A Hidden Tax Strategy for Business Owners: How Self-Rental Can Cut Taxes and Reduce Risk

What if a single tax strategy could legally sidestep self-employment tax, protect your assets, and reduce your audit risk—all without changing how much money your business earns?

This is exactly what the self-rental strategy can do for business owners who also own their business property. Though rarely discussed outside advanced tax planning circles, this method—when implemented correctly—can provide significant tax advantages while also strengthening liability protection.

Here’s how it works, why it’s legitimate, and how to take advantage of it using a real-world example (with altered names and figures for illustration).

The Scenario: Meet Alex and Priya

Alex and Priya run a digital marketing firm structured as an S corporation. They have three full-time employees and operate out of a 3,500-square-foot office building that they personally own. Right now, all the expenses related to the building are paid directly by the operating business.

Building-Related Costs:

  • Depreciation: $28,000
  • Utilities: $22,000
  • Property Taxes: $24,000
  • Insurance: $14,000
  • Mortgage Interest: $18,000
  • Repairs and Maintenance: $12,000
  • Total Building Expenses: $118,000

Their firm generates $470,000 in annual net income before these expenses and before paying themselves. Each owner takes home $55,000 in wages and another $120,000 in distributions. This raises red flags with the IRS, especially regarding “reasonable compensation.”

The Solution: Create a Legal Self-Rental Arrangement

Step 1: Form a Separate Legal Entity to Hold the Property

Alex and Priya set up a new LLC to hold the building, transferring the property and mortgage into it with lender consent. This move separates real estate from the operating business and enhances liability protection.

Step 2: Establish Market-Based Rent

They determine market rent is $28/sq ft, or $98,000 annually for their space. Commercial leases are typically triple-net.

Step 3: Draft a Triple-Net Lease Between the Entities

The S corporation leases the space from the LLC for $98,000 annually. It continues to pay operating expenses per triple-net standards.

Resulting Financial Shift:

  • LLC (Real Estate Holding Company):
    • Rental Income: $98,000
    • Expenses: $46,000
    • Net Income: $52,000
  • S Corporation (Operating Business):
    • Rent Expense: $98,000
    • Operating Costs Paid: $72,000
    • Total Building-Related Deductions: $170,000
    • Net Income Before Salaries: $300,000

The Tax Benefits of Self-Rental

By shifting $52,000 of profit into the real estate LLC, Alex and Priya:

  • Avoid self-employment tax
  • Avoid the 0.9% Medicare surtax
  • Avoid the 3.8% Net Investment Income Tax
  • Reduce audit exposure
  • Preserve QBI deduction eligibility

If they later sell the business but keep the building, they can still treat the rental income as active for up to 10 years under IRC §469.

Why This Strategy Works

The IRS allows this if the arrangement is legitimate and arms-length, requiring:

  • Separate legal entity ownership
  • Fair market rent
  • A formal lease
  • Standard commercial practices

Final Thoughts

This isn’t about gaming the system—it’s about using the tax code strategically. If you own your business and its building, self-rental could provide major tax savings and better structure with minimal effort.