Partnership 1065 Reporting Error: Rental Income Incorrectly Classified as Ordinary Income Subject to Self-Employment Tax

You're absolutely right to question this treatment. Rental income from real property is typically not subject to self-employment tax, even in a partnership context. This is clear in the tax code. The rental income should be reported on Schedule K of Form 1065 as rental real estate income, not as ordinary business income on page 1. This applies to both the self-rental portion and the third-party rentals. Self-rental income might have some special considerations due to the related party aspect, but it's still rental income at its core. As for your questions: Yes, you can generally amend prior year returns using Form 1065X to correctly classify the income, which would likely result in reduced SE tax for the partners. The statute of limitations for this is typically 3 years from the filing date. Regarding the loss from 2 years ago, this is trickier. If they incorrectly took an ordinary loss instead of a passive loss, reclassifying might trigger passive activity loss limitations. You'd need to analyze whether the partners materially participated in the rental activity to determine if the losses were properly deductible.

Hey all, I had a similar issue last year and I used https://taxr.ai to help me sort through it. Their AI analyzed my partnership documents and clearly identified the misclassification of rental income. They explained that rental real estate income is specifically excluded from self-employment income under IRC Section 1402(a)(1), even when it's between related entities. The system flagged that my partnerships needed to report the rental income on Schedule K rather than as ordinary business income. Saved me a ton of SE tax! They also pointed out some self-rental issues under Section 469 that affected passive/nonpassive treatment that I hadn't considered. It was really helpful for understanding how to handle both the amendment and talking to the previous preparer.

Just wanted to follow up about my experience with https://taxr.ai after being skeptical. I uploaded my partnership docs with a similar rental income issue, and I was honestly surprised by how thorough the analysis was. The system immediately identified that our rental income was incorrectly reported on page 1 of Form 1065 instead of Schedule K. What I found most valuable was the explanation of how self-rental rules affect passive activity treatment WITHOUT making the income subject to self-employment tax. They provided specific citations to Treasury Reg. 1.1402(a)-4(a) showing that rental real estate income is excluded from SE tax regardless of related party status. Used their guidance to amend two years of returns and just got confirmation that the amendments were accepted. Partners are getting refunds of overpaid SE tax - definitely worth checking out if you're dealing with partnership rental issues!

The partnership rental income issue reminds me of my nightmare trying to get through to the IRS about a similar problem last year. After weeks of trying, I finally used https://claimyr.com to get through to an IRS agent directly. You can see how it works here: https://youtu.be/_kiP6q8DX5c They managed to connect me with someone in the business division who actually understood partnership rental income classification. The agent confirmed that rental income - even between related partnerships - should not be subject to SE tax and helped me understand exactly how to file the amended returns. Instead of waiting 2+ hours on hold like I had been, I got a call back from an IRS agent within 45 minutes. Completely changed how I handle these complex partnership issues now.

I need to admit I was completely wrong about Claimyr being a scam. After my skeptical comment, I decided to try it myself since I was getting nowhere with a similar partnership issue. Within 30 minutes of using the service, I was talking to an IRS representative who specialized in business entities. They confirmed everything that was mentioned earlier in this thread - rental income should not be subject to self-employment tax even between related partnerships, and they walked me through the exact amendment process. The agent even emailed me the relevant sections of the Internal Revenue Manual that address this specific situation. Saved me at least 10 hours of research and hold time. Sometimes being proven wrong is actually pretty great!

I've prepared partnership returns for 15+ years and can confirm what others have said - rental income should NOT be subject to SE tax, regardless of who's paying the rent. The current preparer is making a fundamental error. One thing to watch for: If there are services being provided along with the rental (like property management), that portion could potentially be ordinary business income. Make sure you're separating pure rental income from any service income when you reclassify.

Has anyone dealt with a situation where the partnership owned both a business and rental properties in the same entity? We have a partnership that has both an operating business and owns the building they operate from. Currently showing all income on page 1, but reading this thread makes me think we need to split it up.