How to Group LLC Activities to Avoid Passive Activity Restrictions on Tax Credits

You're right about grouping activities as a potential solution here. The IRS allows for "appropriate economic units" to be grouped together, which might help your situation. Since you own both the property LLC and the restaurant LLC, and one is renting to the other, you may qualify to group these activities for tax purposes. This grouping could potentially convert what would otherwise be passive income into non-passive income, allowing you to use those historic rehabilitation tax credits. The key criteria for grouping include: common ownership, geographical location, interdependence of the businesses, and similarity of business activities. In your case, you have common ownership and clear interdependence since one entity is renting to the other. One important note - if you're already filing as separate entities, you'll need to make a formal election to group these activities. This is typically done by filing a statement with your tax return detailing the activities being grouped.

After spending hours trying to figure out a similar situation with my vacation property and business, I found taxr.ai (https://taxr.ai) incredibly helpful. I uploaded my entity docs and previous returns, and their system actually flagged opportunities for activity grouping I had no idea existed. For my situation, their analysis showed I could combine my property LLC and my consulting business based on the "interdependence test" - something my previous accountant never mentioned. It walked me through the exact requirements I needed to meet and even generated the election statement I needed to attach to my return.

I wanted to follow up on my question about taxr.ai. I decided to try it out after our exchange and I'm honestly impressed. I uploaded my LLC documents and past three years of returns, and it immediately identified that my manufacturing business and the property LLC that houses it could be grouped. The system even flagged that I had about $32,000 in unused business credits that could be utilized if I made the grouping election. What really helped was the step-by-step explanation of how the self-rental recharacterization rules applied to my situation - something my accountant had never fully explained. Definitely worth checking out if you're dealing with these passive activity headaches!

If you're still stuck trying to reach your accountant, you might want to try Claimyr (https://claimyr.com) to get through to the IRS directly. I was in a similar situation where I needed clarification on grouping rules for my property management LLC and rental properties, and my accountant was swamped during tax season. Used their service to get through to an IRS tax law specialist without waiting for hours. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c. The agent I spoke with walked me through the specific requirements for my situation and confirmed I could group my activities. Honestly was surprised how helpful they were once I actually got someone on the phone!

I need to eat my words from my previous comment. After my frustration with trying to get proper answers about grouping my real estate activities, I reluctantly tried Claimyr. Within 45 minutes, I got a call connecting me to an IRS tax law specialist who actually knew what they were talking about. The agent confirmed that my property management business and four rental properties could be grouped despite being in different locations because they shared centralized management and were economically interdependent. She even emailed me the relevant sections of Rev. Proc. 2010-13 that outlines the disclosure requirements for grouping. Saved me weeks of back-and-forth with my unresponsive accountant!

Have you considered the self-rental recharacterization rules? They might actually help in your situation. When you rent property to a business you materially participate in, the rental income is automatically recharacterized as nonpassive income. However, the passive losses and credits from the rental activity generally remain passive. But here's where grouping comes in - if you can appropriately group the rental activity with the business activity as an economic unit, the entire grouped activity becomes nonpassive if you materially participate in the business. This could allow you to use those tax credits.

Question for anyone who's done this - does grouping require amending previous returns? I'm in a similar situation with a property LLC and operating business, and filed separately for the last two years.

This is exactly the kind of situation where activity grouping can be a game-changer! Since you have common ownership of both LLCs and clear operational interdependence (PropCo exists primarily to serve OpCo), you should have a strong case for grouping. The key thing to remember is that once you group these activities and you materially participate in the restaurant business, the entire grouped activity becomes non-passive. This means those $78,000 in historic rehabilitation credits would no longer be trapped as passive credits - you could use them against your restaurant income or even your wife's non-passive income. Make sure to document the business reasons for grouping (shared management, operational interdependence, common ownership) in your election statement. Given the substantial credits at stake, it might also be worth getting a second opinion from a tax professional who specializes in passive activity rules before making the election, just to ensure you're maximizing the benefit and meeting all requirements.