Did you know you can rent a property to your own business and save thousands in taxes—but only if you structure it correctly? Mess it up, and the IRS could trap your losses or even hit you with unexpected taxes.

This is a common scenario we see at TaxElm, where business owners own a building that they use for their business operations. However, many fail to structure this correctly, either because they’re following bad advice from a friend or working with an accountant unfamiliar with these tax rules.

My goal today is to bring clarity to this subject—so you can confirm that your current setup is correct or structure it properly from the start.

What Is a Self-Rental?

A self-rental occurs when you own both:

• A business (such as an S Corporation or LLC)
• A rental property (held in a separate LLC or personally) that your business rents from you

From a legal standpoint, this is smart—keeping real estate in a separate entity protects liability risks. But from a tax standpoint, if structured incorrectly, it can cause serious problems.

What Is the Problem With a Self-Rental?

Without proper tax planning, your self-rental triggers two major tax problems:

1. Makes Rental Income Non-Passive: This means you cannot use passive losses from other investments to offset this income.
2. Makes Rental Losses Passive: This means you cannot use losses from the rental against your business income.

This setup creates a worst-case scenario—profits are fully taxable, and losses may be trapped. But with proper structuring, you can avoid this "trap."

How Do I Avoid the Self-Rental Trap?

As previously discussed we want to avoid the self-rental problem if at all possible.  Fortunately, the IRS gives us an option. The IRS offers a grouping rule in IRS Reg. Section 1.469-4(d) which allows you to group the activity from your rental building with your business and treat them as one activity for tax purposes. This means that instead of your rental losses being trapped as passive, you can use them to offset your business profits.

With that being said, to qualify for the grouping there are a few things that must be true:

1.  Common Ownership: You must have the same ownership in your operating business as the building.
   • Example: If you own 100% of both the business and the rental property, you qualify. If you and a partner each own 50% of both, you qualify.
   • Note: For tax purposes, married spouses are considered a single unit when determining ownership percentage for grouping.
2. Related Use: The operating business must actively use the building as its primary location. Any portion of the rental activity that is not associated with the operating business, would not be grouped. For example, you have a 4 unit commercial building that your operating business uses 2 units of and you rent the other 2 units to another party.  You could do the 1.469-4(d) grouping election on 50% of the building while the other would remain separate and passive.

Note: This grouping rule does not work if you're organized as a C Corporation.

Self-Rental Example

Let's put this into practice. 

Let’s say you own a chiropractic clinic structured as an S Corporation and you also own the building it operates from through a separate LLC.

• Your S-Corp generates $500K in profit for the year.
• Your Building LLC incurs a $100K loss (from depreciation (including a cost segregation study), insurance, and mortgage interest).

Without the grouping election:

• The $100K loss is passive, meaning you CANNOT deduct it against your $500K S-Corp income.
• You still pay taxes on $500K in business profit.

With the grouping election (IRS Reg. 1.469-4(d)):

• The IRS allows you to treat both businesses as one activity for tax purposes.
• You can offset your $500K S-Corp profit with the $100K loss from the rental property.
• You now pay taxes on $400K instead of $500K, saving thousands in taxes.

Key Self-Rental Implementation Items

As with any tax strategy, the important piece is implementation and, more specifically, correct implementation. Here are some key things to consider:

1. Rental Agreement: Set up a formal rental agreement between your business and the LLC that owns the property. The rent charged to the operating business must be at Fair Market Value (FMV).
2. Make Election: Make the 1.469-4(d) grouping election on your tax return the first year this applies.
3. Maintain Documentation: Ensure you maintain documentation (rental agreements, lease payments, operating agreements, etc.).

Important Note:  This grouping election applies only to properties your business actively operates from. If you own rental properties not used by your business, this election does not apply and you would use another.

A self-rental strategy can be a powerful tax tool, but only if structured correctly. Without proper planning, you could face trapped losses and unexpected tax burdens.

If you’re unsure whether your setup is correct, TaxElm can help ensure that your rental and business are structured to maximize deductions and minimize IRS scrutiny.