Understanding the Challenge
A common ownership structure for commercial buildings involves separating the business operations from the real estate ownership. This structure, while often beneficial for liability reasons, can present challenges when it comes to tax implications. The primary issue arises from the passive loss rules, which limit the ability to offset passive losses (like those from rental activities) against active income (like business income).
The Solution: Grouping of Activities
To overcome this limitation, the IRS allows for the “grouping of activities” under §1.469-4. This provision permits the combination of a rental activity with a trade or business activity if they form an “appropriate economic unit.”
Key Factors for an Appropriate Economic Unit:
To qualify for grouping, the activities must meet the following criteria:
- Similarities and Differences in Business Types: The activities should be similar in nature, such as both being involved in healthcare or retail.
- Common Control and Ownership: The same individuals or entities should control and own both activities.
- Geographical Location: The activities should be located in the same general geographic area.
- Interdependencies: The activities should rely on each other to some extent, such as sharing employees, equipment, or facilities.
Benefits of Grouping Activities
When activities are grouped, the passive loss rules no longer apply. This means that losses generated from the rental activity can offset active income from the business activity, resulting in significant tax savings.
How to Group Activities
To group activities, you simply need to make an election on your tax return. It’s generally best to make this election in the first year the building is placed into service. Once the election is made, it’s difficult to change, so it’s important to ensure that the activities meet the criteria for grouping.
Conclusion
Understanding and implementing activity grouping can significantly impact your tax savings potential. However, navigating these complex IRS regulations requires expert guidance to ensure compliance and maximize benefits. At CSSI, our team of tax specialists has helped thousands of property owners optimize their tax strategies through both activity grouping and cost segregation studies. We can analyze your specific situation and help determine the most advantageous approach for your business and real estate investments.
Contact CSSI today for a free comprehensive evaluation of your tax saving opportunities and learn how we can help you implement these powerful strategies.