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Real estate rental income as 'business' income for state tax purposes 

By most media accounts, rental real estate is a "business." Whether it is a local report touting a successful commercial development or the measure of a politician's business acumen, real estate and the business of real estate are constantly in the public's eye. From a state income tax perspective, however, characterization of a rental real estate fund's income as apportionable "business" income is not always appropriate. State by state variances in the apportionment or allocation of real estate rental income has the potential to subject a real estate fund's activity to an overall levy of state tax that exceeds 100 percent of its income.


In general, most states do not levy an entity-level income tax on partnerships. Instead, the levy of income tax typically falls on the individual or corporate partners. In this setting, partnerships generally must disclose information to state agencies regarding their partners' distributive share of the operating business' activities in the given state. They may also be required to serve as withholding agent with regard to non-resident withholding tax.

Partners receive information from the partnership as to their respective share of income, deductions, and withholding tax paid on their behalf by the partnership. Based on this information, it is the partners' responsibility to interpret and potentially adjust their state taxable income computations, taking the information provided by the partnership and other sources into account.

Practically speaking, however, the individual partners often directly allocate this reported partnership income on a state by state basis, using the income computations provided by the partnership, instead of considering whether applicable state tax provisions specific to their situation might create a different result. For instance, some states, such as Ohio, do not provide for an individual tax exemption that is taken into account in the partnership's computation of Ohio taxable income. Instead, individuals must file their own Ohio return in order to receive this exemption.1

The practical reality that individual investors depend on the partnership's calculations reinforces the degree of care that must be exercised by the partnership in applying state tax law. Tax rules specific to the real estate industry, which often differs from state to state (examples of which are discussed below), add to this complexity.

Further complications in the partnership's determination of each state's share of taxable income arise from tiered partnership structures, unitary relationships between partnerships and their partners, and treatment of gain or loss from the disposition of real property, though these scenarios are beyond the scope of this discussion. This article will focus exclusively on the allocation to one state, or the apportionment among states, of rental income by a single partnership actively engaged in the rental real estate business.

1 See Ohio Rev. Code Ann. §5733.40 for the definition of a partnership's "adjusted qualifying amount" (i.e., the withholding base). See Ohio Rev. Code Ann. §§5747.02 and 5747.025, providing for personal exemptions that may be taken into account in computing an individual's Ohio taxable income and that are not included in Ohio Rev. Code Ann. §5733.40.

​If you have questions regarding this article, please contact:

Courtney L. Clark, senior manager, Deloitte Tax LLP

Mathew W. Culp, senior consultant, Deloitte Tax LLP

The authors thank Valerie Dickerson, Gregory Bergmann, David Adler, Joseph Gurney, and Tom Cornett for their helpful review and editorial guidance.

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