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February Week Three

Independent grocers are reporting that February week three sales were down 5.39 percent compared to the same period in 2015. Next week we’ll see how February finishes out.

Tomorrow the Bureau of Labor Statistics will release its February unemployment report. Initial estimates place job growth back in the 200,000 area, which would be a welcome sign after the tepid gains of January.

Same Store Sales
% Change from last year

Same Store Sales – Previous Months

BGBC Partners Tax Update: Self-Rentals and Passive Loss

Does your store lease a building from a company you own? If so, beware of the “self rental” provisions contained in the passive loss rules.

For some background, Congress enacted the passive losses rules in 1986 to eliminate the highly publicized stories of investors reaping significant tax benefits by investing in bogus windmill and other similar projects which generated paper losses which could be offset against business and other income.

The passive losses rules state that passive losses can only be offset against passive income. The rules classified rental activities as being automatically passive activities. So it seems logical that if rental activities are passive activities, the rental income a rental company earns from leasing a building or other property to a related party can be offset by other passive losses from say various investments.

More specifically, you own a grocery business and materially participates in that store’s business. You buy a building placed in a single member LLC. You then rent the building to your store. This is a self-rental, and this arrangement is quite common. Assume you also have other investments in which you are a passive investor. You may think to yourself, no problem, I can just reduce that rental income by the amount of the passive losses from my other investments.

Not so fast.

Here is where the self rental rules kick in. Self-rental income is controlled by a special rule in the tax code that disallows the use of passive income to offset passive losses. This is to prevent taxpayers from artificially inflating rents for the purpose of using up losses limited by the passive activity rules (remember; only passive income can offset passive losses). Income from self-rentals is considered to be “not passive” and therefore cannot off-set passive losses.

One bit of a silver lining is that the rental income is no longer subject to the net investment 3.8% tax. Congress changed this rule since the IRS was trying to treat the rental income as nonpassive for purposes of the passive loss rules, but passive for purposes of the 3.8% tax.

There still may be valid business reasons for entering into a self rental arrangement. However, the primary purpose is now business driven and not tax driven.

The passive loss rules, the net investment 3.8% tax rules and these self rental rules are all part of a complex web of interrelated provisions. You should consult an experienced CPA who can help you structure around and within these provisions. As you know, a little bit of upfront planning can prevent lot of trouble down the road!

BGBC Partners, LLP is a full service certified public accounting and business consulting practice.

For more information, contact Brad Bell, CPA or Steve Reed, CPA/ABV/CFF at BGBC Partners, LLP (317-633-4700).

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