For anyone else running into same problem:
I finally called IRS and spent 2 hours on the phone with a special department for assisting professional accountants, during which even the rep admitted she was stumped. But after consulting with her boss for a while, they finally pointed me to pages 8-9 of Pub. 555 which they interpret as saying that even in community property situation, if we kept the businesses completely separately, we do not have to allocate the income/loss 50/50. That it should all go to the person running the business - income atax and SE tax.
Total contradiction to all other info, but so long as I have some publications that seems to say that and record of the time/date and rep. number who instructed me to do so, I figured i'm in the clear. So that's how I did it.
