The tax code severely limits losses generated from passive real estate holdings. These kinds of losses are capped at low levels and in many cases excluded entirely. If, however, the taxpayer has passive income from other real estate holdings the loss can offset that income.

A strategy to avoid this limitation occurs when the taxpayer rents real estate to his or her business operated through a corporate structure. The rental income received from the taxpayer's business would be passive and theoretically could offset otherwise excluded passive losses. The strategy in effect was designed to convert active business income into passive rental income and allow offsets of passive losses against this income.

The IRS set up guidelines therefore reclassifying rental income from a taxpayer's business as active income, therefore preventing the offset of passive losses. An appeals court recently upheld this rule.

Despite this however, there are situations where it can still be advantageous for a taxpayer to rent personal real estate to his company. If the business is an "S" Corporation this structure can be used to reduce self-employment tax.

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