I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox 👇 Also on YouTube at PlugAccountingandTax!
Supercharge SMB Equity: 🏭 Elections When Owning Your Own Real Estate
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A powerful unlock 🔐 in small business is owning your own real estate.
But that last point isn't a slam dunk. Section 469, the passive activity loss rule from 1986, treats all rental real estate as a passive activity by default. Any depreciation losses from that real estate get trapped. 🪤 They can only offset passive income. Regulation 1.469-4(d)(1) is the fix for business owners who buy their own building. It lets you make a grouping election that says your rental real estate and your business operate as one activity for tax purposes. ☝️ Suddenly, those depreciation losses become active deductions. They offset your business income directly. You keep the legal separation you need. And you stop leaving taxes on the table. This is one of the most powerful planning tools available to business owners, but it’s easy to miss. 3 ConditionsReg 1.469-4(d)(1) allows grouping only if one of three conditions exists. ⤵️ First, the rental activity is insubstantial in relation to the trade or business activity. So if your rental property brings in minimal income compared to your main business, you can group them. Second, the trade or business activity is insubstantial in relation to the rental activity. This works in reverse. If your primary activity is real estate and your side business is small, you can group them here as well. (Doesn't really apply to us here.) Third, ownership in both activities is proportionate. 👥 Both the rental and the business are owned by the same people in the same percentages. This is the most common path for business owners who also own real estate in the same entity or through related ownership. Note that the criteria of 1.469-4(c) also apply here - meaning you can't use this to group a short-term rental and your trade or business. 🛌 The Logic of 1.469-4(d)(1)This third condition reveals the real logic 🧠 behind the regulation. If you own your consulting business and your rental property in the same percentages, you’re in the exact same economic position as if you’d simply held both assets in a single entity. The tax treatment should reflect that economic reality. Without this grouping exception, the tax code would penalize you for using separate legal structures for liability protection. ⚖️ Section 469 would trap your depreciation losses behind the passive activity wall, creating a tax cost for prudent legal planning. The grouping election corrects that. It says: if the ownership is proportionate, treat it as one activity for tax purposes. You get the legal separation you need without the tax penalty. How to Plan With Bonus DepreciationBonus depreciation lets you write off qualified property upfront instead of spreading it over years. Normally, if that deduction comes from a rental property, it’s passive. It gets trapped. But with the 1.469-4(d)(1) grouping election, you combine the rental activity with your active business. Now that single year depreciation loss flows through as an active deduction. ⛲ Here lies the alpha. You own a consulting business generating $500,000 in profit. You also own a rental property that qualifies for $150,000 in bonus depreciation this year. Those two situations normally live in separate boxes without this election. With 1.469-4(d)(1), you make the grouping election. Now your business and your rental property operate as one activity for tax purposes. The $150,000 depreciation loss from the rental offsets the $500,000 business profit. 🤯 Your taxable income drops to $350,000. You save roughly $50,000 to $60,000 in federal tax depending on your bracket. That’s cash you keep. You can reinvest it in the business, ♻️ fund growth, or reduce leverage on the real estate itself. This works best when the cost segregation is deployed in high-income years. 🔺 Let’s say you’re having an exceptional year. Your income spikes. You also don't own your own real estate. This grouping election lets you use that depreciation where it does the most good: against the spiked income. You control the timing and impact of your tax liability - using tax savings to fund growth. The Procedural RequirementsYou need to make the grouping election on your tax return. 📄 This isn’t automatic. Simply reporting both activities doesn’t count. You need a disclosure statement with details of the grouping. Without it, the IRS won’t respect your election. 💸 Also, the grouping must be consistent year to year. You can’t group one year and un-group the next unless facts and circumstances materially change. This is intentional. You’re committing to a structure, not picking and choosing each year. This works best when one of the three conditions is cleanly met. Document which condition you meet and why. 🖋️ The TakeawayOwning your own real estate for a business owner is great for multiple reasons. But the tax angle and savings isn't automatic. 🤖 1.469-4(d)(1) is the election that unlocks otherwise passive depreciation losses into active deductions - freeing up sweet, sweet cash flow to pay down debt, fund growth, or actually take a distribution. 🫡 🔥 Hottest Finance Posts This Week 🔥
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The Plug [Newsletter]
I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox 👇 Also on YouTube at PlugAccountingandTax!
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