Grouping a property and a company that leased the property

[brennas2]

I'm researching the situation in which the same individual owns a warehouse in an LLC and a manufacturing business in an S Corp he runs and leases the warehouse to the business. 

I read about self-rent and how that can be a tax pit-fall as rental income is considered non-passive but losses passive.  I also read one can circumvent this limitation by grouping the 2 businesses if they are an 'appropriate economic unit'.  

Everything I read focuses on avoiding the rental income from being non-passive, to allow the individual to apply losses from other passive investments to be applied to the rental income. 

My question is, if the rental property and the business are grouped, and the rental property realizes a loss, can that loss be applied again the income of the business since they are grouped as an economic unit?  

Thanks!

[tagteam]

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@brennas2 wrote:

....if the rental property and the business are grouped, and the rental property realizes a loss, can that loss be applied again the income of the business since they are grouped as an economic unit?  

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Yes, but only if grouping the rental activity and trade/business activity results in an appropriate economic unit, which is generally not the case as far as the IRS is concerned.

See https://www.irs.gov/publications/p925#en_US_2019_publink1000104608

[brennas2]

Hi!

My apologies for the slow response and thank you for replying to my post.  I had responded on Tuesday, but it appears not to have posted.  

Appropriate economic unit seems to be the key.  I pasted below the relevant part of the info in the link you provided.  The biggest issue appears to be 'differences in the businesses'.  Owning real-estate will likely differ from most businesses the owner pursues.  Is that why you write the IRS generally does not agree on arguments of the 2 entities being an economic unit?  The rest of the criteria seem to apply to many business circumstances.  1) Common control and ownership; 2) Location (in the building in question!), 3) interdependence - the business needs the building to operate, and in my case, the same employees.  But your perception is the IRS still disputes property and business owners in this situation?  Thanks again! 

1. The similarities and differences in the types of trades or businesses;

2. The extent of common control;

3. The extent of common ownership;

4. The geographical location; and

5. The interdependencies between or among activities, which may include the extent to which the activities:

   1. Buy or sell goods between or among themselves,

   2. Involve products or services that are generally provided together,

   3. Have the same customers,

   4. Have the same employees, or

   5. Use a single set of books and records to account for the activities.

[tagteam · Accepted solution]

@brennas2 The IRS believes the a rental activity and a trade or business activity generally cannot be grouped (see the language in the link). 

However, in a limited set of circumstances (perhaps the one you presented), the two activities can be grouped if they form an appropriate economic unit. The policy is almost exclusively designed to prevent the circumvention of the passive activity loss rules.

If you believe your rental and business form an appropriate economic unit, then you can certainly group them. You should be aware that the IRS can regroup them if they believe they do not form an appropriate economic unit and the primary purpose of the grouping was to avoid the passive loss rules.

[brennas2]

Got it, thank you for the additional information!