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The final episode of the cost segregation series. Wes covers the grouping election, the one tax election that determines whether building losses can offset practice income or get suspended indefinitely. Includes the self-rental asymmetry, how to execute the election, five pros, six cons, and when to make it.
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Wes Read: Welcome back everybody yet to another episode of the Dental Boardroom Podcast. So I am finalizing my series on cost segregation. A very cool strategy when used appropriately. If a doctor owns both their practice and the building and owns them a hundred percent each, or if there's a partner, both the practice and the building entities are held in the same pro rata ratio between those two partners.
What I want to talk about in this episode is a little more. Complex. I'm gonna try to distill it down so you understand it. And if you own your building, this is actually an incredibly important concept and you'll definitely impress your CPA If you follow me on what I'm about to share in this episode, which by the way, is a little bit of a clarification on a couple points.
Uh, from the prior episodes, it was a, an area within, uh, self rentals. I didn't really dive into the uniqueness of being both the landlord and the tenant at the same time. Meaning your, your dental practice, generally an S corporation or if you have a partner, it's a partnership, is the tenant of the, uh, building that is owned in a separate LLC.
And this doesn't work if you have a number of other. Tenants, but most dentists, they're the only tenant of the building that they bought. So if you. Own your practice and are buying a building. Now, if you already bought a building and you didn't elect what's called grouping, which is what I'm gonna go into here shortly, then it's too late.
This is, this is only applicable if you are buying a building. And in the year of buying that building on that first tax return, you are electing to group that building with your dental practice as one single economic unit. So that's a little bit of a preface. And then if they are operating as a single economic unit as opposed to two separate economic units, then there's, there, there's a certain benefit and there's certain disadvantages to electing to treat them as a grouped unit.
So try to follow me along here, but for those of you watching on YouTube, I have, uh, my screen is sharing. I'll narrate it for everyone else. And I wanna start off by. Talking about a key concept in tax for, for you real estate people out there, the income from a rental real estate property that you are renting out.
Let's just start off and say it's not yours. You're not the tenant, you're renting it out to somebody else. That rental income is passive. It is passive rental income and the losses. Passive losses and the IRS says they are passive because you are not actively participating as a real estate professional in the management of those properties.
Now, you heard me talk about in my last episodes the challenge it is to be classified as a quote, real estate professional. In the tax code, you have to be working 750 hours. It has to be your predominant, uh, uh, profession that you're spending your time on. There's all these rules, and it's virtually impossible for an active dentist running a dental practice to claim themselves as a real estate professional.
That's why I brought up the possibility of a spouse who may not be fully engaged in, let's say a W2 job somewhere and is doing real estate in helping manage your real estate property. Or they are an a real estate agent and that's what they do for their day-to-day. Job. When you have that scenario, then you collectively as two spouses operating as one tax unit.
'cause you file a single tax return called the 10 40 tax return. Then you both get the benefit of being labeled as a real estate professional and if so, then you can take these losses from your building, especially losses that. Aggregate in the first year because of the cost segregation. Study that was commissioned and generated huge losses in that first year.
Those losses can then be used to offset any other income you have, like W2 income or K one income from your corporation, or if your spouse has W2 income, you can, you can offset that active income from, or what's called earned income by deducting the. Real estate, you're building losses against that income.
Now normally there's, there's this big wall between those two and the losses in your building that accumulate because all the depreciation. The interest payments, but especially that depreciation and especially if you do that cost segregation it and, and it front loads a lot of the deduction of depreciation in the first year, that will create a loss.
This is very common to have a loss in the early years of owning your building because of the depreciation, especially when you do that cost segregation and you take bonus and accelerated depreciation. Now, normally there's a wall that isolates that loss off. It partitions it off and it says you cannot leak that loss to offset your active income like your W2 and your K one, your, your earned income.
You can't do that. And so that loss that gets sort of siloed off put in a bottle is called suspended loss, and it's suspended until you're building LLC starts generating a taxable profit. When it generates that taxable profit, you can release those losses against. Uh, the income in that. Now also, here's the other thing.
If you have other real estate properties outside of the building that you are operating in a true, let's say, residential rental down the street, or maybe you own a duplex or even a, an apartment complex, you know, with eight doors, if you own this other real estate over there, and that is generating positive taxable income.
You can use the losses from your building LLC for your dental practice. You can take those losses from the ca egg and reduce the income from your other rental properties outside of your practice building. And with that in mind, that concept in mind, let me now explain that the standard process or the standard profile when a dentist own their owns their building is they don't group the building with their practice as a single economic unit.
So non grouped, here's what the non grouping does. If your LLC owning your building has positive taxable income. That positive taxable income is not called passive. It's actually called non-passive. And the reason why is 'cause you are, you are renting it yourself. You are the landlord and you are the tenant.
And that is called a self. Rental, really important term, self rental, your other real estate property down the street or by your house or whatever, that is not a self rental. You, you're not operating a business outta that. That is a true rental and that income over there is passive income because you're not operating in it.
Your building is not passive income, it is non-passive income. And so. If you have losses in your outside real estate, you cannot use the income in your building LLC for your practice. You cannot use the building LLC income to reduce or offset the income or the losses outside of your practice. So let me state that better.
You have, let's say. I'm gonna use a simple low number. You have $10,000 of income in your building, LLC, so the LLC that owns the building that you operate your practice in that that real estate, let's say you have $10,000 of income, and let's say in your rental duplex down the street, you have a $10,000 loss in that one.
Well, guess what? You can't net the two. You can't take that loss on the duplex down the street and reduce the $10,000 income taxable income in your building. LLC. You can't do that. Why? 'cause they're characterized differently. The rental income from the duplex is passive income, or in this case, a passive loss.
The. Income in your building. LLC is non, that's the operative word, non passive. And you cannot net non-passive income against passive losses. They have to be character characterized the same. Now the other way is not true, so let's go with the same scenario and just reverse where the income and losses are.
If you're duplex, if you're duplex. Is running a positive $10,000 taxable income, a positive $10,000 taxable income on your Schedule E. Page one. You have $10,000 plus in your duplex, and then your building has a $10,000 loss. Guess what? The loss in your building LLC is passive and the income on your duplex.
Is also passive, which allows you to offset those two together and pay no income. Therefore, on that duplex taxable income of $10,000 because you use the $10,000 of losses from your building, LLC that you operate in against that duplex income. And so there's an asymmetry that occurs here. And the asymmetry for your building LLC that you practice in.
Has income is labeled as non-passive, and losses are labeled as passive. And those losses can get trapped. They can get trapped. If you don't have that duplex down the street and your building is your only LLC, which is the most common scenario I find with den, with dentist, that loss in the building LLC gets it gets, it gets trapped, it gets suspended, it gets put in a bottle.
Then in the next year, if you have actual positive taxable income in your building LLC, then that prior year bottled up loss gets emptied out and it will reduce the loss in the new year when you have, sorry, it will reduce the income in the new year. And so the key thing here is that cost segregation and depreciation.
Allows you to shift tax benefits from the future into today. And the benefit of that is simply the time value of money. A dollar in your pocket today is worth more than a dollar in your pocket in 10 years. It could be worth twice the value of a dollar in your pocket in 10 years to get that dollar in your pocket today.
So this is a time value of money benefit where you're trying to pay the IRS less now and. And, and, and down the road you'll pay them more. At the end of the day, you'll pay them the same amount. All other things being consistent, but because you're paying a dollar less today, that dollar that is now in your pocket, theoretically you invest that at 10% rate of return over 10 years.
That $1 might turn into, you know, two, $3 and then you pay the IRS a dollar in 10 years and you just pocketed the difference. That is the beauty and the benefit of. Compounded growth and the time value of money. And so cost segregation and depreciation and tax management is so much about managing when you pay the IRS and getting the benefit of deferring, paying the IRS.
That's true when you put money in a 401k, that's true when you put your money in a, in an appreciating stock that just, uh, appreciates in time and you only pay the taxes on that when it sells. So let me come back now to my screen and I've got two boxes here. A scenario where there is no grouping of your building, LLC, with your dental practice, S corporation, no grouping.
The second one is where you group them and the LLC and your S corporation. Now granted your dental practice could be, some states allow an LLC, but it files almost every time as a corporation, as an S corporation or sole proprietor. But generally as an S corporation. So don't confuse an LLC with your building and an LLC of your practice.
If you're in a state that allows dentists practice to be held in an LC, don't confuse us as as the same thing. What matters here is what the IRS gets as a tax return, and there is no such thing as an LLC tax return. So your LLC dentist dental practice is filing an S corporation and your LLC. Building entity, assuming you don't have partners, should file as a disregarded LLC and go straight on your personal 10 40 tax return without filing a separate tax, uh, uh, tax return.
Okay, so on the left hand side, without grouping, this is the most common 'cause. A lot of times dentists don't know about it. And so they don't do it. Their CPA isn't proactive and addresses it, and there's some scenarios where it doesn't make sense to do it because of other extenuating reasons. Maybe there's other real estate properties out there with their own nuanced tax situation.
So this is absolutely something to talk with your CPA and my main point. You may need to be the one to initiate that conversation because your CPA is so busy and doesn't generally do a lot of deep strategic planning, they're just trying to get tax returns out the door on time and do it accurately.
Most CPAs are not really planners, so that's why here at Practice CFO, we lead, everything is about the planning. That's why we're certified financial planners. That's why we. We, I, I started it all with the, the finance aspect in mind. Finance is forward-looking. Accounting is historical looking. The accounting gives the x-rays to then do that forward-looking, strategic planning.
So make sure that you recruit your CPA because they, they understand this. They just need you sometimes to prod them to do the analysis and tell you whether or not it's a good idea to group your building, LLC with your practice S corporation. So let's go over to the grouping. When you group, so again, when you don't group, you're building LLC with your practice.
All rental income is non-passive and all rental losses are passive. And that is a scenario that is, um, detrimental to you as the dentist, but when you group it, it creates symmetry. All the rental income in your LLC owning the building is non-passive. All of the rental losses are non passive, so it's treated from a tax standpoint much more like your S corporation and.
Unlike your duplex down the street, which is all passive income, all passive losses, when it's grouped with your practice, your billing, LLC becomes all non passive income and all losses become non-passive losses. Now, the passive losses are passive. Whether or not you group it with your S-corp or not, that doesn't matter.
It's only on the income side that you create symmetry. Now when you group it, you're building LLC income goes from being non-passive to being, um. Your when, when you, when you group it. Sorry, it's on, sorry. It is on the loss side. My bad. It's on the loss side. Your rental LLC, that owns your building when you don't group that is non-passive income.
But the losses are passive. I know this is a little challenging to follow, but the losses are passive. When you group it with your dental practice as one economic unit, the rental income still stays the same as before. It's non-passive, but the losses now become non passive, which releases. The trapped losses.
When you have losses in your building, they get trapped. Remember I mentioned they're suspended and put in a bottle and you can't use them in the current year, and you can only empty that bottle later when your building has positive taxable income. Well, guess what? When you group it with your S corporation, those losses in your building, LLC, you can use them.
Here's the point. You can use those losses now that they are labeled as non-passive. Non-passive, like. The other non-passive elements of your S corporation, which is your W2 to yourself and your K one income out of your S corporation. Those are both non-passive because you are an operating dentist, you are working in that S corporation that is an active earned income.
So your W2 and your K one are active. Earned income now. Now this is where the beauty comes in. Of course, as mentioned in my prior episodes, you can take those passive losses from your building, LLC. They're now categorized as non-passive, and you can release them to offset your W2 and your K one. So if you do that cost, so you buy your building, you commission a cost segregation analysis, you hire a good firm to do the study, you front load $400,000 of bonus depreciation from the cost segregation study.
In your building LLC, now you're sitting on $400,000 of losses in that first one. And let's say you're cranking it. I'm really gonna use an exaggerated example here. Maybe you're cranking it and doing a million dollars take home between W2 and K one. Maybe it's $300,000, W2, $700,000 K one out of your S corporation that million dollars.
Now you get to reduce that million dollars by the $400,000 loss in your building LLC. So now you're only taxed on 600,000. And that extra 400,000 was gonna be taxed at somewhere around 40, 37% on the very low end. For states that don't have income tax, and for states like California and New York, you gotta add another 10% roughly to that.
That's like 47%. So you get to save almost 50% on that $400,000 reduction because you used the losses from your building to offset your W2 and K one from your S corporation, and that is saving you somewhere around 200,000 bucks in that first year. Now there's other factors that can seep into the analysis from a tax standpoint, but in a clean scenario where the dentist only owns their building and they only own their dental practice, and the building is an LLC that does a cost se analysis and the and, and the, and the practice is an S corp or it, it doesn't have to be an S corp, but the ownership is the same between the building and the S corp.
Then you can elect to group it in the first year and you have to do this in the first year of buying your building. You tell your CP, I want you to group my building, LLC as, or I want to group it with my S corp. So it's treated as one economic unit and this resolves that asymmetry permanently. Both sides of the of the ledger now become consistent and you cannot go back on that unless the rules allowing the grouping break.
Let's say you sell your building, I mean, sorry if you sell your practice, but not the building that breaks. Now you're not allowed to group, but without something structural changing that you cannot ungroup this down the road. And there's pros and cons of grouping. I'm gonna go over each of those pros and cons here in just a moment.
So let me summarize here. A dental practice operating in a building owned by the same person in a related entity, checks every one of the boxes required. In order to treat the building and the practice as one economic unit, and that's almost in every case. It's because all of the requirements are met, allowing them to be grouped.
There's common ownership, there's common control, there's geographic proximity. They're the same thing. Essentially the practice is in the building and there's economic interdependent. Those are the four rules in the IRS tax code. And so the Aden, a dentist who owns their building and operates in their building and is the only tenant satisfies every single one of those.
Very easy slam dunk, not even an audit risk. Okay, so let's come down to the practical mechanics of applying this timing, disclosure, binding, and IRS authority. Let's talk about timing, when to do the grouping. And I mentioned, and I'm going through my slide here, so there's a little bit of repeat, but this is a complicated subject, so maybe a little bit of repeat is good timing.
You must make that election. On the original return for the first year of the building activity begin, it's IE the first year that you bought it. So if you bought it in February of 2026, then your 2026 tax return when filed, you know, and sometime around February, March or April, uh, on that return, it should be elected that it is grouped with the S corporation.
You cannot make that retroactively. Next disclosure. It is critical to attach a statement to the tax return, identifying the grouped activities, and that is with Form 8 5 8 2 85 82. So go to your CPA. Hey, CPA, I just bought my building. I own my practice, I own my building. Those are pretty much the two main things that I own besides my house.
And I want to, I want my building and my practice, my newly owned building, to be treated as an, as a single economic unit. Can you do that by electing the grouping and attaching form 85 82 to the IRS. So the IRS is aware of that. Now, the IRS may say, well, have you thought, I'm sorry, the tax preparers say, well, have you thought through this?
Well, good. Sit down and have the tax preparer look at your global financial situation and tell you whether they agree with that. And if they don't agree with that, it can't be some general comment like, oh, well there's some risks with this, blah, blah, blah. No state exactly why. They are recommending that you don't group your building LLC with your practice.
You want reasons for that. Okay. Let me, let me try to give you one reason Possibly. If a doctor buys a dental practice and a building at the same time and groups, those usually the doctor who buys the dental practice, and let's assume this is their only dental practice, they run a very low income typically in the first few years.
There's already a lot of depreciation in the practice S corporation already. You don't need to pull from the cost seg deductions in the building LLC, but and transition them over into the S corp to reduce income in the S corp when your S corp already has low income. So I don't want you to front load deductions from a cost segregation study when you're already in a low tax bracket.
I'd actually rather you punt the deduction from your building depreciation to future years when your S corporation is cranking it and pushing you in a higher tax bracket. So that's one reason. The best scenario is Dr. Buys a practice, not the building. They run it five years later. They're really cranking it.
They're getting into the highest tax brackets, or maybe deep into the highest tax bracket. Now they buy their building. Now they've commissioned the cost segregation analysis. Now they front load the depreciation through bonus depreciation. Now they group the building with the S corporation. Now they take that huge loss from the cost segregation.
They swing it on over to reduce now the high taxable income coming outta the dental practice from the W2 and the K one. That's the best scenario. And the beautiful thing is, that's the most common scenario 'cause buyers typically can't afford the cash down, the 20% cash down to buy their building. They get a first route of refusal in the process of purchasing the practice, assuming that the seller owns both the, you know, the building and the practice, they get a first route of refusal such that down the road, if the, if the building owner, the seller of the practice who own the building, the seller decides they wanna sell the building in five years.
Well, the dentist who bought the practice now has the first right. They're the first one in line to be able to buy that dental prac, uh, to buy that building. And if they do buy the building. They're now cranking it in the dental practice, taking home a bunch of money, high tax bracket. Now they do the cost say, and now they reduce their overall income and really get the benefit of the time value of money on getting the tax benefits.
So that is the benefit. I just summarized that in a nutshell, but if you didn't follow that, rewind it 1, 2, 3, 4 times, whatever you need to understand the past roughly two to three minutes of what I said there to understand the whole concept here. So back on my slides here, disclosure, attach a statement on the tax return, identifying what, uh, is the grouped activity, the dental practice, and the building LLC.
That's the grouped activity. It's one single unit. One owner owns a hundred percent of each. The geo geographically, they're the same unit. Everything is the same. So that's an easy explanation. Next item is binding. This is binding. This is a binding election. When you do that in the first year of owning your building and attaching that 85 82 disclosure statement of the IRS, and so it's generally binding in all subsequent years.
You can only be changed if there's a material change in the facts and circumstances. And then lastly, the IRS Authority. It's under section code 1.469 dash four F. Don't worry about that. But under that code section, the IRS can ungroup if the election circumvents certain passive activity rules, uh, but a legitimate, in other words, all that's saying is that the IRS has the ability to audit these, and they audit a lot of these.
It is true that even if you're squeaky clean, it could raise an eyebrow. Or could put you a little bit on a radar at the IRS and if they come in normally they'll keep a limited scope, audit it and just look at this grouping election and validate that it's that it's substantiated per the facts and circumstances.
Uh, the worst case scenario would be this would be the, their, their foot in the door. And then they, uh, say, okay, your, your grouping is good. Everything checks out there, but you know what? While we're here, we're gonna look up and down your p and l and your balance sheet, and we're gonna do a full audit.
That typically doesn't happen. Uh, but it could, so there is a slight IR audit risk that goes up here, but as with many things, if you document this right, and you follow the rules. You use the rules to your advantage, then you should be okay. Alright, let's go to the pros and cons here. The pros of this grouping election, the pros of this grouping election.
There's five I'm gonna indicate here. The first one is loss utilization, and this is just a repeat, repeat of the main theme and benefit early year losses from your building LLC, which are accentuated from the cost segregation. Uh, work. Those losses in the building LLC can offset your W2 and K one practice income dollar $4 instead of being locked up in that bottle.
Suspended as passive loss carry forwards. Number two. Number two, benefit cost segregation amplifies it. So the first year bonus depreciation from cost segregation study becomes actually usable in year one. So I sort of lumped that in The first benefit, but this is really a, a, a key benefit to call it separately, is that even if you didn't do a cost segregation.
When you bought your building, there's probably enough depreciation there in that first year that you may have a loss, but it might only be like a 15 to $20,000 loss, and you can use that to offset your W2 and K one when you do the grouping election. If you do the cost segregation, you might take a $20,000 loss and amplify to two or $300,000 loss in year one.
Alright, so the third benefit, it fixes that asymmetry I talked about on the losses. Remember, if you don't group your losses in your building, LLC, they are non-passive losses, so you cannot use those losses if you have income from outside rental property like that, duplex down the street. It creates an asymmetry between the income and losses inside your building, LLC, and so it makes both of them.
There's no way that you can make as a self rental of your building as a self rental, you renting it. There's no way to make the income and losses of your building LLC, both passive. There's no way to do that, but you can make them both. Non-passive. That's the key thing here with the grouping. And when they're both non-passive.
Now you can take those losses from your billing LLC, and again, offset the W2 and K one from US corporation. Sorry if I repeat myself, but this is a complicated subject, so it fixes that asymmetry. It eliminates the unfavorable self rental dynamic where income is taxable, but losses are trapped. Lemme say that again.
This fixes the asymmetry when you elect a grouping. It eliminates the unfavorable self rental dynamic where income from that rental LLC is taxable, but the losses are trapped and not deductible until future years. Moving on to pro number four, simpler participation when you elect a grouping once grouped.
You have one material participation test on both the practice and the building together, and it becomes very clear that these two things are running together, thereby allowing them to be treated as one economic unit. And so all and so income in one can offset losses in the other, and losses in one can offset income in the other, they're treated as one.
So it's taking those losses from one jar and taking the income in a separate jar and taking the losses out of the one jar and putting them in the income of the other jar. And so you have both income and losses in the same jar and they net. That's the beautiful thing here. Alright? And it, and it, when you elect the, the, the grouping, it keeps that, that very clean and simple and defend.
Pro Number five is predictable treatment. What's in place? There's no annual passive activity tracing or carry forward management. So remember those suspended losses that get bottled up in your building, LLC. You have to track those from year to year and how much gets released. It's like you're keeping a ledger.
How much suspended losses are there to still use? That whole thing goes away because you're assuming, assuming that you have enough W2 and K one income from your S corporation to fully absorb the losses from your building. LLC. If your building LLC has losses of 200,000 in year one from the cost segregation analysis, but your W2 and K one from your S corp are only a hundred thousand dollars, you're only going to be able to use a hundred thousand dollars of that $200,000 loss, and the other a hundred thousand is still gonna get suspended and carried forward.
So that's why I say if you're in a low tax bracket in your S corporation. Meaning your W2 and K one, if you're W2 and K one in your S corporation combined is less than 150 or 200,000, you're already in a pretty low tax bracket, especially if you're doing married filing joint and your spouse doesn't have any income, you're in a fairly low tax bracket.
Not much need to accelerate future deductions from cost segregation into the current year to offset that income when it's already being taxed at a as a pretty low rate. I'd rather you pay the taxes this year at the pretty low rate and then use the deduction from depreciation in your CO, in your building to offset your W2 and K one when your W2 and K one were a lot higher.
So the general rule is a tax deduction today is better than a tax deduction in 10 years. The only caveat. Is that if your income is a lot lower today, then your income is gonna be a lot lower in future years, thereby putting you in a lower tax bracket today, let's say the 22% tax bracket, when in 10 years you're gonna be in the, I don't know, the 45% tax bracket.
You may not wanna fully deduct that cost segregation and spread it out over time. So there's a lot going into that analysis. Make sure you recruit your, your CPA to do that analysis. Let's now look at the cons of the grouping election. It's a one way door. It's, it's, you cannot change this. It's binding.
You may be, you may be able to ungroup later if the facts and circumstances change. And I'll go over a couple scenarios here. So, but this is one way door number two as a, as a disadvantage here of the grouping election is partial sale complexity. You sell the building alone. So selling the building alone may not trigger a full disposition of the grouped activity.
Suspended losses may remain trapped. So if you sell the building alone and it triggers, um, a full disposition of the grouped activity, suspended losses are going to remain trapped. So when you have a bottom line here, when you have a partial sale. You only sell the building. Uh, you. And, and that building is gonna create some income.
If you have losses, maybe losses from your, from your S corporation, you may not be able to combine those two. So it does create complexities or tax complexities when there is a, a, a sale of one. Of these two economic units, the building and the S corporation, that one definitely is an area where you need to have a serious conversation with your CPA 'cause it gets a little more complicated.
Number three, you forfeit passive shelter. So future net building income becomes non passive and can't absorb. Passive losses from other investments. So once you make this election, remember in my earlier scenario where I said you have the duplex down the street, and that's passive income, passive losses you're building if you, that you own, if you group, they're both now non passive.
And so before I said if you don't group the losses in your building, LLC are passive. You can deduct your losses in your building LLC, against the income from the duplex down the street. You can do that, but once you group, you can no longer do that because the losses in your building LLC are now non passive.
They're non passive and therefore you can't deduct losses in your building LLC against the duplex income down the street. And, and so that that can come back and hurt you. If, let's say you don't have a lot of income in your S corporation to offset the losses in your building LLC, but you do have income in your duplex down the street or your apartment building down the street is creating a lot of, of, of income, you can no longer reduce that income from the losses in your building LLC because you grouped your building with your practice and you can no longer treat that, that economic unit of the building and the practice together.
Against or in the same jar, so to speak, against the outside income from your duplex or other outside real estate entities. So you, you forfeit that passive, um, that passive combining of your billing LLC with outside income from other real estate properties. Alright, con number four, DSO or partner disruption.
So if you bring on a partner, an equity partner, like if you're selling to A DSO and they buy 60% or whatever. Even if there's a management entity and you still own a hundred percent of your stock, yada, yada, it's treated the, the, the substance of the laws you sold, you sold a portion of your practice and now you break, uh, the compliance with the rules required for grouping the grouping election.
And once that happens, it forces a, an unplanned, uh, decoupling. Of your building and your practice. And now you have to go back to the way it was before. Now that may be okay, since you don't own your practice anymore, you may not be getting anything but a W2 at this point. You essentially are making a lot less money in the corporation because now you're an employee of the DSO and you may not, therefore, need a bunch of losses from the building to offset.
You are now lowered income from the building, so you may not need the grouping to be enforced at that point anyways. Alright, here's another one. If you're under real estate at all, you know about 10 31 exchanges. 10 31 exchange allows you to sell your, your, your rental property and not pay any taxes on the gain of that sale if you roll the proceeds into a newer property entirely.
So if you do that, it's as if you never even bought or sold. To the IRS, you're simply taking what is called your tax basis in the property you sold, and it becomes your new tax basis. And the, um, it carries over into the property that you just bought, and you're effectively deferring paying taxes on the appreciation of your rental, uh, property.
So, but when you group it, now you're building LLC. It's like, it's like your practice. It's an operating active thing now, and the 10 31 exchange is only allowed for passive rentals into selling those in putting the proceeds into a new passive rental. So when you group, it adds complexity when you're analyzing the grouped activity during and after a like kind exchange.
It's not to say you can't do it, but there's some absolute complications there that you need to talk to your CPA about. Uh, I think this works the best when you only real estate property is your building. If you're on target to own 5, 6, 7, 8 other outside rental properties, it may not be the best thing to group.
Again, talk to your CPA. And lastly, number six, semi-retirement trap. If the practice winds down rental income stays non-passive, potentially disadvantaged when passive treatment. So what I mean by that is if you slow down in your practice and you go from taking home 500,000 a year to taking home, I don't know, I'll accentuate here $50,000 a year.
Now you don't have a lot of income in your S corporation. You just, you don't have a lot of income. Now. Maybe you're building, you've owned it for 10 or 15 years and you know, the, the market rate rent is just a lot higher. It's making really good cash flow. Now you've run out of your depreciation and so there's a, there's a very high taxable income now in your building, uh, that you have, you, um, there, the, the benefit of grouping really goes away there.
And it can become a potential disadvantage when that happens. It really only is the advantage when your W2 is a lot higher and your K one is a lot higher from your S corporation, but when that goes away, you're not really getting any benefit from doing this. And now all of your income and expenses in the billing LLC are non passive and you can't really combine them with outside real estate.
Well, okay, so those are the cons of grouping election. And so let's just look at a couple scenarios here and we'll end off with that. Uh, building. So early years, you have a lot of building losses. Without grouping, you are unable to use those losses against practicing practice incomes. A little bit of a summary going on here.
When you do group, you can take those losses in the early, early years and um, and you can use them against. In, uh, practice income. So without grouping, which is normally what I see, those losses are trapped with grouping. Those losses are released and you are, and they're usable against practice income. Um, okay.
Scenario cost segregation benefit. You get immediate deduction with grouping. Without grouping. You have to defer that deduction scenario. Sell a billing only. Sell of the building only you keep the practice and you sell a building. When that happens, if you, if you do group, the losses on the sale of the building are gonna remain trapped from other rentals, you may have, uh, gains from other rental.
Let's say you sold that duplex down the street and there's a big gain, and let's say you sold your building LLC, that you. Did group, you can't take the losses. If your building that you operate in actually has a loss on sale, you can't take those losses and offset the gain on the sale of the duplex when you do the grouping.
Now the chance of you selling your building at a loss is probably pretty low. So I'm not too concerned with this scenario. Okay. Let's go onto the DSO, uh, participation or, or transition where you bring on another owner. This, when you group it, it really adds complexity when you don't group the building and your practice.
It's a, it's quite a bit simpler there because having partitioned ownership between the building and the practice, uh, allows more flexibility in transitioning ownership in each one of the, those two independent of the other. So if you want to bring on a partner for your S corporation and give them 50%, but you don't want them to have ownership of the building.
If you grouped now you got problems, you're gonna have to ungroup or you give your new owner 50% ownership of the building anyways, which I always recommend that. Anyways, I do think you should have a, an alignment of incentives and alignment of ownership between the building and the practice. Because remember, the practice pays money to the building.
It's an expense, and if you have a partner of your dental practice who doesn't own the building with you, then there's gonna be a conflict of what that rent rate should be. Conflict that rent rate now needs to be a true market value, where if your new partner also owns the same pro rata share of the building as they do the practice, if the rent goes up or down for tax planning purposes, then you and your partner benefit the same way and there's alignment of incentives there.
Alright. And the last scenario here, passive income, offset income from other rentals. So this, yeah, this, this, again, I mentioned if you have income from that duplex down the street, if you, uh, if you don't group, you can then use that income and offset it from losses in the, in, in, in the, in the building. But if you group, you are not able to do that.
Okay. So summary. When should you make the. The election to group your S Corporation Dental practice with your newly purchased building. LLC recommended when the client is acquiring the building and plans to operate their long term, that's number one, acquires the building and plans to operate their long term.
Number two, wants to harvest depreciation, especially through cost segregation. Immediately. And number three, the dentist has no near term plans for a sale of the building or bringing on co-owners or co-investors in the building or the practice, unless those, uh. That a new person is going to be another dentist owning both the building and the practice at the same ratio.
With that everybody, that is the final sum of cost segregation and the relationship between the income and expenses. In your building LLC, with the income and expenses in your S corporation. This is definitely one of the most complicated subjects I've addressed here on the Dental Boardroom Podcast. If you don't on your building, ignore all of it.
If you're planning on buying your building, listen to all of it, maybe two or three times. Until next time, everybody have a great one.
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