The Opportunities and Tax Implications of Self-Rental Grouping Election

At a glance:

• The main takeaway: Healthcare providers who self-rent the space they use for their practice may be able to group the two activities together to take full advantage of depreciation and other real estate deductions against the income from their practices.
• The impact on your business: Successfully leveraging the self-rental grouping election can allow property owners who rent to themselves to apply the passive losses from their property to their primary income source to reduce their income tax bills.
• Next steps: Healthcare practitioners should consider taking advantage of the self-rental grouping election to reduce their income tax bills.

Speak to your Aprio tax advisor today.

The full story:

Many healthcare practitioners purchase medical office buildings to use in their practices. These buildings are often owned by a separate pass-through entity that is legally separate from the practice but maintain common ownership. The medical practice then pays rent to the landlord, the real estate entity.

Commercial rental properties are often cashflow positive but can generate a taxable loss due to depreciation. While passive losses are typically limited (non-deductible) until there is passive income or a sale, there are some opportunities that allow you to deduct the losses in the current year.

Have you considered this opportunity and its tax implications?

Opportunities and Implications

Under Section 469, losses stemming from a passive activity (i.e., any activity without material participation) are limited to passive income from other passive activities. These passive losses are often either accumulated and carried over from year to year to offset income from future passive activities or ultimately freed up when the activity is disposed of or sold.

Self-rental rules are further defined as an owner materially participating in an operating company while also owning the rented real estate by the operating company. Self-rental rules clarify that net income from such a rental property is treated as non-passive, but any net losses are treated as passive and therefore limited to other passive income.

What is the grouping election?

Section 1.469-4(c) provides a grouping election that allows certain trade or businesses and certain rental properties to be grouped together for purposes of material participation. If eligible for the grouping election under 469, you may be able to deduct losses from the rental activity against your practice’s taxable income.

Why does Section 1.469-4(c) matter?

If there are losses in the real estate entity (potentially due to accelerated depreciation from a cost segregation study), the losses can offset taxable income from the operating entity. 

There are other implications that should be considered, such as a potential sale of the operating entity or other passive activities the taxpayer may have.

When does the grouping election need to be filed?

The taxpayer must file a written statement with their return in the first taxable year in which the activities are grouped. Any changes in subsequent years should be included with the return in the year of change.

The statement of “regrouping” must explain why the original grouping was incorrect or what facts and circumstances changed to make the original grouping no longer valid.

What are the implications of not filing?

If no election is made, the two activities are treated as separate activities and are subject to the self-rental passive activity rules described above.

Don’t miss out on an opportunity for current tax savings. Reach out to an Aprio advisor to see if this strategy could work for you.

Related Resources:

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