There is a controversial area of passive losses that you need to be aware of if you rent property to an entity that you materially participate. The rules that you follow in this situation are the so-called self-rental rules. The self-rental rule is a creature that was created from Regulation Section 1.469-2(f)(6). It is a difficult regulation to read but roughly translates to "If a taxpayer has rental income from property rented to a business in which the taxpayer materially participates, any net rental income for the year is deemed "nonpassive" (not further defined beyond this). If there is net rental loss it is considered passive."

The self-rental rule only exists to recharacterize income. The purpose of the self-rental rule is to recharacterize what is otherwise passive income into "nonpassive income." However, if a loss occurs it is a passive loss. The determination of the effect of this rule is determined before netting of the properties.

The self-rental rule exists to deny taxpayers the opportunity to construct tax avoidance schemes by leasing property to business entities in which they materially participate, and then using the net rental income as passive income to offset passive losses from other sources.