Self Rental of Shop Bldg to LLC

[ICOUNT]

I have a client that called me re: saving SE tax by renting a shop bldg to his sole proprietorship LLC. He is in the construction business- tax reporting as a sole proprietorship. Taxpayer & wife Jointly own a shop building adjoining the residence which the LLC uses. We have been taken expenses for the building on Schedule C. His question can the LLC pay rent to his wife & him at a fair rental value more than the building expenses and thus save on SE tax. I know this has been discussed at seminars---but I can't put my finger on it in my research. If the business was incorporated I don't think there is a problem. How about an LLC reporting as a proprietorship?

Thanks

[TAXBILLY]

In what state does the client reside? Community property might come into play.

taxbilly

[Gail in Virginia]

It is my understanding that a sole-proprietor cannot rent to themselves to reduce social security but I don't have a citation for that offhand. I also don't know whether being an LLC has any effect on the situation.

[Jake]

If a taxpayer rents property to an activity in which he materially participates, a portion of the gross rental income equal to the taxpayer's net rental income from the activity is recharacterized as income that is neither passive nor portfolio income. Reg. Section 1.469-2(f)(6). The self rental rule does not prohibit a taxpayer from "self renting" it only prohibits them from creating passive income by "self-renting". The purpose behind the rule is to prevent people from "creating" passive income to off set passive losses that would otherwise be suspended. In my opinion the rental income income would still be exempt from the SE Tax.

Jake