Question

Your client is Dr. Quack, an MD who owns 100% of her medical practice of which the legal entity is an LLP. The medical practice generates a net income of $800,000 per year before paying rent.    She currently pays $5,000 per month for rent, so her income net of rent is $740,000 per year.   She is considering the purchase of a commercial office building at a location which would be better suited for her medical practice.   The price of the building is $1 million, and Dr. Quack would purchase it all for cash.   She would move her medical practice into the building, and the LLP which she owns and which employs Dr. Quack would rent the space in the new building for $6,000 per month which is an arm's length rate.     The new building would have depreciation expense of $20,000 per year and $12,000 per year on other costs so it would have net income of $40,000 per year ($72,000 minus expenses of $32,000 per year).   She owns other rental property which has $40,000 in passive losses from prior years which she could not deduct due to the overall passive loss limitations, and those properties currently generate $15,000 per year in additional passive losses.   Dr. Quack wants to offset the passive net rental income which she receives from the medical office building ($40,000 per year) with otherwise unused passive losses she has from her other real estate investments.       Will that be permitted?  

My answer is u can offset up to the 40000 passive loss. However, since she is part of an LLP does that has any effect on the rules? i am worry if there s any rental property exception that i dont know about which would make the 40000 income from current year rental property not able offset as passive income. Please help!!!

Answer 1

IN the given case, section 469 of IRS stating self-rental rule will apply. According to the given section, you cannot offset your passive losses from rental property from your net rentall income of your office buidling. Internal Revenue Code (IRC) Section 469 prohibits taxpayers from deducting passive activity losses (PALs).

The self-rental rule in IRC Section 469 applies when renting property to a business in which you or your spouse materially participates. Under the rule, any net rental losses are still considered passive, but the net rental income is deemed nonpassive. That means net rental income cannot be offset by other passive losses, yet net rental losses can offset only other passive income. This could have negative tax consequences if you hope to offset your self-rental net income with passive losses from other activities.

I hope this will clarify your doubt. Kindly comment if not.