Should Your Medical Practice Own the Building? Entity Planning for San Diego Physicians
She is a physician in San Diego. She runs her practice through a single LLC. The practice is profitable — $520,000 last year. She also owns the building her practice occupies, a medical office she bought in Mission Valley six years ago. Both activities sit inside that same LLC: the patient revenue, the rent she pays herself, the building depreciation. Her preparer files the return, she pays self-employment tax on the full practice profit, and nobody has ever asked whether those two activities belong together.
They probably should not. And separating them is one of the highest-leverage moves a physician in private practice can make.
The Single-Entity Setup That Costs You
A single LLC holding both the practice and the real estate creates a handful of silent tax problems. The loudest is self-employment tax. Every dollar of profit the practice generates is subject to the full 15.3 percent — 12.4 percent Social Security and 2.9 percent Medicare — up to the Social Security wage base. On $520,000 of Schedule C income, that is over $20,000 in SE tax for the year, with no way to carve out the income that comes from renting a building rather than treating patients.
The second problem is that the real estate and the practice have fundamentally different tax treatment. Real estate income is generally passive. Practice income is active. When both sit inside one entity, you lose the ability to apply real estate tax strategies — like accelerated depreciation through a cost segregation study — cleanly against the right income stream. You also lose the ability to make separate elections for each activity, like an S corp election on the practice side while keeping the real estate in a flow-through structure.
And there is a third cost that does not show up on Schedule C: the retirement ceiling. A defined benefit or cash balance plan contribution is calculated from the practice's net income. When the real estate is inside the same entity, that calculation gets muddied by rental income that has nothing to do with how much you can fund for retirement.
The Two-Entity Solution
The standard structure for a physician who owns her practice and her building is two separate entities.
One is the practice entity — a professional corporation (PC), professional limited liability company (PLLC), or an LLC that makes an S corp election. This entity collects patient revenue, pays staff, buys supplies, and employs the physician. It also pays rent to the second entity.
The second is the real estate holding entity — typically a separate LLC that owns the building and the land. The practice pays fair-market rent to the holding company under a written lease. That rental income flows to you as the owner of the holding company, but it is not subject to self-employment tax, because rental real estate is not earned income for SE tax purposes.
A multi-entity tax structure like this is common among business owners who operate from a building they own. The practice pays rent, deducts it as an operating expense, and the holding company collects it. Same dollars, different tax treatment.
Why an S Corp Election on the Practice Side Changes the Math
The practice entity — the one that treats patients — is usually the right candidate for an S corp election. Here is why.
When the practice operates as a single-member LLC or a sole proprietorship, every dollar of profit is subject to self-employment tax. With an S corp election, the physician takes a reasonable salary — for a practicing physician in San Diego, that typically lands in the $200,000 to $300,000 range depending on specialty — and the remaining profit is distributed as a shareholder distribution. The salary is subject to payroll tax. The distribution is not.
That saves roughly 2.9 percent on the distribution portion (the Medicare tax half of SE tax; Social Security is capped at the wage base either way). On a practice clearing $520,000 with a $250,000 salary, the annual savings is roughly $7,800.
The key word is reasonable. The IRS has a long history of scrutinizing professional service S corps for below-market salaries. A physician paying herself $60,000 and taking $460,000 in distributions is asking for an audit. But a salary that reflects what a practice would pay a hired physician for that role passes scrutiny and still delivers meaningful savings. We covered the reasonable compensation question for S corps in detail.
What the Real Estate Side Unlocks
Once the building sits in its own entity, real estate tax strategies become straightforward.
The holding company can commission a cost segregation study on the medical office building. An engineering-based study reclassifies components of the building from 39-year property into shorter-lived asset classes — 5-year property (cabinetry, specialty electrical, plumbing for exam rooms), 7-year property (fixtures, decorative improvements), and 15-year property (land improvements like parking and landscaping). Accelerating that depreciation can front-load tens of thousands of dollars of deductions into the current year.
A cost segregation study in San Diego on a $1.2 million commercial property usually identifies 20 to 40 percent of the building cost as reclassifiable. That is $240,000 to $480,000 of accelerated depreciation that would otherwise be spread over 39 years. Bonus depreciation (currently phasing down) can apply to the 5- and 7-year classes.
None of this works as cleanly when the real estate is inside the practice entity, because the passive loss rules mix with active income in ways that complicate the deduction timing.
Stacking Everything: Retirement and Entity Together
The separate entity structure also clears a path to a higher retirement contribution.
A practice earning $520,000 can adopt a defined benefit or cash balance plan that allows contributions far beyond the $23,500 401(k) employee deferral limit. For a physician in her mid-50s, a well-designed cash balance plan can shelter $100,000 to $200,000 or more per year in pre-tax contributions.
But the plan's contribution is calculated from the practice's earned income. When the building is inside the same entity, the calculation has to account for rental income that is not earned income in the same sense. Separating the entities means the practice can adopt a plan based purely on the patient-care income, and the real estate can sit outside the plan entirely.
This is the stacking effect that well-designed tax strategies aim for: entity separation reduces SE tax, cost segregation accelerates depreciation on the real estate, and a cash balance plan maximizes retirement contributions from the practice — each lever working independently, each one possible because the foundation was set first.
The First Step
Setting up a two-entity structure is not complicated, but it does require sequencing.
You form the holding company and transfer the building into it. You execute a written lease between the practice and the holding company at fair-market rent. If the practice is ready to make an S corp election, you file Form 2553 within the deadline. You set up payroll for the practice with a reasonable salary. Then you commission the cost segregation study on the building in the holding company.
The upfront cost includes entity formation fees, the cost segregation study itself, and potentially some transfer tax on the property. Most of those are one-time. The SE tax savings and depreciation deductions recur every year.
For a physician in San Diego earning $400,000 or more who owns her practice and her building, the question is not whether the math works — it is whether her current preparer is the one who should be designing the structure. Most are not. They file the return. They do not design the outcome.
That is the difference between a preparer and a tax strategist in San Diego. If nobody has looked at your entity setup since the day you opened the practice, there is probably a structure change worth at least one conversation.
Ready to find out whether your current entity setup is costing you? Book a free 15-minute discovery call with Roadmap Tax. Call (619) 280-2700 or email info@RoadmapTax.com. The paid strategy session is where the detailed plan with specific numbers comes together — the free call is the first step, not the whole thing.
FAQ
When should a physician consider an S corp election for their practice?
A physician in private practice should consider an S corp election when the practice's net profit consistently exceeds $100,000 to $150,000. Below that, the payroll compliance costs and reasonable compensation requirements may outweigh the self-employment tax savings.
Can I own my medical office building in a separate LLC from my practice?
Yes, and for tax purposes it is often the right move. A separate holding company allows you to isolate rental real estate income from active practice income, avoid self-employment tax on the rent, and apply cost segregation and bonus depreciation more cleanly.
What is reasonable compensation for a physician in an S corp?
Reasonable compensation for a physician in an S corp is the salary the practice would pay a non-owner to perform the same services. For a practicing physician in San Diego, that typically falls between $200,000 and $300,000 depending on specialty, hours, and practice type.
Does moving the building into a separate entity trigger a tax event?
Transferring real estate into a holding company can have California property tax and transfer tax implications. The structure should be reviewed carefully before any transfer, and the county recorder and assessor should be consulted on any reassessment triggers.
How does entity structure affect retirement plan contributions for physicians?
A separate practice entity allows you to base a defined benefit or cash balance plan contribution purely on the practice's earned income, without the real estate income complicating the calculation. This can enable far higher pre-tax contributions than a standard 401(k) allows.
