Should a Physician Own or Lease Office Space? Real Estate Planning for Medical Practices

A physician deciding whether to lease office space or buy the building through a separate entity isn’t just making a real estate decision, they’re stepping into one of the more counterintuitive corners of the tax code: the self-rental rule, which can turn what looks like ordinary rental income into something that isn’t allowed to offset losses the way rental income normally does. Add in the question of whether that rental income qualifies for the 20% qualified business income deduction, whether cost segregation is worth running on a medical office building specifically, and how ownership versus leasing affects the practice’s eventual sale value, and the decision is genuinely more complicated than “renting is throwing money away” or “always buy real estate.”

Why hold real estate in a separate entity, not the practice?

Almost no experienced advisor recommends a physician hold the office building inside the same PC or PLLC that operates the clinical practice, for reasons that are part liability protection and part tax planning.

• Keeping real estate in a separate holding entity (commonly an LLC, sometimes with a separate ownership structure than the practice itself, since real estate ownership isn’t restricted by the corporate-practice-of-medicine rules that govern the clinical entity) isolates the building’s liabilities (a slip-and-fall on the property, an environmental issue, a structural defect claim) from the practice’s clinical and business liabilities, and vice versa; a malpractice judgment against the practice doesn’t reach an asset held in a separate entity, and a premises-liability claim against the building doesn’t reach the practice’s accounts receivable and equipment.
• The separate entity also allows for a cleaner sale of the clinical practice without necessarily selling the real estate, or the reverse, selling or refinancing the real estate independent of any change in the practice’s ownership or operations. A buyer of the clinical practice may want to lease the space going forward rather than buy the building outright, and a separate real estate entity makes that a straightforward lease continuation rather than a real estate transaction bundled into the practice sale.
• The rent the practice pays to the real estate entity has to be set at fair market value for both entities’ returns to hold up; an above-market rent shifts income from the practice (where it may be taxed at the physician’s ordinary rate after the S-corp wage-and-distribution split discussed in our entity structure guide) to the real estate entity, and a below-market rent does the reverse, and either one invites scrutiny if it looks engineered rather than commercially reasonable.

What is the self-rental rule, and why does it matter?

This is the single most important and most frequently misunderstood tax rule in physician real estate planning, because it runs counter to how passive activity rules normally work.

• The passive activity loss rules under IRC 469 generally treat rental activity as passive regardless of the owner’s involvement, meaning rental losses generally can’t offset the owner’s active business or wage income (subject to a limited exception for real estate professionals or the $25,000 active-participation allowance, which phases out at higher income and is often unavailable to a high-earning physician anyway).
• The self-rental regulation, Treas. Reg. 1.469-2(f)(6), carves out a specific and less favorable rule for the exact fact pattern most physician-owned real estate falls into: when the taxpayer rents property to a trade or business in which the taxpayer materially participates (which describes essentially every physician who both owns the building and actively practices in the clinical entity that leases it), net rental income from that property is recharacterized as non-passive.
• The rule is asymmetric by design: it recharacterizes net income as non-passive (so it can’t be sheltered by passive losses from other, unrelated passive investments the physician might hold), but it does not recharacterize a net rental loss the same way; a loss from the self-rental property generally remains passive and stays subject to the normal passive loss limitations. In practical terms, self-rental gets the worst of both rules: income can’t be offset by outside passive losses, and a loss on the same property can’t offset outside active income either.
• This rule is why a physician who owns the office building and also holds an unrelated passive real estate investment or syndication with suspended passive losses often can’t use those suspended losses to shelter the medical office rental income, a combination many physicians assume will work and are disappointed to learn doesn’t, specifically because of this regulation.

Does self-rental income qualify for the QBI deduction?

Generally yes, and this is one place the rules actually work in the physician’s favor, with an important nuance around the specified service trade or business (SSTB) limitation that otherwise restricts QBI for many high-earning physicians.

• IRC 199A allows a 20% deduction on qualified business income from a trade or business, but income from an SSTB, and the practice of medicine is explicitly listed as an SSTB under the statute and regulations, is phased out and eventually eliminated once the physician’s taxable income exceeds the top of the phase-out range ($553,500 for joint filers in 2026, with the phase-out window itself widened to $150,000 by the OBBBA, indexed annually). Most successful physicians end up with no QBI deduction at all on their clinical practice income once they’re well into that phase-out range.
• Rental real estate, standing alone, isn’t automatically a 199A trade or business at all; it has to rise to the level of a genuine trade or business under the regular 162 standard, or fall within the safe harbor in Notice 2019-07 (250 hours of rental services annually, among other requirements) to qualify.
• The regulations under 199A include a specific self-rental aggregation rule: rental of property to a commonly controlled trade or business (exactly the physician-owns-the-building-and-leases-to-their-own-practice fact pattern) is treated as a trade or business for QBI purposes and, notably, is not itself treated as an SSTB merely because the tenant is an SSTB, so long as the rental entity itself isn’t performing services in the SSTB. This means the rental income can potentially generate a real QBI deduction even in a year the physician’s own clinical practice income is fully phased out of QBI eligibility, a distinction worth understanding precisely because it runs opposite to what many physicians assume (“if my practice is an SSTB and it’s over the income limit, none of my related income gets QBI”).
• The actual deduction amount is still subject to the W-2 wage and unadjusted basis limitations that apply to QBI generally above the phase-in threshold, so a real estate entity with little payroll and a fully depreciated building may find its QBI deduction limited by those separate tests even after clearing the SSTB question.

When is cost segregation worth it for a medical office?

Cost segregation, a study that breaks a building’s cost into shorter-lived components (electrical and plumbing systems tied to specific equipment, specialized flooring, built-in cabinetry and casework) instead of depreciating the entire structure over the standard 39-year nonresidential real property life, tends to produce outsized results on medical office buildings specifically, more than on a typical office building.

• Clinical space carries a disproportionate share of building cost in systems that qualify for shorter recovery periods: dedicated electrical circuits and backup power for medical equipment, specialized plumbing for exam rooms and procedure areas, reinforced flooring in radiology or surgical suites, built-in cabinetry, and certain HVAC components serving specific clinical zones. A cost segregation study on a general office building might reclassify 15% to 20% of cost into shorter-lived categories; a medical office building frequently reclassifies 25% to 40% or more, given how much clinical-specific infrastructure is embedded in the build-out.
• Reclassified components generally qualify for 5, 7, or 15-year MACRS lives instead of 39 years, and, when placed in service after January 19, 2025, potentially for 100% bonus depreciation under the restored IRC 168(k) rules discussed in our physician tax deductions guide, meaning a large share of the accelerated cost can be deducted in the acquisition or construction year itself rather than spread over decades.
• Cost segregation is most valuable on a newly purchased or newly constructed building, or one recently renovated for clinical use, since the study is reconstructing the original cost basis by component; an older building with minimal recent improvement generates a smaller benefit relative to the cost of the study itself.
• The self-rental rule discussed above doesn’t disappear just because depreciation from cost segregation creates a loss in a given year; a loss from the self-rental property is still passive and subject to the passive loss limitation, which means an aggressive cost segregation study that pushes the real estate entity into a loss position may not generate an immediately usable deduction against the physician’s other income, a timing consideration that should be modeled before committing to the study, not discovered afterward.

How does owning vs leasing affect a future practice sale?

Real estate ownership changes the mechanics and often the attractiveness of a practice sale, a topic covered in full in our practice sale guide, but the interaction with the leasing decision is worth flagging here.

• A buyer of the clinical practice (a private equity-backed group, a hospital system, or another physician) is typically pricing the clinical business, its patient base, provider contracts, and cash flow, separately from any real estate. If the physician owns the building personally or through a separate entity, the sale of the practice and the disposition (or continued lease) of the real estate are two separate transactions, which generally gives the seller more flexibility: sell the practice, keep the building, and collect ongoing lease income from the new owner as a landlord.
• If the practice leases from an unrelated third-party landlord, the sale is simpler in one sense (no real estate decision bundled in) but leaves the physician with no residual real estate income stream after the sale, and the buyer inherits whatever lease terms exist, which can be a negotiating point either way depending on whether the existing lease is favorable or burdensome relative to current market rent.
• Physicians planning an eventual practice sale should think of the real estate decision partly as a post-sale income planning decision: owning the building and continuing to lease it to the buyer after selling the clinical practice is a common and often attractive way to retain a stream of income into retirement, distinct from and in addition to whatever the practice sale itself generates in goodwill and asset value.

What should a physician do before buying or leasing?

Model the self-rental income recharacterization before assuming any passive losses elsewhere in a real estate portfolio will offset the office building’s rental income, since that assumption is wrong often enough to be worth checking explicitly. Run the QBI analysis on the rental entity separately from the clinical practice’s own QBI position, since the two can land in genuinely different places. And get a cost segregation study quoted and modeled, accounting for the self-rental passive loss limitation, before assuming the accelerated depreciation translates into an immediately usable deduction.

Related guides:

• Medical practice entity structure: PC, PLLC, and S-corp election, for how the practice entity and the real estate entity should be kept separate
• Tax deductions for physicians: equipment, CME, and malpractice insurance, for the bonus depreciation rules referenced in the cost segregation discussion
• Selling a medical practice: goodwill, non-competes, and capital gains treatment, for how real estate ownership plays into a practice sale
• Starting or buying a medical practice: startup costs and purchase price allocation, for the acquisition-stage version of this real estate decision

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.