In this episode of Tax Tuesday with Anderson Advisors attorneys Eliot Thomas, Esq., and Amanda Wynalda, Esq., we dive into essential real estate investment strategies and tax implications for property owners. Discover why selling a rental property to your LLC is considered a prohibited transaction and learn how to protect capital gains from your primary residence using the 121 exclusion. We discuss the limitations of 1031 exchanges for properties flipped within a year and outline how to determine a reasonable salary from your S-Corp while considering payroll taxes. Additionally, we clarify the requirements for maintaining real estate professional status, the treatment of capital gains within an S-Corp, and the nuances of deductions for short-term rentals. Tune in for valuable insights to optimize your investments!
Submit your tax question to taxtuesday@andersonadvisors.com

Highlights/Topics:

• I just purchased a property through a self-directed IRA and LLC. I own a rental property. Will I be able to sell the rental property to my LLC? – No, you cannot personally benefit, this is a prohibited transaction.
• How can I protect the capital gains from selling my primary residence after adjusting the cost basis? And after taking the 121 exclusion and utilizing that money for investment purposes. – If the home was used as a personal residence for two of the last five years, you might be able to take some money off – it’s 250,000 if you’re single, 500,000 married filing joint.
• Can I use the 1031 exchange when flipping properties under one year of ownership? – The IRS looks at the property as “inventory.” So although it is being used in a ‘trade or business’ you can’t use the 1031.
• How do you determine the right pay for yourself? Is it worth the taxes you pay into Medicare and Social Security? So far, we’ve paid $30,000 in payroll taxes. Will that go towards our tax bill at the end of the year? – You have a ‘reasonable salary requirement’ from an S-Corp. It ranges from 38% to 60%.
• What minimum must you do to maintain your real estate professional status and not be considered a dealer if you intend to flip a house? – REP status is when you spend 50% of your personal services time and at least 750 hours in your real estate trade or business.
• What happens with the capital gain from stocks or from the sale of a rental property when inside of an S-Corp? – It is not ‘ordinary income’- the building is under “separately stated”.
• What is the list of deductions with a STR that’s a short-term rental for those of you in the know in the REI, as passive income when material participation is not met compared to a list of deductions when material participation is met? – There is no difference between passive and non-passive deductions. Google IRS PDF Schedule E.
• If I volunteer my work or time at a nonprofit, is this tax-deductible? – the short answer is no, but you can deduct things like mileage
• I have a W-2 and 1099 income. Bought a house to flip. How can I best take advantage of this financially to save on tax? – you may be able to run certain deductions against your income.
• How does rental property via an LLC affect personal taxes? – we get this question all the time recently. Set up in a disregarded LLC, no impact at all on your personal taxes.

Resources:

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Full Episode Transcript:

Eliot: “How does a rental property via an LLC affect personal taxes?” There were a lot of questions, about five to seven questions, that ran around kind of in that same ballpark so I thought we’d add it in there and maybe straighten that out for you all.

Amanda: That makes a lot of sense. The entity or pass-through taxation tax filing deadline was last week, September 15th.

Eliot: It’s passed.

Amanda: Passed through. It’s September 15th and so people are starting to think about filing their personal tax returns. That is if you filed an extension. If you didn’t file an extension?

Eliot: Then we’re way past.

Amanda: Alright, for all your tax living needs, you can follow Toby Mathis. He’s a founding partner here at Anderson Advisors on his YouTube channel, smash that subscribe button, hit that like button, and sign up for alerts. If you just want to watch these late at night when you can’t sleep. That’s what I do. You can’t stop thinking about tax, right?

Eliot: Can’t stop learning.

Amanda: Also, we have Clint Coons, our other founding partner. His channel is more geared towards asset protection and real estate investing. Both of them together have over 300 properties, and real estate investors. They obviously run Anderson Business Advisors. All of this is real-world tested strategies, tax deductions, and things like that. Give them a follow and a like.

Eliot: Yes.

Amanda: I want to talk about our tax and asset protection workshop.

Eliot: What do we get here? I think we have one coming up here. Do we not? In fact, that’s why they’re not here. We have one coming up in San Diego this weekend. I think it’s Thursday, Friday, Saturday.

Amanda: Yeah. It’s our live event. Every quarter we host a live event. All tax and asset protection partners are in town. A lot of our attorneys are advisors and you can come visit us. We’ve done it in Orlando and Dallas so far this year. This weekend we’ll be out in San Diego.

I think there are still tickets left so head on over to our website if you want to join us. Then I think later this year we’ll be in Vegas. We always try to do at least one in Vegas since we’re mostly based in Vegas. But we also have our webinars, our day long webinars.

Eliot: We got that coming up on Saturday, October 5th, the 19th, and December 5th through the 7th. There you can get in and just watch from home. I’m sorry, the 5th through the 7th is live. That is our Vegas. There we go. The 5th through the 7th, it’s going to be live in Vegas.

Amanda: Eliot will be there. We’ll make him come. If enough of you email in or like, we need to see Eliot in person live in Vegas.

Eliot: Complete silence.

Amanda: Complete silence. The Saturday webinars are really like a boot camp. It’s 9 AM to about 4:30 PM or 3:00 PM. The first half’s asset protection. The second half is tax. I teach advanced tax strategies. I’ll actually be there October 5th and 18th. You can’t get enough of me. Sorry.

Eliot: Good stuff.

Amanda: Sad for you. Alright, first question. “I just purchased a property through a self-directed IRA and LLC. I own a rental property. Will I be able to sell the rental property to my LLC?”

Eliot: We got this property outside of our plan. We know there’s a lot of cash in there. Why not just sell it to the plan? Get some of that money out and we can take it out and do whatever we want with it. Well, we can’t because it’s called a prohibitive transaction. That’s a no. The quick answer is no.

These transactions where you benefit as an individual from something done to or from with the plan, that’s what’s going to get us into trouble and it’s pretty broad and it’s pretty deep. What gets us into that? Anytime you’re thinking that there’s something that you might personally benefit from, you can pretty much count that it’s gonna be a prohibited transaction.

Amanda: Yeah, when I think about an IRA, I like to describe it as being sort of on a planet of its own. You’re on Earth, you can do things on Earth. Your IRA is on Mars, we don’t have the technology or the ability. The IRS says, no, you can’t go to Mars so you’re not doing any sort of business transaction with your IRA.

Not just you, it also disqualifies your spouse, your lineal descendants, that’s going to be your kids, and any companies that they own or run. None of those can do any business with your IRA or the property inside.

Eliot: All those related parties.

Amanda: All those related parties and that’s the reverse too. If you own a property, you can’t reverse-sell it to your IRA. That’s going to be a prohibited transaction. What happens if your IRA participates in a prohibited transaction?

Eliot: We can destroy it. That basically means that all of it becomes taxable immediately and you want to talk about doing some tax planning. That’s where we have to really break out the big guns.

Amanda: Yeah, we want to have to do that kind of planning so it’s considered essentially distributed to you on the first day of the year. If you mess up and do a prohibited transaction on December 30th, it’s treated as having been distributed to you on January one.

Eliot: You got to call us up. We got to get to work on tax planning.

Amanda: That being said, if you purchase a property within your IRA, you’re using IRA funds to purchase the property initially, and you want to then transfer it to an IRA owned LLC. Then that is 100% allowable and we actually do recommend that for asset protection purposes. That means you have that limited liability protection so that if something happens on the property, that LLC is sued, you’re not necessarily putting all of your IRA assets at risk. That’s all the other cash that could be in their stocks, bonds, ETFs, those types of things.

Eliot: Absolutely.

Amanda: Alright. Okay. Question number two. “How can I protect the capital gains from the sale of my primary residence after adjusting the cost basis and after taking the 121 exclusion and utilize that money for investment purposes?”

Eliot: What we got going on here, if you sell your primary residence, first of all, we want to understand what a capital gain is, you bought at some point for a certain amount. Let’s say you bought it for $200,000 and now five or 10 years later, it’s worth half a million, and you want to sell it. While your original basis was $200,000 and there’s some things that can impact that, we won’t go too deep into that. You’d subtract that from the $500,000 sales price. You have $300,000 again.

But in step this 121, 121 is an exclusion just for our primary residence, and it says if it’s your personal residence that you’ve owned and used as a personal residence for two of the last five years, you might be able to take some money off. Usually, it’s $250,000 if you’re single. It’s $500,000, married, filing joint.

In this case, we’re going to take that original basis, $500,000. If we’re single, then we’d be $250,000, that’s $450,000 that we don’t have to pay tax on in that example, subtract it from the $500,000, and you’d only have $50,000 of taxable gain at that point. Outside of doing 121, there’s really nothing we can do against that pile of money related to the sale of the house. Sometimes we can use another entity, yes?

Amanda: Yes.

Eliot: What is that entity? Any idea?

Amanda: We teach a strategy and I go over this in detail in our Saturday webinar, but if you have your primary residence and you want to keep it perhaps as a rental and you just turn it into a rental, then you’re looking at a depreciation deduction based on that original basis, that $250,00. That’s a smaller deduction that you get to take for the business use of your home.

Instead, we’re losing out on that 121 exclusion, that gain excluding that gain, and also we have a pretty low-cost basis if we’ve owned the property for a long time. What you can do, if you don’t want to necessarily sell, you want to keep it as a rental, you can sell it to your own S Corporation and you can sell it for fair market value.

You do need a little bit of cash, at least 10% down, to put into the S corp so that it can purchase your primary residence from you. Again, this is a fair market value, legitimate sale transaction. What you’re going to do is you’re going to set it up as an installment sale and installment sale, also known as seller financing means that you as the property owner, have sold the property to your S Corp, the S Corp’s going to pay a reasonable interest rate and make loan payments to you over the course of five, 10, or 30 years, however long you want to set that loan for, your seller financing it.

Then when you go to report on your tax return, you’re going to recognize all of the gain from the sale in year one so then you’ll be able to stack that 121 exclusion right on top of it. Take that exclusion of $250,000 or $500,000, depending on if you’re married or single or married filing jointly. But moving forward, you’re actually only getting paid in monthly increments, so you’re only then going to be paying tax on that small amount of interest that you receive each month.

That’s a great way to not only take advantage of the 121 exclusion, but keep the property and continue to rent it out while resetting your depreciable basis on it.

Eliot: That depreciable basis being higher, as Amanda pointed out, definitely helps us reduce the cost for assuming against the income coming in from the rental aspect, but remember, we can’t. Because it’s a related party, again, you’re selling to your own S corporation, we can’t do bonus, you hear us talk often about bonus depreciation, so just a little reminder there.

Amanda: We are still doing a straight line.

Eliot: Yes, we’re still doing straight lines. As Amanda also pointed out, she pointed out a lot, but you have to recognize all the gains, if any, that particular year. Exactly right.

Amanda: There are usually some questions that come from the 121 exclusion so you say two out of five years. Does that need to be the most recent two years?

Eliot: That’s a great question. It just says the last five years. It doesn’t specify. In fact, when you look into some of the calculations, sometimes they go by month, sometimes they go by number of days. Basically within a 360-day period or 365, whichever the code is using, they do use both of them sometimes. As long as you meet two years within the last five years, non consecutive or consecutive, we’ve ticked that box.

Amanda: Yeah, if you’ve lived in your primary residence, you’ve moved out maybe, you’re thinking if I move back in to meet that 24-month marker, then you can implement this strategy as well. Even if you’re not doing the whole S Corp sale and keeping it as a rental, you could still take advantage of that 121 exclusion.

Eliot: We used to see that a lot with deployed military. They leave the house, they’re overseas or whatnot, and they come back. As long as they’re still within that five-year window when they do everything, they move back in, they can take advantage.

There are, just so you know, other unique situations when you have to move because of work like that, that come into the 121. We’re not going to go into those today, but just be aware if you run into things and something made you move for work-related, you might still be able to do some things there.

Amanda: Yeah. Alright, “Can I use 1031 exchange when flipping properties under one year of ownership?” What’s a 1031 exchange? Let’s start there.

Eliot: Yeah. Definition is definitely here. In a 1031 exchange, you have an asset that’s used in a trade or business. That means on a regular course through running the trader business. You got a washing machine, whatever it is, you can exchange it for like-kind material. Now it used to be before the 2017 Tax Cut and Jobs Act, I could exchange cars, had clients do that with trucks and things like that in the business. But now after the Tax Cut and Jobs Act, we can only do it with real estate. We got to have a rental or something like that, that we use in a trader business.

Amanda: Held for investment purposes.

Eliot: Absolutely. We exchange that. That’s the relinquished property and then we pick up a new property that we’re still going to use in a trade or business, and that’s the replacement property. The idea is that if we do this properly and the numbers check out alright, then we can defer any of our taxes. We don’t have to pay any taxes, defer them.

That doesn’t mean we don’t necessarily have to pay them later on. We just don’t have to pay them now. It’s possible to defer them for the rest of your life. I passed away. I leave it to somebody, they will get a stepped-up basis and never have to pay tax on it and that way it was basically deferred.

Amanda: All you got to do is just got to die.

Eliot: You just got to die.

Amanda: Easy peasy.

Eliot: You can’t beat that.

Amanda: Alright. How does that differ from flipping properties? Because when you’re flipping, you’re not holding the property for investment.

Eliot: But you’re using it in a trader business and that’s why we get asked this a lot because you’re flipping, that is a trader business and we’re going to use that in a trader business in the future questions we have coming up here. But the IRS looks at it differently.

Yes, it’s real estate. Yes, you’re flipping in the sense that it’s using a trader business because it’s part of your flipping business, but the IRS looks at it as inventory, and that’s the big difference that Amanda’s pointing out.

It’s no different than going down to Target or Walmart and picking something off the shelf. It’s just inventory. We’re not allowed to do a 1031 with that. It’s got to be something that was used in the everyday running of trader business or investment, and that’s certainly not inventory. We got kind of a mix-up here and this is why I like to pick these types of questions because they really are starting to kind of go off-center. We have 1031. We know that’s for exchanging things that are used in a trade or business, real estate, flipping something different where we picked up a property, we fixed it up, and then we sell it right away, like inventory. We can’t use a 1031 with that. Those are two different things.

The one year of ownership, why do you think that’s going about?

Amanda: A lot of times people have the misconception that if you purchase a property, for a flip and then you decide to keep it and you hold it for at least a year, some say if you purchase it in one year, hold it at least to the next year, that you can sell it under a 1031 exchange and get the tax benefits, but no, you can’t.

Eliot: The IRS is going to look at that typically and they’re going to say, look, you can’t change that intent. You held onto it. It was always with that business so it’s very very difficult to try and prove that you ever changed the intent.

In fact, Toby and Scott Estill, work with Toby on the tax toolbox. We have a video, one of the earlier videos where they go over exactly this point. There’s a famous case that I can’t remember the name of.

Amanda: Famous but you don’t even remember the name.

Eliot: That’s what we have Toby for. He remembers all those. But this went on for over a decade. They had bought a property that they intended to sell off the little pieces, flip it, what have you. But over 10 years, they didn’t sell it and the IRS still came back a decade later, a decade plus and said, no, no, no, no, that’s ordinary income, essentially flipping. It doesn’t matter that you had it over a year, but why do we talk about the one-year one?

One thing is because one year is associated or greater associated with what we call long-term capital gains tax, which means. If this was a capital, we held it, we held it over a year, and if we could sell it as a capital asset, we’d only have to pay 20%, maybe 15%, maybe zero, depending on our tax brackets.

But because it’s considered ordinary income, it’s going to be out of ordinary bracket rates, maybe 37%, something like that, 32%, what have you. We got a lot of confusion going on here. The 1031 is for something in a trader’s business. Flipping is completely unrelated and if we’re thinking of flipping, that means we’re never going to run into this one year of ownership that’s irrelevant.

Amanda: Even if you’re a bad flipper.

Eliot: Even if you’re a bad flipper.

Amanda: [inaudible 00:15:45] for more than a year. It’s really your intent when you purchase the property and you may think, well, I can just go into it and not decide, not knowing what I want to do. But as real estate investors, there are a lot of factors that go into purchasing a property.

For the most part, they’re going to lean on what the actions you then take in terms of all of that. If you’re a flipper and you only flip properties, it’s going to be really hard to convince the IRS that in just this one occasion, you didn’t intend to flip.

Eliot: But just real quick to expand on where Amanda was going there. What if you do have a house and you’re not sure what you want to do with it? You don’t know if you want to flip and I have been there that I actually have done. Lost everything on that investment, but nonetheless real estate still I back it all the way. It’s a great investment, but I didn’t know. I didn’t know if I wanted to flip it. I didn’t know if I wanted a rental. But I’m not going to put it in the C Corp unless I know that I know that I know that I’m gonna flip. Then I’m going to put it in my corporation, flip it underneath there, and then I’m okay because I know that I used it for flipping purposes.

Easy to put things into a corporation, as we always say, not so easy to get them back out. Wait till you know what you want to do with that thing. If you’re going to flip it or keep it as a rental, is what I’m getting at, then decide which pathway to take.

Amanda: Alrighty. Another S Corp. “When taxed as an S Corp and on payroll, how do you determine the right pay for yourself? Is it worth all the taxes you pay into Medicare and Social Security? And so far, we’ve paid $30,000 in payroll taxes. Will that go towards our tax bill at the end of the year?”

Let’s attack this piece by piece. You have an S corp. You do have a reasonable salary requirement and that reasonable salary is 33%–60% of the net income. You’re looking at all the income that comes into the S Corp, you’re taking all of the normal business expenses as deductions, and then you have to pay yourself at least one-third up to 60% of what’s left.

We have a lot of clients who, if you don’t necessarily know how much your S Corp is going to make at the end of the year, there’s no requirement that you’re paid every two weeks or every month. That’s more of just normal business practices because when you’re paying employees, they want to be paid more frequently. If it’s just you being paid payroll, you can do those calculations at the end of the year and just pay yourself one lump sum. That’s sometimes easier to implement some of the strategies that we implement for S Corp.

First of all, you do have to pay yourself a reasonable salary. It does not matter if you think you’ll be in Medicare or using your Social Security or if you think the payroll taxes are going to be “worth it”. If your company is making money, you do have to pay a reasonable salary. Eliot?

Eliot: Yeah, and along with the thoughts of reasonable salary, we do throw that out a lot, 25%, 30%, up to 50%, and 60%. You’re going to hear a lot of CPAs talk about that, a lot of tax professionals. Just so you know, that’s just usually what we say to give a guideline. The rules, that is not part of the code. There isn’t anything about 30% or 60%.

Really, it’s what would a reasonable person make doing what you do in the area you do with the profitability, the experience that you have. That’s the real test that they’re going to use, but typically what we’re going to say is anywhere from 25%, 30% up to 50% or 60%. That’s often what we all throw out there.

Amanda: But there are ways to reduce what the reasonable salary would be. If you feel like you’re paying too much in payroll taxes, well then let’s say first take things out of your S corporation using tax-free reimbursements.

This is going to work best if you don’t have any other outside employees. Any sort of reimbursement plan, or retirement plan does need to apply to everyone in your company who qualifies. If you’re the only people on payroll, only full-time employees, then we want to max out that accountable plan. We want the company to reimburse you for the administrative office in your home. That’s going to be a percentage of all of your utilities, your mortgage interest, your rent. Sometimes your landscaping and your cleaning if you have clients in your home. We also want them to reimburse you for mileage, for use of your cell phone, for the internet.

All of these are under tax-free reimbursements under an accountable plan so they’re deductions for the company and then you get reimbursed and those reimbursements not included in your taxable income. By bouncing those expenses for your company, it’s tax-free money in your pocket.  Another one is 288. Eliot, what’s 288?

Eliot: 288 is simply having those corporate meetings. I’m sure you’ve heard about that before. We talk about it an awful lot. The idea is that you can rent out your house to anybody for you, whoever you want for 14 days, no more and the income that you receive is tax free.

Best plan is why don’t you go ahead and rent it to your corporation? Or in this case, your S corporation, it conducts a meeting in your house. Maybe once a month, double up in a couple of months. Meet that 14. That money comes to you tax free and deduction at the same time. Two birds, one stone.

Amanda: Two birds, one stone. And you just charge your company a reasonable rate so you go out, get a quote from a local work office space, conference center, hotel. We’re based out here in Vegas. We’re going to go to that most expensive hotel. Any quote that you can get out there on the open market is going to be a reasonable quote.

I have a client in Brooklyn who has a tiny tiny apartment in Brooklyn, but was able to get a quote from a little hotel around the corner for $3000 a day. He’s able to do this at 14 and that’s again, tax free money to you. That’s reducing the net income to your company, which is then reducing what the reasonable salary that you have to pay yourself is.

Second, a salary is not always bad. We can defer some of that by setting up a 401(k). Again, that’s going to work best if you are the only owners and employees in your company. If you have a 401(k), you do have to offer it to all the other full time employees. You can’t just keep it for yourself or you can’t set up another company with a 401(k) shift money over there so you only have to give it to yourself.

This is going to work best if you’re the only owners and employees and your company, not only do you, can you defer up to $23,000 from the salary you’re paid, add an additional $7500 if you’re 50 years or older for catch up contributions, but your company can then match that up to 25%.

Eliot: Exactly right. So all of that gives deductions against this income, lowering amounts that we’re going to have to pay tax on in the end. Lots of different things we can do here. If we make enough, we can maybe even put into a defined benefit plan where you really get a roll of dice and put heavy amounts in several hundred thousand or more.

A lot of opportunity here with what’s going on in the S corporation. We kind of talked a little bit about this before we started here. That $30,000 remember some of that may not all be just Medicare and social security payroll. It could include some of the federal taxes and state income taxes. A 30, 000 amount might not all just be related to the employment taxes.

Amanda: Yeah. Maybe it’s just the withholding amount, in which case you don’t necessarily want to reduce your withholding unless you want to pay a huge tax bill at the end of the year. That withholding is just taking it out.

Eliot: Correct.Very good.

Amanda: As we earn it, so we don’t owe a lot later. Alrighty. “What is the minimum you must do to maintain your real estate professional status and not be considered a dealer if you do intend to flip a house? Another flipping question. Okay, so let’s define what a dealer is and let us define what a real estate professional is.

Eliot: Yeah, you can’t go two weeks in tax Tuesday without running some questions about real estate professional stats. We run into it all the time. But let’s hit the dealer first because we hear that, but not probably not as much.

Amanda: Because we’re in Vegas, right?

Eliot: Exactly.

Amanda: Dealers everywhere. That’s not what we mean.

Eliot: The dealer here, what they’re referring to is if you flip a lot, remember we talked about the flipping earlier, it’s not the sale of something that’s used in your trade or business. It’s selling inventory over and over. We have a quick buy, then we sell it down the road right away, hopefully at a profit.

We know we want to do that in a corporation, but what if we didn’t? What if we did it in our personal name? If you start repetitively doing that over and over and over, the IRS is going to look at that well, maybe that’s just what you do. That’s your business.

Then all of a sudden you pick up one property and you say, no, I’m going to hold this as a rental, let’s say you’re still flipping on the side, doing a couple of flips here and there, but you have this one property. Then all of a sudden something goes wrong. You hired or you let Eliot in as a tenant and you want to unload that thing. You want to sell it right away, the IRS is going to look at that as a flip because they think you’re a dealer, that’s all you do is flipping.

Even though you had this legitimate, your intent was to have a long term hold, but you sold it right away. They’re going to consider that a flip too and they’re going to hit you with ordinary income tax rates, which are much higher and it’s subject to employment taxes, which we just addressed in the previous question.

That capital gain that we’re talking about, if we’d held it over a year or something like that. A lot of unfavorable treatment. You can’t use install. You can take installment payments, but you have to recognize all that gain right away. The first year, Amanda alluded to that and one of the other questions, was kind of unrelated but same principle.

Amanda: No 1031.

Eliot: No 1031. Exactly. No 1031. Allow with the flipping. None of that going on here. That’s our dealer status. But then we go to REP status. Real estate professional.

Amanda: Real estate professional, you have to meet two tests. It’s when you spend 50% of your personal services time and at least 750 hours in your real estate trade or business. If you have a full time job and you work 40 hours a week, you need to work at least 41 hours a week on your real estate. A lot of times you can’t meet this if you have a full time job.

The places I’ve seen people doing it are people who work part time, maybe teachers who work seasonally, or if you have a spouse. If you have a spouse that works out inside the home, that’s not considered work by the IRS because they don’t know what they’re talking about. That’s a lot of work. That’s 24/7 work, but it’s not recognized by the IRS so your spouse can actually meet real estate professional status.

Then you need to materially participate and so that’s either 100 up to 500 hours of material participation on that activity. Most of the time people are looking at rep status as a way to offset or or create losses against their active income.

Active income is going to be something like flipping because you’re a dealer. Your W-2, your 1099. But the key to rep status is that you actually have to generate losses on what would normally be passive activity.

If you’re not generating losses, then it doesn’t really matter if you hit rep status because there’s no benefit to it. We’ve taken our passive rental activity. It’s now an active activity, but if there’s no loss, you’re not reducing the amount that you’re making, whether it’s through flipping or through W-2.

Eliot: Exactly right. But assuming that we are trying to get the real estate status, like you said, over 50% of our work week in a real estate trader business that we materially participate in, over 750 hours. But then you have to also be managing your rental properties directly yourself or you can aggregate and you just have to materially participate in the overall management of all of your rentals.

In this case, again, we just want to separate real estate professional status. That’s going to have to do with long term rentals, flipping, dealer, all of that going on is a whole different separate job if you will, or occupation. But we’d want to do that in a corporation. Now we can do both.

If we do it in a C or S corporation, that is the flipping, we avoid dealer status. Then we can still use those hours towards getting our 750 hours on the reps so you can do both. You just want to do it in the right entities.

Amanda: Type of entities. Entities are important, not just for your asset protection, but for your tax strategies. Alright. “What happens with the capital gain from stocks or from the sale of a rental property when inside of an S corp?” Is it ordinary income, Eliot? The answer is yes.

Eliot: No.

Amanda: Yes, no.

Eliot: It is income, yes. Ordinary, no. When we deal with a pass through entity, that’s your S corporation or your partnership.  We have what you could call the operational expenses and income for whatever business it’s in. Then we have what’s called separately stated items. That’s a fancy IRS term for things like portfolio income interest, capital gains, dividends, things like that. That is considered outside the business. It immediately takes a fast path to your 1040. We kind of treat those separately. This brings up a lot of different issues here.

Separately stated items, that’s going to be your capital gains, et cetera, things like that, and it is not considered ordinary income, whereas if we were flipping, let’s use that as an example on our S Corporation, that’s going to be the ordinary income from the flip, like we talked about. It’s not capital gains or anything like that. That’s what we would use to distinguish between the two types of income, that type of activity.

Amanda: I was just at a real estate investing or an investing conference for dentists and a lot of them own their practice and an S Corp, but then also own the building. If they did it the wrong way and put their building inside the S Corp, then that’s what we’re talking about, right?

The income and the expense from running a dental practice, the fees that patients pay, the insurance that comes in, minus the cost of an x-ray machine or those little scrapey tools. Those are the normal income, the ordinary income on the S Corp. But the building would be that separately stated investment.

Eliot: If we sold it, yes. The capital gain is going to be a separately stated item. Now, the operation of the building, if you’re renting, if it’s paying rent or something like that through.

Amanda: Like other people are renting space in the building as well.

Eliot: Exactly. That very well might show up on the front.They may consider that being separately stated items as well. To the point, they’re running the operational business, that’s going to be on the front. We call it the 1120S, that’s the S corporation return, as opposed to any capital gains, dividends, things like that, which are separately stated, and they are not ordinary income. They are treated, even if it’s portfolio income, interest, things like that, it might be taxed at ordinary rates, but we don’t consider it ordinary income, and I guess we really should have brought that up, right?

Amanda: That’s rude.

Eliot: Right, exactly.

Amanda: Why are you calling it the same thing if it’s basically the same thing?

Eliot: Exactly. We got ordinary income operational. In the case of the dental practice, portfolio income, which is kind of more your investment interests, things like that, capital gains. Then we have a whole nother bracket between passive and non passive, which is another.  There’s all these different types of income in the code. In this case, it’s not ordinary income.

Amanda: Not ordinary income. There you go. Alright. “What is a list of deductions with a STR, that’s a short term rental for those of you in the know, in the REI, as passive income when material participation is not met compared to a list of deductions when material participation is met?” This is a confusing question  for the answer to just be nothing.

Eliot: Right.

Amanda: There is no difference.

Eliot: There is absolutely no difference. If we take it back for a second, analyze why, well, if you have a short term rental and you’re not materially participating. You don’t do a whole lot. You’re an Eliot. You sit on the couch and don’t do much.

Amanda: You’re Eliot.

Eliot: You have someone except for her daughter.

Amanda: I would say that my husband is sitting on the couch watching sports. Don’t be an Eliot.

Eliot: Well, except for you may not know Amanda’s daughter’s name Eliot too and she’s a hard worker. Okay. Sorry. Fantastic young lady. But if you’re this Eliot, you’re not doing a whole lot. You’re very passive. Okay? I pay someone else to do everything. I pay Eric. He’s out there working and all that.

Anyway, but it’s still a business and if it’s a business, it’s going to have business income, business expenses.  Now let’s switch it and we have someone more responsible than Eliot who is materially participating in overseeing the whole show.  They still have a business, business income, business deductions. Those deductions, that’s all the same. There isn’t any difference between the deductions if you’re passive versus the deductions, if you’re materially participating in it’s non passive.

Now the impact of everything might be different, but you can still do a cost seg bonus depreciation, et cetera on a passive investment. There’s no prohibition to that. In fact, sometimes we do that for some tax savings, but it’s not going to offset against W-2 income, perhaps. It might go against other passive income, but it’s the same list of deductions for a passive  business as it is for a non-passive one.

Amanda: That’s right. How much you work in that business or participate  doesn’t change that. If you have a regular company and you’re buying office paper, you can deduct that whether you still work there or if you’ve retired and you’re just receiving dividends. When we talk about a list, is there an actual list?

Eliot: There are two suggestions I would go with. If you just Google IRS PDF Schedule E. That will show you all the deductions you could take if it’s considered maybe passive as a short terminal or what we have for a long term rental.

But the idea is all those are business related expenses that you can deduct or Google IRS PDF schedule C, that’s where you might have a short terminal that’s non passive. We put it on there. It’s going to have all these business expenses. Either one, look at them both, pull them up, copy them off, save them.

Amanda: Yeah, and that’s just a starting point. Any business expense that’s CORN, so common, ordinary, reasonable, and necessary to the functioning of that business is going to be deductible. For rental properties specifically, we’re looking at utilities, property taxes, furnishings, the expense for a property manager, for legal or accounting fees, all of those things are going to be deductible whether you materially participate or not.

Now, if you are materially participating, maybe you’re deducting home office expenses and if you’re not materially participating, then maybe you don’t have a home office to deduct, but sort of just depends. It’s all going to be the same expenses that are deductible against the activity.

Eliot: Exactly right. It’s all kind of a trick question.

Amanda: Schedule E for Eliot. Alright, we’re going to take a quick break to promote our tax and asset protection workshop. We have day long Saturday seminars coming up October 5th and October 19th. That is the tax and AP boot camp as we call it. Some people have described it as drinking from a firehose.

We have speakers who are experts in their field. I say that knowing that I am going to be presenting the tax sections on both October 5th and 19th, but then we also have in the background CPAs and attorneys that are answering questions so you can come, learn a little, but then also ask questions and get your questions answered.

Then we have our live three day workshops. The next one is actually this weekend in San Diego. There are still tickets left if you want to head over to our website. Then this December 5th through 7th in the wonderful Las Vegas. We’re based out of Las Vegas, so we like to have everyone come see us.

Eliot: Yep, fabulous Las Vegas.

Amanda: Bring your self restraint to that one, right? Some people forget that at home when they come to the Vegas workshops. But go to andersonadvisors.com. I think backslash events and you can get tickets for any of those. The Saturday seminars are free so come often.

Alright. “If I volunteer my work or time at a non profit, is this tax deductible?”

Eliot: Well, no. The time is not.

Amanda: Your time is worth nothing.

Eliot: Right, exactly. At least to the code. This gets asked a lot.

Amanda: Especially people who charge by the hour. As a baby attorney, I was out there charging $600 an hour. If I went and did 10 hours of pro bono work, should I get tax compensated or something.

Eliot: Of course she should.

Amanda: For the $6000 that I didn’t earn working for a paid client, unfortunately, no, it’s just the good feelings I got.

Eliot: Waking up at five in the morning to get there to wherever it is for the non profit, but yes. What you can deduct there are some things you can do. Okay, that’s something and it’s got a great rate of what?

Amanda: 14 cents a mile.

Eliot: It’s not even the 67 cents a mile that we see in an ordinary business mileage, but 14 cents, hey, that’s something. There are little things like that.

Amanda: You do need to be itemizing your deductions though in order to make that expense. If you are not taking the standard deduction, remember the standard deduction bumped up with the Tax Cuts and Jobs Act in 2018. Fewer people are taking our itemizing because the standard deduction is so high. But if you are one of those that itemize that’s going to be on your schedule A, you’re going to be able to deduct things like state and local taxes, medical expenses, charitable contributions, so actual money or property that you’ve donated to a charity. Then that’s where you’ll take that 14 cents per mile.

You do need to document it. You’d need to keep a mileage log or you can do actual expenses so that’s going to be the fuel, et cetera. That’s a little harder if you’re not doing a ton of work with the charity. I always, even for businesses, lean towards the mileage log because it’s just easier. There’s a lot of apps you can use where it’ll track that for you. We can take the mileage and then anything else?

Eliot: Not as far as our time. That’s certainly not the case. I mean we said the donations themselves. There’s really not a lot more.

Amanda: I volunteered at a soup kitchen and so if I’m going and they’re like hey, can you pick up some serving trays and some serving pencils on your way and I leave those there, then yes, keep track of that receipt. You can deduct that again if you are itemizing your deductions.

But if you buy it and you take it and you’re like oh, they don’t really need this and you take it home with you because you’re like oh, I brought it. I’m just going to take it home. Then obviously you didn’t give that to the charity so you can’t deduct that.

Things that you’re paying, that’s really no different than dropping off a garbage bag of stuff at Goodwill though, really.

Eliot: Correct.

Amanda: Your time is worth nothing.

Eliot: Nothing to the code.

Amanda: Alright. “I have W-2 and 1099 income.” Again, a side hustler. We love to see it. And they bought a house to flip. “How can I best take advantage of this financially to save on tax?”

Eliot: How do we? Well, first saying just that 1099 income, I’d want to know what that’s coming from. Maybe we can do something with that. Put it through a C Corporation or an S Corporation.

Amanda: Really better than my answer, which was to sell the house for a loss.

Eliot: You could do that too.

Amanda: You’ll pay less taxes if you flip the house and don’t make any money. I’m just kidding.

Eliot: Always a great deduction there.

Amanda: Let’s first talk about taking that 1099 income and if you’re making maybe $25,000 or $30,000, let’s throw it into an S corp.

Eliot: Yeah, Typically go S corporation. Maybe we have some medical expenses and things like that. So we might want to think of C corporation, either one. We just look at the situation, but that’d be the first thing. I’d want to look at that 1099 income because there’s a lot of different types, there’s over a dozen types of 1099 forms and types of income so we’d want to probably focus on that first because that might have more savings and everything else that we would see in this answer.

But then we bought the house to flip and that, as we talked about earlier, we don’t want to do it in our name. Just number one for liability purposes. All the great tax pay in the world doesn’t do you a hoot of good if you get sued and you don’t have asset protection. So we can save your day all day long on taxes. But if you don’t have that asset protection, it’s not gonna mean anything.

Amanda: It’s just more money to pay the lawsuit with.

Eliot: Right. There’s a bright side to it. You want to talk about your loss. This is going to get you your loss.

Amanda: You sell for a loss or get sued. This is the place you come for like the really great tax advice.

Eliot: Exactly. This is not the Toby Show today. But if we flip that house, let’s do it in a corporation again. SRC Corporation. Take advantage of all those  reimbursements Amanda went over.

Amanda: Accountable plan.

Eliot: 280A.

Amanda: Medical reimbursement plan if you’re in a C Corp.

Eliot: Make enough, pay yourself a little wage, maybe put into retirement plans. All kinds of good stuff. It just doesn’t stop right there. How can we best take advantage of this? Well, that’s the first thing. How are we going to structure all this income coming in and taking advantage of everything we can do there, number one.

Now, let’s say we have leftover cash afterwards from all of this. Well then how we use that. Maybe you buy it, use it to buy another short term rental or something like that and you could get it right off that way. Maybe you have other rental properties in your real estate profession. We talked about that. There might be a play there to take some cost seg bonus depreciation, maybe create a loss there right off against all this income. How you use it after we’ve done everything tax wise that we can immediately to reduce taxable income. That extra cash, maybe you can do something with that or invest into your non profit, set up your own non profit, just don’t count on the mileage as we saw earlier.

Amanda: We’ll contribute to deductions.

Eliot: That’s going to be better than the mileage.

Amanda: 30% of your AGI or 60%.

Eliot: Right, 60% cash, and if that’s what we’re talking about, we have the cash here. Oil and gas investments, things like that. There’s lots of tax planning opportunities here. But again, it all starts with that structuring. We want to get the right entities taking in that income. Get all that handled first, mandalate it out on the S corporation, get those reimbursements, admin office, 280A, if it’s a C corp medical, things like that, pay into retirement accounts, et cetera. Hit all these things first and then let’s see what we have left over and see if some of these other things might work.

Amanda: These questions are great because a lot of times you have an idea. But then that actually just opens the opportunity so it’s not necessarily that you have this W-2 and 1099 income and that the house flipping is going to directly offset that in some way. It’s that we’re looking more deeply into what’s already happening, what tax strategies that we are not taking advantage of that we can sort of get into.

Then again, once we have that cash from the flip, is there something we can then turn around and invest in to generate some tax strategies and some deductions.

Eliot: Yes, great question.

Amanda: Not always a super obvious answer. Alright, our final question. “How does rental property via an LLC affect personal taxes?”

Eliot: We had almost maybe 10 questions related to this question for the last two weeks. I definitely wanted to throw it there. I’ve never seen a question asked so much, probably as much as this was in the last two weeks.

What’s the idea? Strictly speaking, nothing. Okay, you put that rental property, the way we set it up, it’s going to be in what we call disregard LLC, which means it doesn’t have a tax return. It may go through a partnership.

Yeah, that has a tax return, but that is what we learned earlier is a flow through pass through entity so it’s just going to hit your 1040. None of that has any impact whatsoever on your personal taxes.

Amanda: A lot of people are really surprised once we set up an asset protection structure because it can initially look intimidating or complicated. There’s a holding company, there’s individual LLCs for each property. Maybe there’s a land trust that we’ve put in there to avoid transfer taxes or the due on sale clause so it can be three levels or more. That can be intimidating or complicated.

A lot of CPAs, you’ll go to your CPA and they’ll say, what did you get all of these LLCs for? Why did you make it unnecessarily complicated? And it’s because they don’t understand the legal, they don’t understand the asset protection side.

But then a lot of people are surprised, like I said, that in reporting their taxes, absolutely nothing changes. Your entire asset protection structure can be completely disregarded for tax purposes and where you reported that rental before the LLC, you’re reporting it right there. Schedule E page one after the LLC.

Like Eliot said, the only time that changes is if you have a partnership holding company and that’s going to be mostly for spouses. If you own the property together, we’re putting you into a holding company. If you’re not in a community property, stay two owners, automatically a partnership, it’s going to require that 1065 filing. Then that goes K-1 reported on your Schedule E page two.

It actually makes your personal 1040 a lot simpler. A lot of those income and expenses that would normally show up on the Schedule E page one for each individual property are now just reflected on your 1040 through a single K-1 line item.

If you are in a community property state, and there’s like nine of them, California, Nevada, and seven others, I guess, that I haven’t lived in, so I don’t know what they are off the top of my head. But if you are in a community property state and you own that holding company with your spouse, you file a form and you can elect to be treated as disregarded. In that case your reporting doesn’t change at all.

Again, even your bookkeeping doesn’t necessarily have to change. You don’t have to have separate books for each LLC. The IRS rule is that they’re separable, not that they’re actually separate.

Now, is it easier if you have a separate set of books for each LLC? Yes, at tax reporting time, that is going to be easier for your tax preparer. That’s what we recommend for our clients who do their taxes.

One set of books for each tax return. That’s actually what it is. We’ve got Troy, who is our bookkeeper extraordinaire, and he would. I got to make sure I said it right for him. One set of books for each tax return, and then you’re still going in and attributing every single dollar to the property so it’s not that you have an LLC, it’s that you have multiple properties, income, rent from one property. You can’t treat it as mixed in with something else. Your bookkeeping, your tax reporting for the most part is going to be exactly the same.

Eliot: Absolutely.

Amanda: Anything else on that one?

Eliot: Great question. Got asked a lot and like Amanda said, it’s easy to get kind of confused with everything going on in the structure, but the truth is it doesn’t have any impact on your taxes.

Amanda: Would you prefer if you had the option to do a partnership holding versus a disregarded holding? What are the pros and cons of that?

Eliot: Let’s look at the cons first. You have an extra tax return. One can understand that it’s an extra cost, but as Amanda pointed out, the bookkeeping is really going to be essentially the same because you have to keep track of it anyway.  However, the upside is number one, it reports differently on your return. It goes to Schedule E page two, as opposed to Schedule E page one and you can get a lot more lendability. The lenders are allowed to lend more to a partnership than they are to you as an individual.

If we’re in real estate, which is probably why we’re doing all of this, that’s probably going to be a part of someone’s conversation and they’re investing somewhere about getting more lendability. I’m going to like the partnership myself.

Amanda: I do too. Partnerships, S Corp, C Corp, the audit rate for those are a fraction of what the 1040 audit rate is. Would you rather see every dollar and cent that comes in and out regarding your rental properties right there in your 1040 or are we moving all of that to a partnership and then only what’s showing up on your 1040 is just that single line item.

If you do have the opportunity to do a partnership, we do like to do those instead of a fully disregarded entity. But again, not always going to be the case.

Eliot: Yes.

Amanda: Alright, one last plug for the man, Toby Mathis. This is his YouTube channel, tons and tons of information. He’s got a TikTok. He’s a tax-wise Toby on the TikTok. He’s like a Gen Z. He’s basically Gen Z guys. Not at all. Like and subscribe there. You can set it so you get notifications every time something new comes out. They are very popular channels.

Clint Coons, he focuses more on asset protection. I actually know somebody named Clint Mathis. Isn’t that funny?

Eliot: Oh, wow.

Amanda: Professional soccer player.

Eliot: There you go.

Amanda: Every once in a while I mix them up.

Amanda: Fun fact, Clint has a cat named Toby? Toby has a cat named Clint?

Eliot: Oh no, Toby has a cat named Clint. I don’t know if Clint has one named Toby. He might.

Amanda: We got to get him one if he doesn’t,  we got to get him one.

Eliot: I’m sure he’ll be happy.

Amanda: Like and subscribe to both of those channels. Also Anderson Advisors is also on Instagram or on Facebook. We’re on TikTok. And one final plug for our tax and asset protection workshop, October 5th, October 19th, our day long seminars, the bootcamp of tax and AP, if you will.  We’ve got great speakers. Again, this is going to be me.

Then September 26th through 28th, that’s this weekend, we’ll be down in the lovely San Diego. December 5th through 7th, we’ll be in Las Vegas. Tickets for both of those events are still available. If you’re already an Anderson client, just go ahead and shoot a note to your team and we can get you the links for that.

Finally, if you want your question to be featured on Tax Tuesday, please email us at taxtuesday@andersonadvisors.com. If you can all get together and ask the same question, Eliot really really likes that. It makes it easier to choose.

Eliot: Easy voting.

Amanda: It’s funny because it tends to go with the flow of the season. How do I report my taxes? Not surprisingly in September when a lot of people are reporting their business and personal taxes on extension. We get similar questions around April and March as well. So bring us your question. Nothing is too complicated. We leave those for Toby mostly though. Tax Tuesdays live on YouTube and if you want to head over to our YouTube, Toby’s YouTube channels, there’s a whole playlist of former Tax Tuesday questions and replays and all of that. They’re fun to watch.

For all of us tax nerds here, to all of you tax nerds out there, thank you so much for joining us. We’ll see you next time.