Doctors: Buying a Building for Your Practice? Read This First.
One small mistake can silently destroy the tax benefit you’re expecting.
Many of my dentist friends either own — or plan to own — the building where they run their practice.
I wrote this specifically for those planning to buy.
There is a very common tax trap here, and if you miss it, the tax benefit you’re counting on can disappear completely.
If you own a dental (or medical practice) taxed as an S corporation and are shopping for a building to practice out of, read this carefully.
The Strategy Everyone Is Thinking About
Here’s the setup most doctors have in mind.
Your practice is doing well. Let’s say it nets $1 million per year. You’re looking for a clean way to reduce taxable income and you’re thinking:
The practice, which you own 100%, operates as an S corporation
You buy a building for $2m through an LLC you also own
The practice pays rent to that LLC
Then you do a cost segregation study, generate a large loss in year one (say $500k), and use that loss to offset practice income.
On paper, your taxable income drops from $1m to $500k.
Brilliant!
This can be an excellent strategy — but only when it’s implemented correctly.
Before you buy the building, you need to understand exactly when this works and when it does not.
If you structure this wrong, the tax benefit you’re counting on can disappear overnight.
Scenario 1: Standalone Building, 100% Used by Your Practice
You buy a standalone building.
Your practice occupies the entire building.
There are no other tenants.
In this situation, the IRS allows you to group:
Your operating business (the S corporation), and
The rental activity (the building owned by your LLC)
When grouped correctly, they are treated as one activity for passive loss purposes.
To do group them, two requirements must be met.
Requirement 1: One Economic Unit
The activities can be treated as one economic unit if:
You own both,
They are related in function,
They are in the same location,
They are economically interdependent.
This comes from Treasury Regulation §1.469-4(c)(1).
Requirement 2: Same Ownership Proportion
One of the simplest ways to satisfy the second requirement is found in Treasury Regulation §1.469-4(d)(1)(C).
You must own the same proportion of each activity.
If you own 100% of the practice and 100% of the building, you pass.
Result:
Losses from the rental property (including cost segregation losses) is treated as active (i.e., non-passive) losses and can offset active income from your dental (or medical) practice.
This is the scenario most people picture when they hear about this strategy.
The catch?
Finding a true standalone building is often much harder than it sounds.
Scenario 2: Multi-Tenant Building, Only One Unit Is Yours
Now the dangerous version.
You buy a 10-unit building instead — maybe because it’s “a good deal.”
Your practice occupies only one unit.
The other nine units are rented to unrelated businesses.
Even if you own the entire building, this fails the first test. Why?
Because the building is no longer primarily part of your operating business. It’s a true rental property with multiple tenants. The practice and the building are not an appropriate economic unit.
You cannot group them.
Result:
The cost segregation loss (as well as other rental losses) are passive
It cannot offset your active practice income
The strategy fails (and yes, this is where people cry)
This is how doctors lose hundreds of thousands of dollars in expected tax savings.
The Takeaway
Buying a building for your practice is not automatically a tax win.
The details matter:
What type of building you buy
How much of it your practice occupies
How ownership is structured
Before you close on a building, run the facts with a tax professional who understands passive activity grouping rules.
Fixing this after the purchase is often impossible.
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