental expenses, when added with any other miscellaneous itemized deductions, will be reduced by 2% of adjusted gross income. The rental income is ordinary income subject to the federal income tax and any state taxes; it is not subject to the self-employment tax. This limitation appears to be specific to not-for-profit activities only.  If expenses do exceed gross income from the activity, then there are procedures for determining which order to take the deductions in. (See, Publication 535, Business Expenses, section on Limit on Deductions; page 6 of the PDF version.)

For example, suppose Sallie rents out her car and earns $5,000 in gross rents. Her expenses related to the rental activity are $2,500. And her adjusted gross income is $100,000. If this rental activity is not a business and not conducted for profit, then her expenses are reported on Schedule A Line 23. If Sallie has no other miscellaneous deductions, then her miscellaneous deductions subtotal to $2,500, and this is reduced by 2% of her adjusted gross income of $100,000, or a reduction of $2,000. The net amount of her miscellaneous deductions, after this "2% haircut," is $500. That's the amount tax-deductible portion of her rental expenses. The rest are non-deductible.

Flowchart

How is Income from Renting out a Car Taxed?

Is it a trade or business?

 

Yes.

Report income and expenses on Schedule C.

  

Did you have a profit?

  

Yes.

Net income subject to Federal Income Tax + Self Employment Tax + State Income Tax

  

No.

Do you meet any of the five Exceptions for Rental Activity?

   

Yes.

Losses on Schedule C are not limited by the Passive Activity Loss Limitations (PALL). Deduct the loss in full.

   

No.

Did you materially participate?

    

Yes.

Treated as non-passive business. Losses on Schedule C not limited by PALL. Deduct the loss in full.

    

No.

Passive business. Losses on Schedule C are limited by PALL. Fill out Form 8582 to figure out how the losses are handled.

 

No.

Is the activity conducted for profit? (Review 9 factors.)

  

Yes.

Subject to Federal Income Tax + State Income Tax. Report income on Line 21 as "Personal Property Rents." Report expenses on Line 36 as "PPR."

  

No.

Subject to Federal Income Tax + State Income Tax. Report income on Line 21 as "Personal Property Rents." Report expenses on Schedule A, Line 23 as "Hobby Expenses."

      

 

Is Your Car Rental Activity a Business or Not?

The first crucial question to ask is whether your activity of renting out our personal car or truck is a business. This makes a significant difference in how the income is taxed and where the income and expenses are reported on the tax return. Let's see what the IRS has to say about this matter.

Notice here what the IRS is saying:

  • If your primary purpose is to generate income or profit
  • and you are involved in the rental activity with continuity and regularity,
  • then your rental activity is a business.

What other tools and criteria do we have for determining whether an activity is a trade or business? The question of how to define just what constitute a trade or business is an issue that historically the IRS has been silent about. See, for example, Joe Kristan's discussion of whether renting out real estate is a trade or business.  (Note: this is not the same issue, but a related issue.)

Here are the issues as we see it:

Is Your Car Rental Activity Carried on For Profit?

It is much easier to see whether an activity is carried on for profit. After all, you can tell just by observing whether the rental activity generates profits by measuring gross income, subtracting out related expenses, and then seeing if there are any profits left over.

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" (Publication 535).

Rule of Thumb: are You Profitable in 3 out of 5 Years?

The IRS will presume, they say, that an activity is carried on for profit if the activity produces profits in at least three years out of the last five years, including the current year (Publication 535).

In the context of a car rental activity, this means that the IRS will suppose it to be true that a car rental activity is conducted for profit if the car rental activity is profitable at least three years out of any five year testing period. As we saw above, the rental of personal property that is conducted for profit is either taxed as business income subject to the self-employment tax or as ordinary income not subject to the self-employment tax with expenses fully deductible as adjustments to income.

If the car rental activity were to fail this 3-out-of-5 year test, the IRS might start to wonder whether the car rental activity is really a not-for-profit activity. Not-for-profit activities are treated like hobbies: the income is fully taxable at the ordinary rates, and the expenses are deductible as miscellaneous deductions on Schedule A and cannot exceed the amount of car rental income reported on the front of the Form 1040. Depending on a person's tax situation, having a car rental activity treated as a not-for-profit hobby could result in higher taxes. That's because not everyone benefits from itemizing their deductions, either because they don't have enough deductions to itemize or because their itemized deductions are so drastically phased out that taking the standard deduction is better.

You can ask the IRS to hold off making any determination about whether your car rental activity is conducted for profit. In technical jargon, this is called making an election. Under this election, you 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 the car rental activity has generated profits in at least three of those five years. This election is made by filing Form 5213 with your tax return. What you get by making this election is that "the IRS will not immediately question whether your activity is engaged in for profit. Accordingly, it will not restrict your deductions," the IRS explains in Publication 535. In exchange, you give up or waive the normal three-year statute-of-limitations on audits, and extend this to two years after the due date of the return for the last year in the five-year period. However, this extended audit statute of limitations applies only with respect to deductions related to the car rental activity and to any related deductions that might be affected mathematically by changing the car rental deductions. The rest of our tax return is still protected under the normal three-year audit statute of limitations.

For more details about this special election, see the Not-for-Profit Activities section of Publication 535 (page 5 of the PDF version).

Is Your Business a Passive Activity?

If the business owner does not materially participate in the car rental activity of the business, and the business incurs a loss for the year, then that loss might be suspended under the passive activity loss limitation rules (PALL). These rules are spelled out in detail in Publication 925, Passive Activity and At-Risk Rules.

But let's be clear about the situation. You have already determined that your car rental activity is a business and is conducted for profit. You are reporting the income and 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: is this loss limited by the passive activity rules?

If not, then the full amount of the loss is carried to the front of the Form 1040, where the loss offsets any other income reported on that form.

If yes, then the loss is suspended. The loss is not carried to the front of the Form 1040. Instead, the amount of the loss rolls over (is carried over) to next year's tax return, where it offsets any net positive income on next year's car rental Schedule C.

So how do we determine if a car rental business is a passive activity? We have to decide whether you, the person who is renting out their car, materially participates in the business.  And to decide that, we review the 7 tests for material participation, which are detailed in Publication 925 (page 5 of the PDF version). The test most tax professionals remember is the first test: "You participated in the activity for more than 500 hours" during the tax year. Five hundred hours might be a pretty high target to meet for people who are renting out their cars through a sharing economy platform.

Fortunately taxpayers need to meet only ONE out of SEVEN tests for material participation. Five hundred hours of activity is one test. The third test asks if the taxpayer participated in 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, including any non-owners. This third test might be a more feasible target for people renting out their cars.

What if the person doesn't have one hundred hours of participation? Let's look at the second test. This asks if the taxpayer's participation in the activity for the year was substantially all of the participation in the activity of 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, then the taxpayer materially participates in the business.

Accordingly, we recommend that clients keep track of the number of hours of every person (owner, staff, contractors) who works in the business.

Notice the following logic:

  • "A rental activity is a passive activity even if you materially participated in the activity"
  • "An activity is a rental activity if tangible property (real or personal) is used by customers or held for use by customers and the gross income (or expected gross income) from the activity represents amounts paid (or to be paid) mainly for the use of the property."
    • Applies to tangible personal property, such as cars
  • EXCEPT
    1. "The average period of customer use is
      • "7 days or less, OR
      • "30 days or less and significant  personal services were provided in making the rental property available for customer use
    2. "Extraordinary personal services were provided in making the rental property available for customer use.
    3. "Rental of the property is incidental to a nonrental activity.
    4. "You customarily make the rental property available during defined business hours for nonexclusive use by various customers.
    5. "You provide  property for use in a nonrental activity of a partnership, S corporation, or a joint venture in your capacity as an owner...."
  • Conclusion,
    • the rental of personal property (cars) as a for-profit business is subject to the passive activity losses
      • even if the owner materially participates,
      • and thus any losses are limited by PALL;
    • EXCEPT if any one of statements 1 – 5 (above) is true, then the activity is not treated as a rental activity, and thus any losses are not limited by PALL.
      • Exception 1 looks promising here.

ADVISE: Keep track the number of days for each rental, and at the end of the year, take the average to see if it might be less than 7 days. If so, then any losses for the car rental business are not limited by the passive activity loss limitations. That means the net loss from the Schedule C would flow to the front of the Form 1040, where that loss will offset other types of income.

"If the activity falls outside the rental definition, it is passive or non-passive based on whether the taxpayer materially participates." (IRS.gov, Passive Activity Loss Audit Technique Guide, February 2005, PDF, page 2-3.)

"Reg. § 1.469-1T(e)(3)(ii)(A)-(F): Six exceptions to the definition of rental. If an exception applies, the rental activity is treated as a business and the material participation rules apply." (page 2-8)

Passive losses offsets positive passive income.

Record Keeping

  1. Log of work hours – name of person, and number of hours worked
    • Use: total # of hours worked for each person
    • For the owner, are they over 500? Over 100 and at least as much as any other person? Substantially all?
  2. Log of rentals,
    • measuring the number of days the car is rented out each time.
      • Use: take an average at the end of the year.
    • And measuring the number of miles driven each time
      • Use: For the standard mileage rate
    • And measuring total miles the car was driving for the year
      • Use: to measure total miles
      • To measure rental use (if taking actual expenses)
  3. Gross receipts (income)
  4. Expenses, categorized by type, such as
    • Car expenses, such as
      • basis and depreciation
      • Financing costs (interest)
      • Or lease payments
      • Gasoline
      • Repairs
      • Tires
      • Oil changes and other routine maintenance
      • Auto Insurance
      • Car washes / detailing
      • Parking / tolls (if applicable)
      • Citations / tickets are not deductible.
    • Commissions (paid to the carsharing networks)
    • Monthly service charges or access fees or data service charges
    • Equipment installation fees
    • Cost of extra keys needed for the rental
    • Professional photography (to take a picture of a car)
    • Special equipment or services (satellite radio, GPS, etc.)
    • Professional fees (attorneys and accountants)
    • Any other expense that is reasonable and customary considering the nature of the business.

First published December 31, 2015. Revised February 23, 2016. Version 1.1. Questions? Comments? You may email the author, or send a message via Twitter.