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Can your company pay itself rent?

If you are like many small business owners, you own both the company that operates your business, as well as the entity that owns the property that is rented to that business.  This is what’s known as a self-rental.  If not structured properly, however, you may run the risk of not being able to deduct any losses that may result from the rental activity.

Here’s the background :

In general, net rental losses are  considered passive in a self-rental situation.  However, if such activities result in net rental income, it is re-characterized as non-passive.

Why do the  self-rental rules exist?

Self –rental regulation is in place to prevent business owners who control both the lessor and lessee activities from creating excessive rental income….income that can be used to offset losses from other unrelated passive (rental) activities. In essence, rental income from self-rented property cannot be used to trigger the allowance of passive losses.

This rule does not apply, though, if there is a written binding contract entered into before 2/19/1988…if you’ve been in business that long.

Is there any way around this?

Yes, there is a way to work around this as long as  you have the same ownership percentage in both the active business and the rental activity that rents to the business and each are formed as either a proprietorship, S corporation, or single-member LLC.  To do so, you must make an election to group the two activities together as one related activity.  This would allow you to offset any self-rental losses against your business income.

Consider this scenario:

  • Susan owns 100% of a single-member LLC through which she runs her law practice that has $400,000 of taxable income.
  • She also owns 100% of an S corporation that holds a building that is rented to the LLC law firm that has a loss of $100,000.

Positive outcome:

Since Susan owns 100% of both activities and the building is rented to the law firm, she can elect to group the activities together, thereby allowing the $100,000 loss to be offset by the active business income for a net taxable income of $300,000.

In a related side-note:

Final Net Investment Income Tax (“NIIT”) Regulations exempt self-rental income (other rental income is subject to NIIT), whether grouped or not, from the 3.8% NIIT.  Proposed regulations sought to subject self-rental income to NIIT.

In summary:

Although they may be housed in separate entities, consider grouping your business and your building together as one related activity to allow  self-rental losses to offset your business income.  To find out more, please contact Victor C. Belgiorno at 516-861-3704 or  or Bob Jahelka at 516-861-3707 or .

 
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