For many business owners, owning the building from which they operate feels like a smart strategic and financial move. It can provide stability, potential appreciation, and control over your workspace. Yet most owners overlook a powerful tax planning strategy that can unlock even greater financial efficiency: the grouping election. When structured correctly, grouping your real estate ownership with your operating business can transform how your deductions and losses are treated, resulting in real tax savings — not just theoretical ones.
The Conventional Structure and Its Limitations
Typically, professional advisors recommend that the operating business and the real estate entity be separated for liability and risk management reasons. For example, you might own a retail operation under one company and the building under another. While this structure limits risk exposure — protecting your business operations from real estate liabilities and vice versa — it can have unintended tax consequences if not planned around.
Under the Internal Revenue Code’s passive activity rules, rental real estate activities are generally considered passive. This means losses from owning and renting your building cannot normally offset the active income generated by your business operations. If the building generates depreciation or produces losses, those losses could be trapped and unusable against your operating income, diminishing the economic benefit of owning the asset.
Enter the Grouping Election
The tax code specifically IRS Regulations under Section 469 allows taxpayers to make grouping elections to treat multiple activities as a single activity for tax purposes if they constitute an “appropriate economic unit.”
In practical terms, this means that if your operating business and the real estate entity you own are sufficiently related sharing common ownership, control, geographic proximity, and business integration you can elect to group them together instead of treating them as separate activities for passive loss purposes.
The grouping election is a formal choice you make on your tax return. It signals to the IRS that these otherwise separate activities are economically inseparable and should be treated as one unit for determining gain, loss, and passive loss treatment.
What Does Grouping Actually Do?
The primary benefit of grouping your operating business with the building you own is that it changes how the passive activity loss rules apply. Instead of treating the rental activity of the building as passive — and therefore limiting the use of any losses or depreciation to passive income — those losses can potentially be applied against the active income of your operating business. In effect, it allows you to maximize deductions and reduce taxable income in the year those deductions arise.
For example, suppose your building generates a sizable depreciation deduction in a given year. Under normal passive activity rules, that deduction might be limited if the building’s rental activity is isolated from your operating business. With the grouping election in place, depreciation from the building becomes part of the same activity as your operating business, giving you greater flexibility in applying that deduction to reduce tax on active income.
What Makes an “Appropriate Economic Unit”?
Not every business and property arrangement automatically qualifies for favorable grouping. To make the election, the activities must form an “appropriate economic unit” based on all facts and circumstances. Key factors typically include:
- Common ownership or control of both the business and real estate entities.
- Shared operations or overlapping management responsibilities.
- Geographic proximity the operating business uses the space owned in the real estate entity.
- Logical economic interdependence between the activities.
A professional advisor can help document and determine whether your situation meets these criteria — an essential step before filing the election.
Timing and Formalities
The grouping election generally must be made in the year the activities first qualify as an economic unit. It’s a proactive choice; once made, it governs how the IRS treats those activities going forward. In certain cases, taxpayers may be able to file a late election with an amended return if the election was overlooked — but you should consult your advisor on timing and procedural requirements.
Beyond Passive Losses: Material Participation
One reason grouping elections are especially important for real estate owners stems from achieving material participation. For instance, grouping several rental activities (including your business-related real estate) can help meet the IRS’s material participation tests for purposes of passive loss rules. This becomes particularly valuable when the taxpayer’s involvement in each activity separately doesn’t meet the threshold but combined they do.
Why Business Owners Should Care
From a purely tactical perspective, grouping elections are not about creating artificial tax sheltering; they are about aligning tax treatment with economic reality. If your business depends on the building you own, separating tax treatment of those activities can distort your true economic picture.
Here’s why every owner with a business-owned real estate interest should understand grouping elections:
- They can unlock deductions that otherwise would be limited by passive loss rules.
- They better reflect the economic reality of your integrated business and property.
- They preserve flexibility for deductions during years of heavy depreciation or investment in property.
Ultimately, grouping elections are a powerful, yet underutilized tool in the tax planning toolbox especially for owner-operators with real estate holdings. When applied thoughtfully and correctly, they align your tax position with business realities while maximizing your ability to deduct the full benefits of your investments.
Like any specialized tax strategy, grouping elections should be implemented in close coordination with your CPA or tax advisor to ensure compliance and optimize outcomes. But for business owners who own the buildings they operate from, the potential benefits make them well worth exploring.