How to Avoid the Self-Rental Trap

March 2nd, 2022 at 4:06 PM

Let’s say you own the building.

Now, let’s say that you rent this building to your business.

With no tax planning, you have a self-rental, and that

• makes rental income from this building nonpassive, meaning that it cannot offset any passive losses (very bad); and
• makes rental losses from this building passive losses, meaning that you likely cannot deduct the losses this year (also very bad).

So, there you have it: with no tax planning, you get the worst of both worlds.

Solution

But wait—there’s a solution (often overlooked).

Under a special grouping rule, you can qualify to group your separately owned rental building with your separately owned business and treat the two of them as one activity for purposes of the passive loss rules.

Ownership

Rental. Your ownership of the rental might be as an individual, an S corporation, or an LLC. For this strategy, you can use any of these forms for your ownership.

Business. You can own the business as a proprietorship, an S corporation, or an LLC—all these forms work for this strategy.

Note that the C corporation does not work.

Two into One

What makes two into one possible? Your ownership!

The regulations say that if each owner of the business has the same proportionate ownership interest as each owner of the rental, then the taxpayers may group the business and rental activities as one activity.

Technically, the rental and the business need to pass the appropriate-economic-unit test, which gives great weight both to the extent of common control and to the extent of common ownership.

You have no problem here because you have both 100 percent control and 100 percent ownership of both the business and the rental. This puts you home free on this test.

And if you are married, you can include your spouse in the mix.

Mark S. Fineberg, CPA