Self-Rental Trap-Avoid It Like The Plague!

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.

Self-Rental 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.

Election

If you qualify to group your self-rental with your business, you need to make a formal election to let the IRS know what you are up to. The election rules are specified in Revenue Procedure 2010-13

Takeaways

You don’t have to suffer self-rental rules, which make your rental losses not deductible when you own the property that you rent to your corporation.

You can, in fact, benefit from the grouping rules when you have a self-rental.

If you would like to discuss the self-rental rules or wording of the Election document, please call me on my direct line at 509-543-7600 or send a request HERE.

March 2022

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