What are the tax benefits if your business buys a property instead of leasing it?
In this article, we’ll tell you how one of our client’s took advantage of low market prices and interest rates to acquire a property for use by their S Corp and realized substantial tax benefits by getting around the dreaded self rental rules.
Our client runs a successful business in downtown Los Angeles. An opportunity came up for our client to buy a mixed use property in LA that can be used for personal living and for their business operations.
Due to the current lending climate, however, the bank required our client to acquire the property personally as opposed to through the S Corp. Moreover, we advised our client that having the S Corp own the property would potentially create legal exposure to the property and the business.
But owning the property personally and renting it to the S Corp triggered the IRS self rental rules, which treats the rental income as non-passive and the losses as passive. The same would be true if our client transferred the property to a LLC that rented it to the S Corp.
Thanks to some effective tax planning, we showed our client how to have their cake and eat it too by buying the property personally and renting it to the business at a loss.
How was our client able to take a tax deduction for the passive rental property losses in light of the self rental rules?
We advised our client on a special rule in the tax code that allows a taxpayer to make an aggregation election to combine two activities (a passive and non-passive) into one. In our client’s case, by making the election to group the rental property(passive) with the operating S Corp(active) as one activity, our client was able to utilize the rental property passive losses to offset the S Corp’s active income.
Taking advantage of this election, however, requires you to meet certain ownership tests and to file an appropriate election with the IRS. Moreover, if your operating business is a C Corporation, then you wont be able to take advantage of this election since the tax code does not allow a C Corporation business to be grouped with a rental property.
If your business is thinking of acquiring a property, then contact the tax professionals at Gedeon Law & CPA for assistance with qualifying for the grouping election and for analysis to determine whether buying that property as opposed to leasing it is a good deal or not.