Rental of Property to a Non-Passive Activity

[Burke]

If you rent property to a trade or business activity in which you materially participate, net rental income from the property is treated as nonpassive income, and any loss is non-deductible. So, a single-member LLC owns rental property to which it rents office space to an S-Corp of which this same individual is the sole owner. However, the S-Corp only rents one office out of 6 in the bldg, the others being occupied by tenants non-related to the SMLLC. In the computation of rental income/loss on Sche E, do you pro-rate by square footage of the office vs. bldg to determine the disallowed loss? And since the loss is generated by the depreciation, is that adjusted in the accumulated depreciation allowed? If this is the case, I cannot figure out how to make my software compute it, so it means overriding the calculation, which I can do. But I would prefer not to if I don't have to. IF the scenario were that the Sche E produced a net profit, the prorated part would be considered ordinary income, but no SE tax, correct? So some would be passive income and some would be ord income, but it all flows through to the same line on the 1040. And probably would to the 8582 as well. Am I overthinking this?

[Maribeth]

My understanding of the self-rental rule is just a little bit different than yours. The income from the rental is not considered passive; therefore, the income cannot reduce income or increase losses from other rental activities so that the taxpayer may qualify for the $25,000 special loss allowance.

If the self-rental has a loss, then that loss IS considered passive. The loss from the self-rental is included with all other passive losses in the calculation of the $25000 allowance.

Maribeth

[Burke]

The income from the rental is not considered passive; therefore, the income cannot reduce income or increase losses from other rental activities so that the taxpayer may qualify for the $25,000 special loss allowance.

I am not following you. Did you mean to say the income cannot INCREASE income (on the 8582) or increase losses?

If the self-rental has a loss, then that loss IS considered passive. The loss from the self-rental is included with all other passive losses in the calculation of the $25000 allowance.Maribeth

As soon as I posted my question, similar threads appeared below and I have printed out the one from Gretel on Self-Rentals dated 4/23/09. This seems to support your position, although I am not sure what NSA is (Natl Society of Accountants?). My bad. I should have done this first. However, I had done some research elsewhere and had in my hands the day before a publication that specifically outlined my scenario about an S-Corp, more than 5% owner, self-rental situation that said the loss was not deductible. Now I cannot find where it was to save my neck. It kind of runs counter to common sense that the income is non-passive, but the loss is passive.

[Maribeth]

It is a double whammy for the taxpayer. They cannot use income from the rental activity as passive. Therefore, that income will not affect the aggregation of other passive income & losses in order to determine the $25000 allowance. For instance, if the taxpayer had a self-rental with a $10,000 income and a rental house with a $28,000 loss, only $25000 of the rental house loss would be used and $3000 of the loss would be suspended.

If they have losses from the self-rental, it is considered to be passive loss. For instance, if the self-rental had a $5000 loss and the rental house had a $28000 loss, the total loss would be $33,000, with $8000 suspended.

As to your orginal question as to how you would allocate the rentals from the building, with all other things being equal, I would use the square footage and allocate it that way.

hth,

Maribeth