It’s our last Tax Tuesday episode of 2024! In this episode, Anderson attorneys Amanda Wynalda, Esq., and Eliot Thomas, Esq., address several listener questions on a variety of tax topics. They cover the tax implications of moving into a rental property, including how it affects capital gains and depreciation. They discuss the possibility of using an LLC as a management company for rental properties, allowing for contributions to a personal IRA. Eliot and Amanda also explain how negative cash flow from rentals can affect deductions and tax filings, the importance of staying organized with rental property expenses, and the consequences of transferring ownership in a 1031 exchange. Other topics include options for offsetting passive income with retirement accounts, consolidating LLCs under a Wyoming holding company, deductions for 529 plans, and the stepped-up basis for gifted stocks. Tune in for expert advice on these and more!
Submit your tax question to taxtuesday@andersonadvisors.com
Highlights/Topics:
- What are the tax implications of moving into one of our rentals? Bought the property 13 years ago, have never lived in it, taken expenses and depreciation on the returns or should we just rent it from ourselves through our property manager? – Just moving in, no real tax consequence. Once you move in you’re not paying capital gains. The 13 years will be considered ‘non-conforming use’. Don’t rent it to yourself.
- I own three rental properties. Can I use that LLC as a management company? Take a 10 to 15% management fee and use that money as an earned income to allow contributions to my personal IRA. Would that contribution be deducted from my rental income as cost to the rentals and Schedule E? When is the deadline for the contribution? My LLC has some expenses too. If my net income is only $3,000, can I still contribute $7,000 to my personal IRA and deduct that amount? – You’re running passive rental income through a mgmt company to make it ‘active’ income, yes you can do this. You need a management agreement that you actually pay before December 31st.
- Can I use negative cash flow as a deduction towards income /capable gains? I’m in California and nothing cash flows for at least a few years. If I’m negative $1,000 or more cash flow, is this a deduction against passive income or capital gains? – Capital gains come in when you sell the property. You can pull passive losses from other properties you own.
- What expenses are incurred for rental properties or tax deductible and what is the best way to stay organized when keeping records of bills and expenses for rental properties to make it easier at tax time? – Google IRS Schedule E page 1. There is a list there to refer to. Good bookkeeping is essential.
- Can I transfer the ownership of a property owned by an LLC tax as a partnership that I purchased as a replacement property in a 1031 exchange or will that trigger a taxable event? – Yes you can transfer, but it will trigger a taxable event.
- My wife receives income from multiple sources, real estate rental, consulting, etc. We plan to set up a C Corp to consolidate the passive income and offset some of that income with retirement contributions into a solo 401 (k). Unfortunately, we did not set up the C Corp in time for the tax year 2024. What options do we have with respect to retirement accounts to offset her passive income for 2024. What can we still do? – Consulting is not usually passive income.
- Can multiple individual LLCs mix of small businesses and rentals be consolidated into one tax return under a Wyoming holding company? If so, is that a recommended practice? Adding in a small business? – For rentals, this is a standard protection structure, one property per LLC. You can add the active, but we would not recommend it.
- How much can we deduct with a 529 plan for our kids?- Some states may give you a deduction, but at the federal level, there is no deduction.
- If I gift my stock to my aging dad and become the beneficiary the stock when he passes will I get the stepped-up basis after I inherit them? – This is fantastic. Yes, you can do this. This is great, but they have to live for at least one year after the gift, and you have to make sure he’s actually going to leave it to you upon his death!
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Full Episode Transcript:
Amanda: All right, everyone. Welcome to Tax Tuesday. I’m your host, Amanda Wynalda, joined here by…
Eliot: Eliot Thomas. Good to be here.
Aman: It is. It’s good to be here. We walked up all the way from downstairs together.
Eliot: Yes. It took a long journey to get here, but we’re here.
Amanda: We are thankful you guys are here. Why don’t you throw open to chat where you’re joining us from?
Eliot: Exotic locations.
Amanda: Yeah. Any exotic locations. Let’s open this chat up. No one’s here.
Eliot: No one’s here.
Amanda: There must be a delay. All right, Maryland.
Eliot: Go Terps. I’m an Orioles fan. Go Baltimore.
Amanda: Florida is here.
Eliot: Very cool state.
Amanda: Welcome, welcome. Idaho, Boise specifically. Always some people from California. I’m a California native, so welcome. We’re out here in Las Vegas.
Eliot: Yes, fabulous.
Amanda: It’s getting pretty cold out here, not as cold as Chicago though. Bakersfield, Washington, San Diego. We always get people from all over the US. Usually at least one or two from international.
Eliot: Ann Arbor.
Amanda: Well we’ve got a whole group of tax professionals helping out in the Q&A. Let’s go over quick rules. We have the live Q&A. If you have a question, we have 10 questions Eliot picked for us, which we’ll be going over. But if you have a question, whether related to what we’re talking about or not, we have got an awesome group of tax pros here. We’ve got Tanya, Jeff, Dutch, Jared, Arash. They are going to answer all those questions in the Q&A.
Also, if you’re joining us live on YouTube, we’ve got Troy manning the chat there. Hit us with what you’ve got. It’s the end of the year.
Eliot: Yes, last episode.
Amanda: Yeah, last episode of the year. We expect some crazy stuff from you guys, so keep us guessing. All right.
If you do not get your question answered, you can email taxtuesday@andersonadvisors.com. Eliot goes through all those emails on a biweekly basis and picks out the top 10 or the interesting ones. We try to keep a good mix going on.
Or if you need a more detailed response than what you’re able to get into the Q&A and you’re a platinum or tax client here at Anderson Advisors, you can reach out to your team. Submit a question. We can jump on the phone and get that answered for you. This is basically a fast, fun, and educational way to get tax questions answered.
Eliot: Yes, a lot of fun.
Amanda: There are worse ways to spend your afternoon. We’re just going to go over the questions real quick.
First one will be, “What are the tax implications of moving into one of our rentals?” We’re talking about a rental into a personal property. “We bought the property 13 years ago, have never lived in it, and have taken expenses and depreciation on the returns. Or should we just rent it from ourselves through our property manager?”
Question two we’re going to look at is, “Three residential rentals as a sole prop, and what the taxes would be if we moved to an LLC?” Eliot, why don’t you go through the next couple for us?
Eliot: Yup. “I have three single family rentals that I manage myself. I also have an LLC. Can I use that LLC as a management company, take a 10%–15% management fee and use that money as an earned income to allow contribution to my personal IRA?” Excellent question. “Would that contribution be deducted from my rental income as cost to the rentals and Schedule E? When is the deadline for the contribution? My LLC has some expenses too. If my net income is only $3000, can I still contribute $7000 to my personal IRA and deduct that amount?”
Amanda: A lot going on there.
Eliot: There is, but that has a lot of good elements to it. Second, “Can I use negative cash flow as a deduction towards income/capital gains? I’m in California and nothing cash flows for at least a few years. If I’m -$1000 or more cash flow, is this a deduction against passive income or capital gains?”
Amanda: Good one. A reminder, if you guys are joining us live and you’re throwing a question at us, please put it into the Q&A. That’s where we’ll be able to answer it for you. The chat is more for technical difficulties, things like that. Go to the Q&A if you’re asking us any questions.
All right. “What expenses incurred for rental properties are tax deductible? And what is the best way to stay organized when keeping records of bills and expenses for rental properties to make it easier at tax time?”
Eliot: Good questions. “Can I transfer the ownership of a property owned by an LLC taxed as a partnership that I purchased as a replacement property in a 1031 exchange? Or will that trigger a taxable event?”
Amanda: 1031 is always raising red flags. You got to do those perfectly for them to work.
All right. “My wife receives income from multiple sources, real estate rental, consulting, et cetera. We plan to set up a C-corp to consolidate the passive income and offset some of that income with retirement contributions into a Solo 401(k). Unfortunately, we did not set up the C-corp in time for the tax year 2024. What options do we have with respect to retirement accounts to offset her passive income for 2024?”
Eliot: What can we still do? “Can multiple individual LLCs mix of small business and rentals be consolidated into one tax return under a Wyoming holding company? If so, is that a recommended practice?”
Amanda: Wyoming holding company, that sounds like somebody who visits our YouTube channels a lot.
“How much can we deduct with a 529 plan for our kids?”
Eliot: Good question. “If I gift my stock to my aging dad and become the beneficiary of the stock when he passes, will I get the stepped up basis after I inherit them?”
Amanda: We shall see.
Eliot: Yeah, all these exciting things.
Amanda: All right, we’re on Toby Mathis’ YouTube channel. Toby is one of our founding partners here at Anderson Advisors. Subscribe. You’ll get a notification every time he uploads a new video. I honestly don’t know how he does so much content. He’s just an encyclopedia when it comes to tax issues, questions, and videos.
We had our live tax and asset protection event two weekends ago, and he spoke for probably a few hours, a couple of hours at least. He felt like he didn’t get even enough, so he sent out additional content, an hour-and-a-half extra video of additional content. This man is a machine.
Eliot: Does not shut down.
Amanda: Our other founding partner is Clint Coons. He focuses more on real estate asset protection. Between them, they have over 300+ rentals, so all of these strategies whether on the tax side or the asset protection side, come from real world experience.
Eliot: They definitely walk the talk.
Amanda: Talk the walk.
Eliot: Talk the walk, whichever it is.
Amanda: We’re out there in the trenches with you. Remember to like and subscribe there.
Speaking of our tax and asset protection workshops, we have a couple coming up. These are our free virtual events. Those are about from nine to four o’clock on saturday. We’ve got one coming up on December 21st. I will be there teaching advanced tax strategies and estate planning. And then we’ve got another one on December 28th. These are really great. We actually do some really great offers and deals. These are good prices out there for us.
Eliot: There you go. Go check it out.
Amanda: You do. You should come. Learn something, Eliot.
“What are the tax implications of moving into one of our rentals? We bought the property as an investment 13 years ago, have never lived in it, and have taken expenses and depreciation on our return. Or should we just rent it from ourselves, maybe through a property manager?” Let’s take this piece by piece. What is the tax implication of moving into a rental?
Eliot: Just moving into it, really no tax consequence. You’re just going in there. I guess the difference is assuming that you’re not renting it, that you’re just going to go ahead and call it your home, right there, really nothing has changed other than you’re not claiming rental income anymore. You’re not taking the associated deductions for it, that’s certainly different. The interest, property taxes, and things like that will go on your Schedule A now as an individual.
Amanda: You got to itemize those.
Eliot Yes, that’s exactly right.
Amanda: If you’re taking the standard deduction, you’ll actually lose some deductions on your tax return. But if you’re itemizing, same local taxes, mortgage interest, you can’t deduct that still on your Schedule A.
Eliot: Yeah, to get above your standard deduction. Now when you move in there, your basis in the house is going to change. When you originally purchased this house, you bought it for X amount of dollars, and there’s been some depreciation over the years as you rented it out. That’s what we call the adjusted basis, and that’s going to be your basis right now.
If you sold it, if you stayed there for a while as a personal residence, and then sold it, you’re going to have that lower adjusted basis. Typically, that’s going to figure into whether or not you can do the 121 exclusion on the sale of your primary residency, things like that.
The fact that you had what we call a non-conforming use, you used it as a rental first, that’s also going to come into play if there was a 121. 121 is just if you sell your primary residence after you’ve owned it and lived in it as a primary residency for two of the last five years, then you can get a deduction of $250,000 single, $500,000 married filing joint. But that’s going to be factored by that time you spend it as a rental. It’s going to lower how much you can actually exclude.
Amanda: Once you move in, you’re not paying capital gains once you’re turning in to your primary residence.
Eliot: Correct. There’s no tax event in that regard. Correct, yup.
Amanda: Go a little bit. Tell me more about how the new basis is figured out. Give me an example.
Eliot: Originally we bought (let’s say) for $200,000, that was our original purchase price. Let’s say $25,000 of that was our land, so we couldn’t depreciate that. That just gets set aside, the $25,000 for the land. But that means you have $175,000 that was available for basis to be depreciated at that point.
Example, let’s say we took $50,000 of depreciation from the $175,000, that will leave $125,000 as what we call the adjusted basis. Now, when we move into it as our primary residency—again, assuming that we’re not renting, and we’ll get to that part—then that’s our new basis, $125,000.
Why do we care? Because, again, if we’re there for over a couple of years owning it and using it as our primary residency, then we might be able to take advantage of Section 121, which is the exclusion on the sale of your primary residency, two of the five years.
That’s going to be impacted because $125,000 will be your new marker, not the fair market value when you moved into it. A lot of people think you get that adjusted stepped up basis, perhaps you do not. Here, we didn’t sell it, you just moved into it.
There are also more calculations that will go into how much of that 121 exclusion will be allowed because you had a lot of years, 13 years, of what we call non conforming use, where you didn’t use it as your primary residency. There’s going to be a fractional impact by that 13 years. You may not have much to use of the 121, but there’ll be something, and that certainly helps.
Amanda: Will that fraction increase if you stay in it longer than two years?
Eliot: Yup. The longer you use it as a personal residence, the more you’ll have available of the exclusion later on, but it’s still at 13 years. It’s probably going to be a hefty amount that you can’t use.
Amanda: All right. The other option they have is to rent it from themselves. We generally think that renting your own property from yourself isn’t going to work for a number of reasons.
First, the rent that you’re paying, you’re paying with post tax dollars, so it’s income that you’ve earned some other way, paid taxes on, and now you’re paying yourself in rent only to circle it back through your own tax return to pay tax on it again. That’s no fun.
Eliot: Yeah, it’s really not a good practice.
Amanda: We also run into some vacation rental rules. Can you explain those?
Eliot: Yes. We have another rule in the code that says if you stay the greater of 14 days or 10% of the fair market rental days, then you could be limited in how much you can take as a deduction. We’re going to step back from this for a second.
Let’s just say you have a beach house or something like that that you like to use. Who wouldn’t? But if you stay there too much and it is a rental, normally, you’re not going to be able to take all the deductions that you want to as you would be accustomed to having a rental property.
You’re going to be limited to the amount of income, and your amount of income here is what you pay as rent. You’ll only be able to deduct up to that amount. The other losses just get trapped, and we may not be able to take them. We frown on that a little bit.
Amanda: On renting it from yourself, the income and expense, the best you could do is zero it out. But from a tax perspective, because you’re using post tax dollars, you’re paying in tax amount twice. That’s not going to work out so great.
The bottom line is no more deductions, no more rental deductions unless you’re itemizing. If you end up being able to take advantage of the 121 exclusion, it’s going to be a proportional interest based on how many years you’ve lived there.
Eliot: Exactly.
Amanda: Alright. “I own three residential rental properties as a sole proprietor. Would the taxes on each rental be higher, lower, or stay the same under an LLC?” This is a situation where just an individual owns three rental properties in their name. Are the taxes going to be different in an LLC?
Eliot: Typically speaking, they’re not. They’re not going to be any different because if we put it into a disregarded LLC, which just means it doesn’t file a return, it comes onto our 1040 just like you’re doing right now, it’s still going to go on Schedule E, then there isn’t any difference in the taxes.
There may be an annual filing fee, cost of setting up the LLC, things like that, but those are minor in the bigger scheme of things here. You’re still going to have so much income coming in, so many deductions, and that won’t change.
Amanda: A lot of times when you’re setting up a structure, even your bookkeeping is not. The way you keep your records doesn’t change a whole lot, especially with a disregarded entity. What normally showed up on your Schedule E page one will still show up on your schedule E page one. You will be able to take the expenses for setting up the LLC, maintaining the LLC. That’s going to be an additional deduction.
Really, when you step back and look at it, on the tax side, you break even, but on the asset protection side, huge difference, huge benefit, to not only have the inside protection where your entity, your property is not going to attach to your liability to you personally, but vice versa. If you go out and get a judgment against you, your creditor is not going to be able to reach past that LLC and get to your property.
Eliot: I would just add one more thing here. When we always talk about LLCs, it does matter how that LLC is taxed. For rentals, we’re always going to tell them to put in disregarded like we talked about or partnership because that all comes back to our return. That LLC could be an S-corp or a C-corp.
We never recommend really putting an appreciated property into there, so that’s a no, no, other than Clint’s video where he talks about selling your personal residence if you want to hold on to it and turn it into a rental, but that’s something completely different. Just make sure we’re not turning this into a C-corp or an S-corp.
Amanda: The answer to this question changes dramatically if the LLC that you put your properties in, you tax it as a C-corporation.
Eliot: Because they got a flat rate of 21%, but don’t go thinking that that makes it a good idea if you’re in a higher tax bracket.
Amanda: Stick with disregarded entities. All right.
“I have three single family rentals that I manage myself. I also have an LLC. Can I use that LLC as a management company, take a 10%–15% management fee and use that money as an earned income to allow a contribution to my personal IRA?
Would that contribution be deducted from my rental income as a cost to rentals in Schedule E, and when is the deadline for the contribution? My LLC has some other expenses, so the net income in the LLC is only $3000?”
What we’re really looking at here, the 10,000-foot view, is taking passive rental income, running it through a management company to make it active so that the person asking the question can qualify for retirement contributions. Can we do that?
Eliot: Quick answer, yes. Yeah, we can move it over. Traditionally, your rental income is passive, as you were just discussing. Because of that, because we move it into the management fee, that’s an active business, so we have changed it into active income. If that LLC again is disregarded, sole proprietorship type thing, that comes directly to your personal return earned income, and we could do exactly what you say.
Amanda: Schedule C. Logistically, we need a management agreement. You want to set up a management agreement for that fee on that side.
Eliot: We want to actually pay it, before year-end, before December 31st.
Amanda: If it’s a Schedule C, if your management company has disregarded Schedule C, how is that payment to an IRA work?
Eliot: Then you have earned income. Let’s say it’s $10,000, all that is earned income, so an IRA here, you would be able to contribute up to $10,000 because you have that much earned income, so that’s fine. I think it’s $1000 extra if you’re over 50 to catch up, so we have $7000 or $8000 in my example. However, going down here, we see that the net income is only $3000. There, we would be limited to $3000 that we can put in, unless we had other sources of earned income.
Amanda: The IRA, the max contribution is $7000, and it’s not limited by the total income through the Schedule C?
Eliot: It is not. It’s just overall earned income.
Amanda: What if we did a SEP?
Eliot: A SEP, then that typically is sponsored by the business, the sole proprietorship, the management company in this case. There, you can contribute quite a bit, but it’s going to be, in the case of a sole proprietorship, 20% of what your net income, as I was saying earlier.
If the LLC was a C-corp or an S-corporation, we’d have to pay you a W-2 wage, and then it would be 25% of that amount that the corporation could put into a SEP.
A SEP is a business plan deduction, so it doesn’t have anything to do with the individual. It’s really the business contributing to it, so we don’t have things like the ability to pay catch-ups and things like that.
Amanda: An alternative is if you do a C- or an S-corp for the management company, would be to do a Solo 401(k) as well.
Eliot: Absolutely. Really good plan, yeah.
Amanda: The same thing, you would have to pay yourself a wage. The company could match that up to 25%. The total amount you can get into those things is $69,000 a year.
Eliot: Solo, then you do have to catch up again. If you’re over, you get $7500 there.
Aman: For this particular question, the 10%–15% percent management fee with about $3000 coming through, would you recommend them sticking with a disregarded management company or running it as a C-corp?
Eliot: If we feel really obligated that we really want to put into an IRA, then I’d probably stay with an LLC taxed as a sole proprietorship. Personally, if you had this as a C-corporation, then you can move it over there and get that $3000 back without paying any tax on it. You’ve got to weigh it out.
$3000 is a difficult amount. That may not be enough to warrant the extra return of a C-corporation, a management, C-corp. But if that number changes and we’re just using this as an example, only $3000, maybe it’s a little bit higher, then maybe C-corporation would be a preferred use of an LLC.
Amanda: Because then at that point, you’re pulling the money out as a tax-free reimbursement for things like your cellphone, your internet, your mileage, your out-of-pocket medical, 280A meetings. But if your goal is for that retirement planning, then this is a great play.
Eliot: It is, yup. Very good question. A lot packed in there, but it’s a good question.
Amanda: “Can I use negative cash flow as a deduction toward income capital gains? I’m in California and nothing cash flows for at least a few years. If I’m -$1000 or more cash flow, is this a deduction against passive income or capital gains?”
Let’s start off by assuming we’re talking about rental properties here. When you guys submit your questions, more info is always better. We’ll assume you’ve got rental properties, -$1000 at the end of the day. Is this a deduction against passive income or capital gains?
Eliot: First I just want to talk about negative cash flow. That’s really not a tax term. That is more just your bank account. Whether you had more rents coming in than you did expenses, in this case we didn’t, it sounds like, so we really wouldn’t use this in a tax aspect.
Amanda: What’s the translation?
Eliot: When we’re talking about this case, we’re just talking whether we have net income or net loss. That’s our tax way of describing it. If we were indeed negative cash flow, I’d be hard pressed to see how you could have that situation and not have an overall net loss on this. We’re going with the assumption that we have a net loss after depreciation, things like that, and all expenses.
Now, because it’s a rental, we’re going with that assumption, then it is passive, probably. That passive loss can only be offset against passive income, so you’ve got to find another source of passive income to offset that against. It will not offset against capital gains or a different type of income.
Amanda: Two different things.
Eliot: Yes, right.
Amanda: The capital gains come into play if you sell the property. If you’re doing $1000 in losses every year and you go and sell the property, so you’ve built up passive activity losses or PALs, what happens if they sell the property at that point?
Eliot: If we sell that property later on and we’ve built up these passive losses, we can release the PALs as we call it. That means that those passive losses from that one property will first come in and wipe out what would otherwise be capital gains on that. We’ll knock it down.
Let’s say we have $1000 gain and we had $800 passive losses, that passive loss of $800 would come in and wipe out the first, of the $1000. You’d have $200 at that point left over. At that point, you could pull passive losses from other buildings or other rentals that you have to offset that last $200.
Or if you sold (let’s say) and you had $1000 gain, and you built up $1200 of passive losses on that one building, all $1200 will wipe out that $1000, and the extra $200 will go against any other income on your return. They’re just like an ordinary loss, so it could be very beneficial with tax planning.
But it doesn’t go against our capital losses. Let’s say if we’re selling stock, an extra $200 in my example would be if you didn’t have any other ordinary income. But generally speaking, a passive loss without selling just within an ordinary year will not offset against capital gains.
Amanda: If you have a passive loss on this year’s tax return and some capital gains, those two things aren’t going to offset each other.
Eliot: Exactly.
Amanda: All right. “What expenses incurred for rental properties are tax-deductible, and what is the best way to stay organized when keeping records of bills and expenses for rental properties to make it easier at tax time?”
Eliot: This is clearly going to be what I’m going to say, get on and google IRS PDF Schedule E.
Amanda: Schedule E page one. We’ve got an example right here. Hold it up, Eliot.
Eliot: We do. I’m going to find it here.
Amanda: It’s going to list the exact expenses that you can take.
Eliot: We can’t see that.
Amanda: Can’t really see it?
Eliot: Nope.
Amanda: It lists the exact expenses you can take. Read them off.
Eliot: Yeah, we got advertising, mileage, cleaning, maintenance, commission, insurance, legal and other professional—Anderson—management fees, mortgage interests, repairs, supplies, taxes, utilities, depreciation, and another category for anything else.
Amanda: That’s going to include probably HOA fees, gardening, landscaping, pool service, things like that.
Eliot: To organize all this, it’s going to be your bookkeeping. Bookkeeping is fundamental. You have to have good bookkeeping. How are you going to do that? You’re going to have these categories here for expenses. That’s exactly what you’re going to do because that’s what the IRS wants to see. You categorize according to these, get that PDF Schedule E from the IRS, and it will show you exactly what to put into your bookkeeping. We got bookkeeping here.
Amanda: Yeah, we do. We’ve got actually a special, our bookkeeping essentials package. Three months, plus it includes QuickBooks online. It does not matter how long it takes for us to do those three months of books. It’s all included and at no additional costs.
After that, if you want us to continue doing your books, they’ll give you a quote based on how long it’s taken those three months. It’s $995 for new Anderson created entities and $1195 for a non-Anderson or client-formed entity over a year old.
I’m probably going to throw a curveball at Miss Patty, but we’ll probably find a link to throw up into the chat for you. I’m going to throw a curveball at you and say, tax deductible expenses. Is there a line, or talk to us about what capital improvements can I deduct just in that calendar year?
Eliot: Yeah, that’s a great question. There are a lot of different ways to look at those capital improvements. They could be added to basis, and we have to depreciate them over time. Not as much fun as immediate deductions.
Amanda: Not as much fun.
Eliot: But you’ve heard Toby talk about this many times. You can have the $2500 de minimis election. Everything you buy on an individual purchase that’s under $2500, you can typically go ahead and expense, even if it would traditionally be something that you’d have to depreciate. That could be something to take advantage of.
We also have a category that if it’s something that’s five-year property, typically, depreciable property that you put in there, and maybe it has to be repaired usually every three years, because you have to repair it within the lifespan of it, the depreciable life, you can go ahead and expense that as well, the maintenance expense under that. That’s an exception to capitalization as well.
Amanda: Give me an example. What’s a five-year property?
Eliot: Let’s say it’s winter time. Let’s say you’re in the colder regions and you have a fireplace. Maybe something gets broken there, and every five years you’re having to replace it, but it’s 10-year property. Normally we depreciate over 10 years, but you’re having to repeatedly replace it or repair it, put major repairs in. Then that, you could go ahead and automatically deduct the cost of.
Amanda: That’s one.
Eliot: Yeah. And if you put all these together, if we have enough going on as far as those capital bases and things like that, you can always look at doing a cost segregation and maybe bonus depreciation. That’s always something to look at as well, but that would probably be a little bit higher dollar amounts we’d be looking at there.
Amanda: I will say in terms of keeping and staying organized, bookkeeping is essential because if you’re hiring outside parties or contractors to do any of this work, you are going to have to send them 1099s. Those are due January 31st, and it’s going to be a whole lot easier to send that 1099 if you’ve got bookkeeping, especially if you’re hiring the same company repetitively to do things, and you’re having to consolidate everything you’ve paid them throughout the year into one 1099.
Eliot: That is a huge point. Get that 1099 for your independent contractors. Every year we run into that issue. Hey, I paid somebody. They told me they’re going to give me their information. Guess what? You didn’t get it. Now you’re on the hook from the IRS.
Amanda: You definitely want to get that W-9.
Eliot: Yes, W-9. It’s one of those. I think it’s the W-9.
Amanda: Yeah, you definitely want to get that W-9 before you pay them that final payment.
Eliot: Yeah, W-9.
Amanda: “Can I transfer the ownership of a property owned by an LLC taxed as a partnership that purchases the replacement property in a 1031 exchange, or will that trigger a taxable event?” Can you transfer it? Sure.
Eliot: Can we? Yeah, absolutely. No problems.
Amanda: But will that trigger a taxable event?
Eliot: Very well might.
Amanda: Yes it will. 1031 exchange, I expect if you’re spending your afternoon listening to two attorneys talk about tax, you’re probably familiar with the 1031 exchange. But for those of you who aren’t, it’s a specific way that you defer gains on a rental property by taking those funds and rolling it into a new rental property. There’s a very specific timeline you have to follow, but the new property is what this person is calling, the replacement property.
Because it is a tax strategy, typically the original property and the replacement property are going to need to hit the same tax return for the consecutive years, and that’s what allows you to defer those taxes. But with a partnership, we’re looking at a partnership return.
Eliot: Partnerships are treated a little bit better. That’s exactly right. You’ll have, in this case, the 1031. You’re giving up a property that you’d used in a trade or business. That’s key. You give it up, you’re picking up a new one. That’s the replacement property that the individual is asking about here.
That replacement property, if you’d had gain, if you’d sold the first property, you can defer that gain if all the numbers work out for the replacement property and you defer it. To defer it, one of the things is you have to keep the same taxpayer rules.
That means in this case, a partnership, it was in partnership A, the one you gave up. That means you have to pick up the replacement property in the same partnership A. You can’t put it in a separate partnership, a different partnership. That’s something that will typically refuse the deferral of the taxable gain.
Amanda: Even if the partnerships are owned by the same individuals, you are still going to hit a different 1065 there.
However, if you’ve got multiple properties in that partnership, you could move that replacement property to an LLC disregarded to the partnership. In that situation, if we got the P-ship, and we move the property to an LLC disregarded to the partnership, we’d still get the tax return. It’s still hitting that same tax return.
From an asset protection standpoint, if you’ve got multiple properties in that partnership, then it would probably be a good idea to separate them out into underlying LLCs.
Eliot: No question.
Amanda: All right. Here we go. Put in a small plug for our tax and asset protection workshop. This is a one day free webinar you can enjoy from the comfort of your own home, especially for those of you in those colder regions. Got some hot cocoa, a blankie, and tax. What could be better? Tax and asset protection.
I actually will be joining you on December 21st. We’ve got another one on December 28th, our last two of the year. Sign up. They’re a fun time.
All right. “My wife receives passive income from multiple sources, real estate consulting, et cetera. We plan to set up a C-corporation to consolidate the passive income and offset some income with retirement contributions into a Solo 401(k).” Kind of related to an earlier question. “Unfortunately, we did not set up the C-corp in time for the tax year 2024. What options do we have with respect to retirement accounts to offset her passive income for 2024?”
Let’s take this piece by piece. Passive income from multiple sources. Real estate rentals, yes, passive income. Is consulting generally going to be considered passive income?
Eliot: Very rare.
Amanda: Very rarely. If she’s the one offering the consulting services, that’s actually going to be active income. What if you were invested into somebody else’s consulting firm?
Eliot: It could be, but it’s highly unlikely.
Amanda: That’s a pretty rare situation.
Eliot: Yeah. I’ve never heard of it, but it’s possible I suppose. Yeah.
Amanda: Sure. Assuming all the income we’re discussing is passive, what is the consequence of moving that to a C-corporation?
Eliot: We wouldn’t want to do that. The only way we could get that in there, if we use the C-corp as a management corporation, we’re shifting some of the rental income in there, but we wouldn’t be moving at all.
Amanda: Yeah, we don’t want to put our real estate into a C-corp.
Eliot: Exactly. If you put appreciable real estate into a corporation, it’s really easy to get in. Very darn near impossible to get out without a taxable event, and you’re going to want to get it out eventually. There’s no step up basis if you ever leave it to your heirs for that property. There are a multitude of reasons why we wouldn’t put appreciable.
Amanda: Corps also pay a higher, flat 21% tax, which is 1% higher than the highest capital gains rate.
Eliot: That’s correct, yeah. We got all these issues of why we wouldn’t want to put in there. The rental income, you don’t want hitting that C-corp in that aspect that you’re going to put the rental in there. But again, you could do a management fee, and you could have your consulting coming in. There, you could pay it all out as W-2, which is earned income. Earned income allows us to contribute to retirement plans.
It looks like we were thinking along those lines when we were talking about setting up a Solo 401(k). But here, we didn’t do that. We don’t have the C-corp, but you still have the consulting income, which is I’d be willing to bet my bottom dollar that that’s going to be the type that’s ordinary income, active income, subject to employment tax. That means we could put into a SEP IRA, a traditional IRA, or both. You got that earned income coming in. The rental, that’s passive. That’s not going to help us here.
Amanda: What are the SEP and the IRA limits? IRA is seven?
Eliot: Yes. With $1000 if you’re over 50 for what we call the catch up. The SEP is going to be $69,000. The SEP is what we call business expense. It’s not the employee putting it in or whatnot. It’s the business, so we don’t have a catch up for that.
Amanda: We can do both.
Eliot: Yes, you can do both.
Amanda: “Can multiple individual LLCs, a mix of small business and rentals, be consolidated into one tax return under a Wyoming holding company? If so, is that recommended?”
For rentals, that’s going to be a pretty standard asset protection structure. We’d have an LLC owned by a Wyoming holding company and one property per LLC. That’s pretty standard, so yes. If this is a disregarded structure, it all just shows up on your Schedule E page one. If you’re married or if you own these through with a business partner, you could have a partnership tax return, a 1065 here.
“How does it work if you add in a small business? Let’s just assume that this is an active business. Are we wanting to put that under our Wyoming LLC?”
Eliot: Just to directly answer the question, can you do it? You could, but do we want to?Amanda’s is the better question. Should you do that? Do we recommend it? Not at all. I wouldn’t because, why do we have a box around that business to begin with? That’s usually where we’re looking for our asset protection, is it not?
Amanda: Yeah. We’re typically looking to separate our active and our passive assets. On this side, we’ve got our passive rentals going to our anonymous Wyoming holding company.
When you’re running a business, typically you can’t be anonymous because you’re either the face of the business or you’re working directly in it. You want to separate that. You don’t want to create a direct line from you as an individual to your passive, anonymous Wyoming holding company.
That said, could you have your active business owned by a separate Wyoming LLC? Sure, especially if you’re in a state where that active business, maybe it’s an Inc, maybe it’s an LLC. If it doesn’t offer something like charging order protection, or it doesn’t protect maybe a single member LLC in that state, then sure, have it owned by a Wyoming LLC. You’ll get that extra charging order protection. Taxes will most likely end up being exactly the same, but we don’t want to co-mingle those two things. This is more of an asset protection question than a tax question.
Eliot: It really is, yeah. But they mentioned the tax returns, so I threw it in here.
Amanda: Yeah, they do.
Eliot: Could you? Yes. Do we recommend it? Not at all.
Amanda: This structure, though, if both of these Wyoming entities are disregarded and all these entities are disregarded, we still only have one tax return. You still only have your 1040. You’re adding in an additional holding company and still staying with one tax return.
Eliot: Good point.
Amanda: All right. “How much do we get to deduct with a 529 plan for our children?” Eliot’s response to this was, I’ve never looked into it because we don’t have kids. I have six kids and I’ve looked at it a lot. How much do we get to deduct?
Eliot: We get to deduct nothing. There is no deduction for 529 at the federal level. Some states might give you some deduction if you’re doing an in-state plan for an in-state university. Fifty states, 50 different answers to that. No, I didn’t research all those. But the federal, there’s no deduction.
Amanda: Some states don’t charge income tax. There are not 50 different answers.
Eliot: Yeah, that’s true. You’re right. That’d be no tax. There’s still no deduction.
Amanda: For example, we’re in Las Vegas, Nevada. There’s no state tax in Nevada. Thank you everyone who makes your annual deposits at our casinos. I have 529 for my kids, so I wasn’t pushed to invest into a Nevada state plan. I could essentially look at which plans across the country worked the best and choose one. I chose New York. I don’t know, it was probably doing well when I made that choice, so we don’t get a tax deduction for that.
My parents live in California, and they get a deduction for the amounts they contribute to their grandkids’ 529 plan. It’s going to depend on the state. It’s usually going to be limited to an in-state plan for the state that you live in. If you invest in an out-of-state plan, you’re going to have to check those rules.
We looked up an example, I think. Illinois, if you invest in an in-state plan, you can deduct up to $20,000, so that’s a pretty good deal.
Eliot: Pretty respectable.
Amanda: A 529 plan, for those of you like Eliot, the childless cat ladies out there, what I like to call the real people with freedom, 529 plans are essentially a college savings plan, although they can be used for education lower than the college level, but essentially for qualified tuition expenses, things like that.
You’re putting in after tax dollars, and then essentially it grows like a Roth. All of the earnings, all the growth is tax-deferred, tax-free if you use it for qualified tuition expenses or education expenses. You can actually, this is pretty new in the last couple of years, convert the remaining amounts in a 529 to a Roth IRA. What are the limitations on that?
Eliot: We got an overall limitation of $35,000. Maybe not everything, but hey, we’ll take it. $35,000 is great. There’s also a limitation, I think. It’s a five-year rule. You can’t put in more than what was put in subsequently before the last five years.
In other words, if you had it for 11 years, the first six years, you can put it up to that amount over to a Roth. That’s one of the limits. That five-year look back rules each year.
Amanda: That actually makes sense.
Eliot: It does, yes.
Amanda: College is usually four years. The idea is that you’ve had the plan, you’ve used most of it for college, that four or five years is up, and then whatever’s remaining, as long as it’s under $35,000, you can roll into an IRA for the kids. I guess they’d be adults at that point.
Eliot: Yeah, but it’s still great, very good. It’s certainly better than doing nothing because it grows tax-free as Amanda pointed out, so that’s really nice.
Amanda: All right. Certainly better than doing nothing. It indicates that Eliot might not like 529 plants. Tell us why.
Eliot: I don’t like it. I just don’t like them.
Amanda: You prefer the Roth IRA.
Eliot: Yeah, I do because you’re already a Roth then. If we didn’t need it, let’s say the kids got scholarships or something like that, you already have it in there. I don’t like the overall. The cost of tuition, $35,000 doesn’t seem very generous to me. It’s certainly better than nothing.
I’ll take it, don’t get me wrong, but I would have liked to have just started as a Roth, had it grow for the kids, and you can put in your contributions after five years, after that Roth is settled. Hopefully you’ll start early with the young ones, then you could take out for college expenses and things like that and not be penalized.
Amanda: The original amounts you had put into the IRA after five years, you could take it out tax-free and then pay for college that way. But if you’re getting a late start, your kids are in their teens maybe, and you got to beef up that plan fast, you’re still going to be limited to that $7000. Maybe that’s the situation.
Eliot: You can front load on the 529. That’s another, I think, a really great plan. You can put up to five years in there. Of course, you can’t contribute for five years, but that allows someone in year one to put a whole lot in there and get it growing tax-free. They’ve come a long way. Ten to 15 years ago when I started this, the 529s were very not good.
Amanda: Back in my day.
Eliot: Exactly, back in grandpa Eliot’s earlier days. But now, they’ve really done a lot to make them more attractive.
Amanda: All right. Last question of the year.
Eliot: This is it, folks.
Amanda: This is the last Tax Tuesday of the year, everyone. Our next one’s not going to be until Tuesday, January 14th. Mark your calendars, or even better, subscribe to Toby Mathis. You’ll get a notification when we come back live in the new year. All right.
Eliot: We better get this one right.
Amanda: “If I gift my stock to my aging dad and become the beneficiary of the stock when he passes, will I get the step up in basis after I inherit them?” Inherit the stock.
Eliot: This is fantastic. Yes, you can do this. For the younger people who have done really well in stocks, you can gift it to your aging parents. On their passing, they’re going to take your basis, what you originally bought it out.
Let’s say you bought IBM at $10, probably not realistic. But if you did and then you gave it to your aging parents, they would receive it at $10 basis, but they have the stock. As long as they leave it to you when they pass, then you’re going to get stepped up basis in that stock. All of your gain, that’s a fantastic deal, but they have to live for one year after you’ve given it to them. This is not something we do, maybe if we’re on a watch or something like that.
Amanda: We got to keep dad kicking for at least a year in order to get that step up in basis. One thing I did think of after we were strategizing about this one is, what if dad is on some Medicare or government assistance program? What is that asset of this stock and the income from the stock going to do to that?
Eliot: That’s a fantastic one. You want to make sure you know what plans it might be impacted by. The asset wealth of your parents, they’re impacted if you put a whole lot and gift it over, but all those questions aside, and you got to make sure dad leaves it to you. I’ve seen fights.
Amanda: Crazier things have happened. If you give it to him, it’s his. Even if you have some written agreement or contract, that’s not really enforceable when it comes to inheriting.
Eliot: That is a great point because I can’t gift to anybody and have strings attached. I can’t say, hey, here’s your gift and sign this paper saying you must leave it to me. That’s not a gift. There’s no way you could really enforce the parent to do it other than be really mean to them. I don’t know if that would work.
Amanda: We do not promote elder abuse on this channel.
Eliot: Wasn’t suggesting that, but get them to feel guilty for not leaving it to you.
Amanda: You would get the step up in basis, but make sure that the additional asset and the income from those assets aren’t going to affect any government assistance or program your dad’s in. You’ll end up paying a lot more out-of-pocket for the care that they’re not able to get. You had also said something about Bitcoin, that this could work for Bitcoin.
Eliot: We’re not sure exactly. Crypto has a lot of the same attributes as a stock. It’s capital unless you earn it, and then it’s just like if you’re in stock. I haven’t seen anything that specifically allows us for crypto, but it very well might be. We’ll continue to look at it, but we couldn’t find anything yet on that.
Amanda: Crypto landscape’s still a little wobbly.
Eliot: It is, yeah.
Amanda: All right. Like we said, this is our last Tax Tuesday of 2024. Join us in 2025 on January 14th. A quick way to get notification of that is to smash that subscribe button as the kids say. Thank you for joining us.
You can also subscribe to Clint’s YouTube channel, Real Estate Asset Protection. Toby tends to focus more on tax, Clint tends to focus more on real estate, but they both know a lot about, so you’ll get all of that with both of them.
Again, finally, a final plug to come join us at our tax and asset protection workshop. There’s one this Saturday, it’s a totally free virtual event. We’ve got another one on December 28th.
Eliot: Again, thank you for a great year as this is the end, and thanks to our staff. We got Troy, Jared, Dutch, Kenny.
Amanda: Arash, Jeff, Patty, Alyssa, Tanya, Jen. They do have the real magic.
Eliot: How many questions do we have today?
Amanda: I got the answer somewhere. Over 100, almost 120 questions they answered today.
Eliot: Just about every episode, we’re well north of 100. They do a lot of work, so thanks to the team.
Amanda: That’s not even counting what you guys are sending us on YouTube or the YouTube chat. If you have a question you want to be featured in Tax Tuesday, email us at taxtuesday@anderson.com. Visit us at Anderson Advisors. If you’re a platinum client, submit a question. Come to the knowledge room. If you say something really nice about Eliot, he promises to pick your question.
Eliot: It helps. No.
Amanda: All right, that’s the end.
Eliot: Thank you. Happy New Year.
Amanda: Thank you, everyone. Happy New Year.
