Renting your commercial building to your spouse's SMLLC

A sole prop can't rent his or her building to his or her business and generate rental income or deductions. I get that but this is what I have:

Husband owns commercial building 100%. When tenant didn't renew their lease, his wife formed a SMLLC (sole prop) to run the dog boarding business that the former tenant abandoned. It is very profitable. She is paying rent to her husband for leasing the same space. Same rent as the previous tenant.

If they file a joint return, can the rent be deducted on her Schedule C and includable on his Schedule E? Or do attribution rules preclude the income/deduction in this case?

It's one return, and you can't create income and deduction within that return. Think of the potential for abuse. W inflates rent deduction to reduce her Sch C income and SE tax. Rental income increases, reducing passive losses or even creating passive income. Meantime, there has been no real economic change in the taxpayers' wealth.

Or do attribution rules preclude the income/deduction in this case?

(3) Participation of spouse. In the case of any person who is a married individual (within the meaning of section 7703) for the taxable year, any participation by such person's spouse in the activity during the taxable year (without regard to whether the spouse owns an interest in the activity and without regard to whether the spouses file a joint return for the taxable year) shall be treated, for purposes of applying section 469 and the regulations thereunder to such person, as participation by such person in the activity during the taxable year.

If they file a joint return, can the rent be deducted on her Schedule C and includable on his Schedule E?

I think that this is okay. An SMLLC is treated as a disregarded entity for tax purposes. As a result, the transaction is viewed as the wife paying rent to her husband. It's been allowed before, even on a joint return. See Rev. Rul. 74-209, TAM 8104004 and Cox, T.C. Memo. 1993-326.

Since I had no idea that this could be ok, I took a look at the cites.

RR 74-209. I don’t think this is applicable.

The husband and wife reported their income from the property in separate Federal income tax returns. OP says it is a joint return. They were filing separate returns. He paid her 50% of the FMV. He didn’t try to pay himself the other 50% of the FMV rent.

LR 8104004 says

Because Husband and Wife filed joint income tax returns for the years at issue, the rationale of Rev. Rul. 74-209 is not applicable. Furthermore, the rental transaction lacks economic reality and contradicts the express language of section 162(a)(3) of the Code.

Therefore, Husband is not allowed a deduction under section 162 of the Code for the rent paid to Wife; and, accordingly, Husband is not allowed a deduction for the rent in computing his net earnings from self-employment for purposes of the SECA.

Cox. This is new information to me. I did not know that paying rent to the community could work. Thanks for the lesson.

Had one like this, but they were divorced.....you can always inc the biz and then it's ok.

The Cox case overruled TAM 8104004. The Tax Court ruled that filing a joint return rather than separate returns didn't matter:

At the hearing on the cross motions, respondent continued to emphasize that the fact that joint returns were filed by petitioners is determinative here, and that petitioners were attempting to reallocate income among one taxable unit in order to achieve a tax benefit under the passive loss limitations. Respondent has not, however, pointed us to any authority that the filing of a joint return somehow changes the basic tax nature of the items in question, and we simply believe that respondent is incorrect in her position.

In addition, the 8th Circuit affirmed the Tax Court's decision.
https://law.justia.com/cases/federal/ap ... 90/481306/

I assumed using a passive activity loss was the issue here. Is it?

The rev rul and the TAM pre-date section 469. The Cox case did not raise 469(h)(5). May not have been a passive loss issue there.

I don't see the relevance of 469(h)(5). This question isn't about deducting a rental loss.

Maybe, maybe not. It might be about SE tax. Or who knows. Not stated.

The Cox case overruled TAM 8104004. The Tax Court ruled that filing a joint return rather than separate returns didn't matter:

At the hearing on the cross motions, respondent continued to emphasize that the fact that joint returns were filed by petitioners is determinative here, and that petitioners were attempting to reallocate income among one taxable unit in order to achieve a tax benefit under the passive loss limitations. Respondent has not, however, pointed us to any authority that the filing of a joint return somehow changes the basic tax nature of the items in question, and we simply believe that respondent is incorrect in her position.

In addition, the 8th Circuit affirmed the Tax Court's decision.
https://law.justia.com/cases/federal/ap ... 90/481306/

Dave, this is really great stuff. Appreciate your guidance - it is spot on.