Aligning Business Structure with Tax Strategy

 

If you own real estate and/or high-value equipment—CNC machines, welders, forklifts, even IT infrastructure—and you’re not leasing it to your own manufacturing company through a separate entity, you might be leaving money and protection on the table.

Self-renting equipment is a strategy where business owners hold key property in one legal entity and lease it to another entity they also own. It may sound like paperwork for paperwork’s sake, but done right, it can unlock tax benefits, protect assets and improve long-term planning.

But it’s not without complexity. The IRS has specific rules about self-rentals and missteps can lead to audits or lost deductions.

Why Lease Equipment to your Own Business?

  • Legal Liability and Asset Protection

In manufacturing, equipment failure or accidents can trigger legal claims. Holding real estate or equipment in a separate legal entity creates a liability barrier between operating and holding companies. If something goes wrong on the shop floor, the equipment company may be shielded from direct claims—and vice versa.

This can be especially useful when third parties are involved in service, transport or co-location agreements.

  • Control and Flexibility

While owning equipment within your operating company gives you control, structuring it through a self-rental arrangement adds strategic flexibility. You can formalize the terms of use, set maintenance schedules, plan replacement timelines and manage residual value — all while separating ownership from operations.

Want to sell your manufacturing business down the line but keep the machines and lease them to a new owner? You can. Need to transfer the equipment entity to your kids while maintaining operational control? That’s also on the table.

  • Financing and Collateralization

Separately held real estate can serve as collateral for loans independent of business operations. It also simplifies asset valuation for financing, acquisitions or divestitures.

  • Succession and Exit Planning

Separating business operations from property ownership allows for more flexible exit and estate planning. Owners can transfer ownership of the business or the real estate independently, making it easier to transition assets to heirs or buyers.

Tax Treatment: Where Things Get Complicated

While the legal and operational benefits are straightforward, tax treatment of self-rental arrangements is more nuanced. Rental income is typically considered passive under IRS rules. However, when the rental is to a business in which the taxpayer materially participates (i.e., is actively involved in daily operations), special self-rental rules apply. (For more on material participation, see IRS Publication 925.)

Self-Rental Tax Treatment Overview

  • Recharacterization of Rental Income

Self-rental rules fall under IRC Section 469, which governs passive activity loss limitations:

  • Income from renting to a commonly owned business in which the taxpayer materially participates is reclassified as non-passive (active) income.
  • Losses, however, remain passive. These passive losses cannot offset active income and may be suspended and carried forward until they can be used to offset other passive income.
  • Important: Passive losses from the self-rental activity can be applied against future active income from the same activity.

  • Why This Matters

This mismatch in treatment means:

  • If the rental generates profit, passive losses from other investments cannot offset the income.
  • If the rental produces a loss, it may be suspended unless the taxpayer has other sources of passive income.

Compliance: What the IRS Expects

  • Fair Market Rent

Leases between related parties must reflect fair market value. Documentation supporting rent calculations should be maintained and reviewed periodically. Over- or undercharging rent may draw IRS scrutiny.

  • Grouping and Aggregation Elections

Taxpayers may elect to aggregate rental and business activities to treat them as a single economic unit. This election allows rental losses to offset business income. However:

    • The election must be made in the initial year the activities are reported.
    • A formal statement must be attached to the tax return to establish the grouping.

When Does This Work Best?

Despite the complexity, self-rentals can offer substantial tax benefits under the right circumstances:

  • Net Investment Income Tax (NIIT) Exemption: Rental income reclassified as non-passive is not subject to the 3.8% NIIT that typically applies to passive income.
  • Qualified Business Income (QBI) Deduction: If grouped properly, self-rental income may qualify for the 20% QBI deduction, which usually excludes rental income unless specific criteria are met.

Self-renting property to your manufacturing business isn’t just a tax trick—it’s a strategy. It gives you control, protection and options for the future. But it needs to be done right.

Between tax rules, fair market rent requirements, entity structuring and bookkeeping, this is not something to DIY.

If you’re buying new property, restructuring your business or planning for succession—now’s the time to evaluate if a self-rental structure fits.

Talk to an advisor who understands both manufacturing and the tax code. When aligned with your long-term goals, self-renting property can be a powerful way to grow, protect and transition your business wisely.

Contact a manufacturing advisor to start building a strategy tailored to your business.