Can I use passive losses by renting my building to my own business?
The claim: “Renting your building to your business creates passive income that absorbs your passive losses.”
False: the self-rental rule blocks it
No. Under Treas. Reg. §1.469-2(f)(6), net rental income from property you rent for use in a trade or business in which you materially participate is treated as not from a passive activity. That income cannot absorb passive losses from other activities. The rule applies only to net income, so a net loss from the same rental generally stays passive. The Seventh Circuit upheld the rule in Krukowski v. Commissioner.
Reviewed by Ebot Mbi, CPA, EA · Last reviewed · Law and figures current as of September 17, 2026
Key takeaways
- The self-rental rule recharacterizes net rental income as nonpassive when you materially participate in the business that uses the property.
- Passive losses generally offset only passive income under IRC §469, so recharacterized rent does not free them up.
- Net losses from a self-rental are not recharacterized and generally remain passive.
- Grouping the rental with the business under Treas. Reg. §1.469-4(d)(1) may be possible in limited cases, such as identical proportionate ownership.
- Self-rental structures can still serve liability, financing, and estate planning goals when modeled correctly.
Where the claim comes from
Business owners who hold their building in a separate LLC and lease it to their operating company are often told that the rent creates passive income. The pitch is that this income can soak up passive losses from other investments, such as rental properties or limited partnership interests.
Treasury anticipated that approach. The passive activity regulations include a specific rule for property rented to a business in which the owner materially participates.
What the law actually says
IRC §469 generally allows passive activity losses only against passive activity income, with unused losses carried forward. Rental activities are generally passive under IRC §469(c)(2).
Treas. Reg. §1.469-2(f)(6) provides that an amount of your gross rental activity income from an item of property, equal to the net rental activity income from that property, is treated as not from a passive activity if the property is rented for use in a trade or business activity in which you materially participate for the year. The rule looks at your participation in the business using the property, not at the legal form of the entities involved. It can apply whether the business is a sole proprietorship, partnership, S corporation, or C corporation; Krukowski itself involved rent paid by the taxpayer's law firm, a service corporation he wholly owned.
In Krukowski v. Commissioner, 279 F.3d 547 (7th Cir. 2002), affirming 114 T.C. 366 (2000), the court rejected a challenge to the rule's validity, finding it within Treasury's authority and consistent with Congress's goal of eliminating tax shelters.
Because the rule recharacterizes only net income, a self-rental that produces a net loss generally keeps that loss passive. That asymmetry can leave an owner with nonpassive income in profitable years and passive losses in unprofitable ones.
Grouping can change the analysis. Treas. Reg. §1.469-4(d)(1) allows a rental activity to be grouped with a trade or business activity only if the grouping is an appropriate economic unit and one activity is insubstantial in relation to the other, or each owner of the business has the same proportionate ownership in the rental activity. For net investment income tax purposes, the regulations under IRC §1411 contain special rules for self-rental income, which can affect whether the rent is subject to the 3.8% tax.
What is true and what is not
It is true that owning real estate separately from an operating business is common and can provide liability separation, financing flexibility, and estate planning options. It is also true that the rent is deductible by the operating business when it is reasonable.
It is not true that the arrangement creates passive income to absorb unrelated passive losses when you materially participate in the business. The rent is recharacterized, and the passive losses remain suspended.
- You materially participate in the tenant business: net rent is nonpassive.
- You do not materially participate in the tenant business: the self-rental rule does not apply to that property.
- The self-rental produces a net loss: generally passive.
- Grouping may be available only in limited circumstances.
What to do instead
Model the structure before you rely on it. Identify which activities are passive, how much suspended loss you have, and whether any genuine passive income exists to use it. Consider whether grouping is permitted and advisable, since grouping decisions are generally difficult to change later.
Set the rent at a fair market rate and document it with a written lease. Suspended passive losses are generally released when you dispose of your entire interest in the activity in a fully taxable transaction to an unrelated party, which may be a better planning point than a self-rental. We coordinate with your attorney, who drafts the legal documents.
How ebotCPA helps
We map your entities and activities, apply the self-rental and grouping rules, project how the rent and losses will be treated over several years, and document the lease terms and elections.
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.
Assumptions: Tax year 2026; married filing jointly; income in the 24% bracket ($211,400 to $403,550 for 2026).; The owner materially participates in an S corporation that leases the owner's building at fair rent, producing $20,000 of net rental income.; The owner has a separate long-term rental with a $20,000 passive loss and no other passive income; the rentals are not grouped, and the $25,000 allowance is fully phased out.; Net investment income tax and state tax are not computed.
| Net self-rental income | $20,000 |
|---|---|
| Character under Treas. Reg. §1.469-2(f)(6) | Nonpassive |
| Passive loss from other rental | $20,000 |
| Passive loss allowed against the self-rental income | $0 |
| Passive loss carried forward | $20,000 |
| Federal income tax on the self-rental income (24% × $20,000) | $4,800 |
Under these assumptions, the $20,000 of rent is taxed as nonpassive income, about $4,800 of federal income tax, while the $20,000 passive loss stays suspended.
Illustration only; not a projection of your results.
We coordinate with your attorney, who drafts the legal documents.
Frequently asked questions
What is the self-rental rule?
Treas. Reg. §1.469-2(f)(6) treats net rental income as nonpassive when you rent property for use in a business in which you materially participate.
Are self-rental losses passive?
Generally yes. The rule recharacterizes only net income, so a net loss from the same property usually remains passive.
Does the self-rental rule apply if my business is an S corporation?
Yes, if you materially participate in the S corporation's business. The rule looks at your participation, not the entity type.
How can I use my suspended passive losses?
Against genuine passive income, or when you dispose of your entire interest in the activity in a fully taxable transaction to an unrelated party.
Have facts like these?
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.