4 Guidelines For Claiming Rental Property As a Business on the FAFSA

Rental Property on the FAFSA has always been an area of contention in my mind.  The manner these assets are listed on the FAFSA can mean the difference of thousands of dollars in financial aid.   For the government to tell you what is and is not a business enterprise that is making money kind of frosts me.  The 2009-10 FAFSA Application and Verification Guide states the following…

At times a student or parent will claim rental property as a business.  Generally, it must be reported as real estate instead. A rental property would have to be part of a formally recognized business to be reported as such, and it usually would provide additional services like regular cleaning, linen, or maid service.

If at all possible, you want to claim real estate as a small business, and therefore qualify for the small business exemption on the FAFSA form.  Here are a few guidelines to follow which make claiming real estate as a business much easier.

1.  Organize under a separate legal entity – Don’t hold rental properties directly in your name and expect them to fly with a financial aid officer.  They should always be organized under a C-corp, S-corp, LLC, or similar entity.  This is by far the most important qualification to be considered a business asset.

2.  The more activity the better – If you just have one piece of property that you rent out, or if you have a vacation cottage on a lake that maybe you rent once or twice during a season; don’t expect that to be considered a business asset.  The more activity you have in real estate the better.  You need to be able to demonstrate substantial levels of material participation and activity.  If you have multiple properties and active participation in managing them, it will strengthen your case.  This is one area where going big and acquiring more assets will help you.

3.  Show associated activity – The following activities showing in your corporation may also indicate more business activity, rather than just rentals:

  • Develops or redevelops
  • Constructs or reconstructs
  • Acquires
  • Converts
  • Operates or Manages
  • Brokers
  • Other business activity associated with the property

4.  Other activities – There are other signs or activities which will add weight to listing real estate as a business operation:

  • Registering for appropriate state and local permits
  • An employer identification number (EIN)
  • Fictitious name registration or DBA for the business
  • Separate business checking account

These four guidelines will definitely strengthen your hand in getting that small business exclusion on the FAFSA form.  But it is not a black and white standard.  Some schools will let you keep the exclusion, others will not.  My recommendation is when in doubt, list the property as a business.  Make the school take the initiative to prove it otherwise.

How to Raise Rents – The Nuisance Rental Increase

Every landlord is faced with the question: should I raise rent? And if so, by how much and how often? I like to employ what we call a nuisance increase.

If you raise rent by too much, you run the risk of the tenant moving out. An increase of $50-$100 or more will probably get your tenant thinking about another place to call home. Now, if for some reason you haven’t raised rent in many years and your current market rent really is $150 above what you now charge, you have two options.

First, you can raise rent by the full amount, explaining to your tenant that it’s the going rate and they will have to pay that amount elsewhere for a comparable dwelling. However, there is still a good chance that they will move out because they’re probably not prepared to take such a large hit to their budget.

The other alternative is to begin using the nuisance increase strategy by raising their rent every year when their lease renews by about $20-$25 until you reach current market rent. This amount usually won’t make a tenant move out – it should feel like a minor nuisance to them, but it’s easier for them to pay $20 more per month then go through the hassle of finding a new place and moving all of their stuff.

Ideally, you should be employing the nuisance increase strategy from the beginning with all of your properties. But, there is an upper limit to what you can charge for a certain property. You don’t want to price your unit out of the current rental market; stop increasing the rent before you reach this point. Instead, reevaluate every year and only increase the rent when prices go up again.

The nuisance increase works well because tenants can understand that your costs to maintain the property go up over time. Every year, you usually see a little bump in your property taxes and insurance, and over time repair costs go up as well. Tenants are okay with this. They usually aren’t okay with you blindsiding them with a huge rental hike.