Passive Losses – Do they limit the benefit
of cost segregation?
By David McGuire, Director
dmcguire@mcguiresponsel.com

	David McGuire

As most CPAs and real estate owners know, a large percentage of commercial real estate in the United States is held by passive investors. Unfortunately, if the passive activity creates a tax loss at the end of the year, the loss cannot be used to offset active income.

Due to the limitations of passive losses, real estate owners are often limited in the benefit they can derive from a cost segregation study. A cost segregation study can accelerate large amounts of tax deductions into the current year for an eligible real estate owner. However, even a high-income individual who has large amounts of "active" income but "passive" losses may not be able to benefit from these additional deductions.

This does not necessarily mean a cost segregation study cannot benefit this individual. Additional consulting should be done to see if something can be done to allow the building owner to access some of these savings.

The most common answer to the passive activity limitations on an owner-occupied building is to see if the owner is charging under-market rent for the building. If the rent can be adjusted up, the owner can lower the taxable income in the operating entity through increased rent, while creating taxable income in the passive entity. This will allow the owner to access the benefits of the cost segregation study.

Another way of allowing owners to access this benefit is to look at the bundling rules. If the ownership in both the passive and active entities is the same, and the real estate entity leases to the operating entity, it may be a situation where the activities can be "bundled." In effect, this will net the passive and active activities together prior to calculating taxable income.

These are just two of many different ways to look at this. The owner of the real estate also needs to look at both the carry-back and carry-forward rules, as well as the cost of any leasehold improvements in the facility. The main thing is not to disregard cost segregation simply due to passive losses. It is important to discuss with a qualified individual to see if something can be done to free up these valuable tax savings.

Warmest regards,

David McGuire
Director