Are you thinking about buying a building and renting space to your business?

When you do this, you enter a special area of tax law that I will call the “self-rental trap.”

Rental activities occupy their own section of the tax code, and much of it is not pretty. Here’s the overall rule, which you likely know: rental activities are passive activities.

And you likely know that you have a number of hurdles you need to jump before you can deduct your passive losses.

But did you know that the tax code imposes even higher hurdles when it comes to a self-rental? Here’s what happens when business owners rent property to businesses in which they materially participate:

• If the self-rental produces a net income, the income is non-passive. This destroys the hope of using the rental income to free up suspended passive losses. It also makes this income taxable.  
• If the self-rental produces a loss, that loss is passive. Often this suspends the loss and likely adds it to other suspended losses.

As you can see, the self-rental trap gives you the worst of the income and the worst of the loss. Not to worry.

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