The more you know and learn about taxes, the less likely you are to be audited. According to the recently published 2018 Internal Revenue Service (IRS) Data Book, only 0.5 percent of all returns filed in the 2017 calendar year were audited. Toby Mathis and Toni Covey of Anderson Advisors often answer your tax questions with “it depends.” Why? Facts and circumstances. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
Highlights/Topics:
- How do you know if you’re overpaying taxes for your LLC? Refer to tax designation of LLC and compare it to other choices (i.e., corporation, partnership, sole proprietorship)
- What are the most beneficial types of qualified retirement plans (QRPs) and LLCs for tax shelters? It depends, but try things that defer taxes (401k, real estate, C or S Corp)
- How can we protect a Special Needs Trust from probate? Avoid probate through a living trust by adding special needs provisions for when it becomes irrevocable
- I have several personal IRA accounts and want to convert them to a QRP in our real estate investment company. Can I use that money to purchase more properties? Yes
- I have owned a property located in a qualified opportunity zone for a number of years. Is there any special tax benefit, if I install a new roof? No
- Do I always need to take salary out of my C Corp? No, salary is a part of compensation and still requires withholding and paying taxes
- How do owners receive a yearly salary from their businesses? You pay it; there’s no federal rule for pay periods, but some states require pay periods for certain employees
- Do I have to designate myself as a dealer, if I do fix and flips? IRS designates you as a dealer based on facts and circumstances; doesn’t matter how long you hold a property
- Can I write off a vehicle that’s 6,000 pounds or more? Yes, you can write off entire cost, but limited to $18,000 a year, and more than 50% must be for business use
- What is a 1031 exchange? Selling real estate and buying more of equal or greater value to not pay taxes and use an intermediary
- Does S Corp need to pay payroll taxes? You pay some payroll taxes, as opposed to sole proprietorship – where you pay 100% of payroll taxes
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Resources:
501(c)(3) Nonprofit/Charitable Organizations
Modified Accelerated Cost Recovery System (MACRS)
Using Cost Segregation in Residential Real Estate
Explaining the Trump Tax Reform Plan
Tax Cuts and Jobs Act, Provision 11011 Section 199A – Qualified Business Income Deduction FAQs
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, another great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets. One of my favorites as well is our Infinity Investing Workshop.
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Full Episode Transcript
Toby: First off, I have Toni Covey here and your interesting pictures. That was your no one size fits all. I’m going to make you guys watch that again, just because I’m evil. Is there a one size fits all? The whole idea there is when we get these questions, and we have a ton of questions to go through as you guys hopefully can see them. The answers, oftentimes, it depends because what oftentimes happens is there’s so many facts and circumstances that change things. Like when somebody says will an LLC help me save taxes? The answer is it depends on how you tax it. An LLC isn’t a tax designation, it depends on whether it’s ignored, partnership, corporation, C Corp, S Corp, all those things come into play, what type of activity. I don’t want to say it depends, but there’s no such thing as that.
Again, sometimes if you do get a one size fits all answer, like oh, it’s always best, that’s what you’re getting. You’re getting a unitard that may not look good on everybody. I’m going to get out of that. I’ve seen enough of that picture.
How do you know if you’re overpaying with your taxes with your LLC? Well, the easy way to consider this is if you’re driving–and I use this example a lot–where somebody flies into Disney World and they fly into Orlando Airport. They grab a rental car and they drive to the airport. And if they follow the signs, they’re going to hit about five or six toll booths along the way. It’s a lot, I might be exaggerating, it might be three or four, but it’s a lot. You see to be hitting a toll booth every couple miles.
Locals, or if you know how to use Google Maps and say avoid tolls, know that you can actually avoid any tolls by simply driving down Sand Lake Road. Sand Lake Road, you avoid the tolls, but you hit a couple of red lights, that’s about it. It might take you a couple minutes longer.
How do you know whether you’re overpaying just comes that you have to know somebody that knows the area, knows what you should be paying, then you can tell whether you’re actually overpaying. What you don’t do is go to somebody who doesn’t know that area, unless they’re really well versed in it, like they know business tax, go to a business tax person and say is this consistent with the other businesses you see. If somebody knows real estate tax, have them take a look at your return and they will be able to tell whether you’re on the toll road, or whether you’re on the no toll road.
It really comes down to—it’s that simple. People that know this stuff know it. If you don’t know it, you don’t. So how do you know if you’re over paying taxes with your LLC? You have somebody take a look.
If you guys have heard me over the last many months and years, we always make fun of people that say, “I save tax with an LLC, or I’m taxed as an LLC,” because we know that doesn’t exist. LLC is a state designation and it chooses how it’s going to be taxed by the IRS. You can be a sole proprietor, partnership, S Corp, C Corp, whatever, we could have it ignored. What it really comes down to is we take a look and say what would you be best taxed as? If you had rental real estate, for example Toni, you had some rentals, are you going to want to stick that in a C Corp?
Toni: No.
Toby: No, right? How would we know if you’re over paying taxes? Well, we’d look and say how was that LLC taxed? Where’s it landed? We know there’s a lot of benefits to having real estate, we don’t want you to lose it. So how do we know if you’re overpaying, we look at the tax designation of that LLC and we compare it to the other choices.
I used to say that taxes, there’s three rules. That is calculate, that’s rule number one. Rule number two is a version of rule number one, which is calculate. Rule number three is way more difficult than the first two which is calculate, right? You just get a pen and paper out and you got to figure out which way is going to be better for you. Same thing as if you’re doing retirement plans, you got to figure out whether it’s worth it for you to save some taxes if you’re going to pay taxes in the future, which would be like a traditional IRA versus a Roth, would it be better to pay the tax now?
Toni: It’s best to look at it on a quarterly basis. That’s when you’re making your estimated tax payments. Obviously if you’re going to be making quarterly estimated tax payments, you should be having your financials looked at on a quarterly basis.
Toby: It makes sense, is that what you guys like to do?
Toni: Absolutely.
Toby: Toni, by the way, is an EA, which stands for?
Toni: Enrolled Agent.
Toby: And Enrolled Agents, who gives you that designation?
Toni: The IRS.
Toby: Right, so it’s different than a CPA. CPA, that’s a state designation. And then there’s lawyers, which is also state. The only federal designation that you can get that I know of, is that the EA?
Toni: Well there’s a few others but it’s not specific to tax.
Toby: So it’s just for tax, the only one is Enrolled Agent. You guys learned how to do all the forms and fun stuff. And Toni, you’ve been with us forever, right? Well over a decade.
Toni: 13 years.
Toby: Thirteen years, she knows her stuff. What she’s saying is do a quarterly. I say you look at your finances quarterly, and make sure that you’re not going off the rails. Because it sucks when you get to the end of the year and somebody says I wish you had told me. You like having those conversations?
Toni: Oh, those are fun. There’s so many things you can do throughout the year for you if we just have the opportunity to look at it and play around with it. Geek out with the numbers a little bit.
Toby: Somebody says this is my first time hearing of an enrolled agent. This is interesting because I used to say I like CPAs and I like EAs. About 80% of the papers out there has neither designation. I don’t want to say anything bad against a CPA but you don’t necessarily know tax returns and how to prepare taxes.
Toni: It’s not what they specialize in. Not all CPAs specialize in taxation.
Toby: A lot of them are doing audit work, which means they’re verifying the information that’s creating the finances. If you’re a big publicly traded company, you got auditors running around and what they’re doing is verifying everything.
Toni: And then you have a CPA is like the ones we have here in Anderson who do specialize in tax.
Toby: CPA testify against you, anybody can testify against you. CPAs have some rules that sometimes we fight with where they have different masters sometimes. Jeff’s a CPA, he’s awesome, he’s amazing. But CPAs tend to be more conservative because not only do they owe you a duty, but they have licensing issues too.
You always want to deal with somebody who has a license, I’ll just say it. Whether it’s federal license or state license. What messes you up is when you have somebody with no license. Honestly, there’s some situations where you see somebody who’s working in a fast food restaurant two weeks before they go over to start preparing people’s taxes, and that scares me. And when the Inspector General did a study, you don’t have to take my word for it, go read this stuff. We quite literally had a 0% accuracy rate on business returns on the chain prepares and it was pretty ridiculous. It’s like wow, 0%? 0%, it’s freaky.
Yeah, so the answer is EAs specialize in taxation. They understand the IRS forms, pubs, and codes. That’s what they learned. They’re not going to go audit a company doing a publicly traded audit. What they are going to do is they are going to prepare returns and they know the federal laws and they learn the state laws too, when they go in prep. But for the most part what they really care about is the IRS, your state taxing agency something different, but they obviously have to learn that too.
Next question, what are the most beneficial types of QRPs and LLCs for tax shelters? This is always a fun one. Again, they say tax shelters, that has a negative connotation, although I still like to say it too sometimes. All it’s doing is what can we do to defer tax? The beneficial types, it really depends on your activity. Remember, no size fits all, right?
But QRPs, that sounds for qualified retirement plan. LLC doesn’t exist in the tax code as a taxable entity. You could actually have an LLC that’s owned by a QRP. The taxation goes to the QRP, and then that QRP denotes whether or not you’re going to pay tax later. As to whether it’s a Roth 401k or a traditional 401k, whether it’s subject to mandatory distribution or minimum required distributions. All those things come into play.
The most beneficial types, I like things that defer taxes. I like 401Ks. As far as owning real estate, holding real estate, I’m going to have an LLC that is either disregarded to an individual, or taxed as a partnership, which closes to an individual. If I’m flipping real estate, I am either going to be an S Corp, a C Corp or an LLC taxed as an S Corp or a C Corp, because when you are flipping real estate it is considered ordinary active income. I do not want that flowing under my return, helter skelter. I want to be able to avoid as much of that tax for as long as humanly possible. Those are some of those. Do you have anything you want to throw on there?
Toni: Not to take it away, it’s just when I look at questions like this, I’m with you. It just depends on what you’re trying to accomplish. You want to defer income, all types of QRPs have been beneficial. It depends on what you’re trying to do, whether you’re doing it in a version of a Roth, traditional, so you have the Roth where it’s growing, the income’s growing tax free, or you can defer the income if you’re doing it in a traditional type of manner. Or maybe we’re looking at a different type and we’re going across entity types here. We’re talking about PRP becoming an LLC. But what about a nonprofit?
Toby: We can do general rules. You’re not making much money if you’re below $25,000 for example. Let’s say it’s a kid that’s getting started. I’m telling them use a Roth IRA as a savings account. There’s no penalty to take the money back out, only if you have gain on it, and they’re not going to have much if it’s only in there for a little while. If it stays in there for a long time, you never pay taxes on it ever again, you’re in a really low tax bracket. You’re not trying to get a tax deduction.
For example, the first $12,000 somebody makes, they’re college students, it’s tax free. Why mess around with that? And If I put that in a Roth, and I let it sit there, and I do that every year… Let’s just say I put $1,000 in every year for 10 years, and I never pay tax on any of it anyway. That $10,000, give it 50 years to ferment. You’re talking about having hundreds of thousands of dollars tax free. That’s issue number one.
What if somebody is in a high tax bracket, they’re in California, they have state income tax, federal income tax, they have a little bit of a penalty with the net investment income tax, they have all these little things that are nibbling away at them. And they’re really in a 50% tax bracket. Now, you’re going to look at deferring that. You’re going to be looking at 401k, you’re going to be looking at things like defined benefit plans, you’re going to be trying to get that into something else.
A charitable LLC, there’s just charity remainder trust, we’ll go over that. But a charitable LLC, not really, you’re talking about a 501(c)(3) or a charitable entity that does not pay tax. Even if I am a high tax, I make it a million dollars a year. I know that I can make 600,000 of it deductible with the stroke of a pen. That’s what I know because I could write a check to a 501(c)(3). Even if it’s my own 501(c)(3), I can get a $600,000 deduction because that’s what the code says. I know I can lower taxes but there’s different tools out there.
But just as a rule of thumb, if you’re buying and holding, you want it to flow onto your Schedule E. You’re going to make sure that it’s going on page one or two, either disregarded LLC or a partnership. If I’m flipping a property wholesaling, I’m a real estate agent, I’m more than likely going to run that through an S Corp. If I have too much money, maybe a C Corp. Especially if I’m in the $100,000 to $200,000 range, I’m adding a 401k. I’m going to try to jam some money in there and defer it. Anyway, kind of an open ended question.
How can we protect a special needs trust from probate? This is very interesting. There’s some pretty bad stories out there with special needs, arrangements gone awry. The first question is why should we protect it from probate? And what happens when it goes through probate? I’ll give you guys examples out of Pennsylvania where grandparents tried to give their special needs grandson money. They skipped the parents, saying it really needs to go to my grandson because he’s going to need care for the rest of his life. The state of Pennsylvania took it all because they’ve been providing care for the child since he was an infant. When the grandparents passed, the child was in his early 20s, so they just said thank you for paying us back.
That’s if it goes through probate, probate is really there to help the creditors, helps lawyers and creditors. Let’s just say this, avoid probate, you use a trust to avoid probate. You say special needs trust, you make a living trust, and you add special needs provisions so that when it becomes irrevocable, when you die, is when that living trust becomes irrevocable. You already have the provisions in there that says to the trustee don’t give the beneficiary money if it’s going to cost them benefits. So if the state is providing them benefits, give them the maximum allowance that they can receive on an annual basis without losing that benefit. They’re actually letting the trustee make a decision.
If you set up an irrevocable trust where you give up all incidents of ownership, then it’s not going to be probated anymore. If I create a special needs trust that I have no say on, I’m giving it up and I’m going to have a third party manage it for the benefit of somebody who’s a special needs individual, then I’m going to have those same types of provisions but I’m getting rid of my ownership during my lifetime, then that would also avoid probate. If you don’t own it, it’s not going to probate.
Somebody’s asking a question that has to do with the last question we had, which was I have several personal IRA accounts, I want to convert them to a QRP in our real estate investment company. Can I use that money to purchase additional properties for investment rental income properties? The answer is yes, in the QRP. The QRP would be the buyer, or here’s an easy one. If you have a QRP, you can borrow money from it, I can borrow up to $50,000 per participant up to half of the money. If I roll $100,000 into a QRP, I could borrow $50,000 out the next day. I can use that to invest individually.
There’s a couple different ways to do it. A lot of people like to invest inside the QRP, I’m not necessarily one of them. I know that with real estate, I could avoid taxation for the most part. And if I put it in a QRP and it’s a traditional QRP, eventually I’m going to have required minimum distributions at 70 and a half, I know I’m going to have tax.
Somebody says I have owned a property located in an opportunity zone for a number of years. Is there any special tax benefit if I install a new roof? No, unfortunately no. That’s not how the qualified opportunity zone works. The roof would just be added to your bases. It would be depreciated over 27.5 years if it’s residential, if it’s commercial that will be over 39 years. You do get a little tax benefit on whatever amount of the previous roof that you didn’t depreciate. You might get a little tax benefit, but no. Chances are you’re not going to get anything. Why did I answer that, I’m crazy.
Do I always need to take salary out of my C Corporation? Toni, I’ve been bombarding this whole show. You guys know I’ll do. What do you think?
Toni: There’s no requirement to take the salary out of the C Corporation.
Toby: The answer is no. Do I always need to take a salary out of my C Corporation? No. You don’t ever have to take a salary. Here’s how it works. Salary is just a part of compensation. I can pay you in cars, I still have to do withholding. If I wanted to give you a car every month, here Toni, here’s a new Maserati. You have tax on it, you’re going to pay the tax on it. You really want a new Maserati every month?
Toni: You know I’ll pay that tax.
Toby: You got to do withholding stuff. I can hear Patty cackling, I could hear it through my wall. I’m just kidding.
I’ve never taken a salary out from my C Corp. That’s good, we’d like to zero amount, in fact 80% of that or so, probably more. How many buyers, do you think, do you see when we actually pay a tax? We have thousands of returns.
Toni: Pay a salary?
Toby: Yeah. Do you see whether they pay tax or pay a salary?
Toni: Very seldom.
Toby: Somebody says what if it is a lease? You have to pay tax on the lease values. If I give Toni a car, the value of that she’s paying tax on. If I give her the car, it’s the full value of the vehicle. If I let here use the car, that is the lease value for her personal mileage.
If I’m a business and I say, “Hey, real estate agent employee, here’s the car.” 100% of that mileage is business, it sits in my office and they only use it when they drive clients around. That individual has to pay zero tax on it, it’s all the company. But if they drive it home, they drive it to a vacation, they drive it to pick their kids up and go to soccer games, go and do whatever else, they pay tax on that portion. There’s actually a schedule that the IRS gives out. It kind of stinks.
How do owners receive a yearly salary from their businesses? You pay it. There’s no rule under the Federal Law to receive pay at a certain period. There’s nothing that says you have to pay people biweekly. Your state may have that, and it’s only certain employees. If it’s you, you pay yourself whenever. If it’s somebody you hired, it might be I got to pay them at least every other week or something like that. Every state is a little different. Do you love questions like that?
Toni: I do.
Toby: If somebody asks you a question, this is going to be kind of weird. If I sell financial real estate properties, can I be taxed on […] or would I have to pay tax on the entire sales gain even though I’m not getting the money right away? Fred, you asked a great question. The answer is it depends on whether you did a flip or if you’re selling properties that you were doing a buy and hold.
If I pick up a property and I sell it, I do it on installment note. There’s no such thing as an installment sale for tax purposes when I am a dealer. If I’m buying property to sell property, I can do an installment sale but I have to recognize the tax the day I sell.
If I am doing investment properties, I have something that I’ve held for a lot of years and I’m just going to sell it to somebody because I’m getting tired of owning it, I can take that. I pay tax as I go. Part of it is return to base which is zero, part of it is long-term capital gains which is whatever rate you’re at—could be 0%, 15%, 20%, depending on what your tax bracket is. Part of it is depreciation recapture, the 12-50 recapture which is your ordinary bracket cap to 25%. Part of it would be interest because it’s a note when the IRS will compute interest if it’s over $10,000. Good question, Fred.
Toni: You can still do the installment. If you so choose, you can opt out and opt to recognize all that income in the first year.
Toby: Yup. Here’s a good one. Fred responded with, “Do I have to designate myself as a dealer if I do fix and flips, IRS designated me as a dealer.” The IRS would say you’re a dealer, the facts and circumstances make you a dealer. It doesn’t matter how long you hold the property.
There is a case out there for a guy who held a property for 10 years, his intent when he bought it was to sell it. Took him 10 years to sell it, he was still a dealer. On that one, there might be a way to sell the paper. Maybe you sell it, maybe you sell the note to somebody else where you get a third party financing company. Instead of doing seller finance, you get somebody else to get the interest on it so you can get the money now. More than likely, it could be ordinary.
Somebody says, “I thought there was a way to write off a vehicle that is 6,000 lbs or more. How does that work?” Alfonso, you can write that out if what they are doing is beyond the luxury car, limitations of a luxury car, you’re really limited to about $18,000 a year. If you buy a big old Suburban or a Land Cruiser, even the Tesla X, those are over 6,000 lbs. You can write the whole thing off in year one. The problem is more than 50% of it has to be business used, or you have to recapture that whole thing again. You can have five years where you don’t have to worry about that. Plus, as you receive the money, if you’re personally driving around that car, that’s the same as receiving money and they tax you on it. They say you look at the value of the vehicle, then we assess the portions. It kind of gets stinky.
Let’s keep going. Martin asked a question, what are the benefits of cost segregation? Cost segregation, what we’re doing is when you have the Modified Accelerated Cost Recovery System or the MACRS, normally I’m taking a house, a rental property and the IRS says, “Write it off over 27 and a half years.” This property has to be replaced every 27 and a half years. If I have a $250,000 house on a $100,000 lot that I paid $375,000 for, they’re going to say you can write off the $275,000 house over 27 and a half years. That’s $10,000 a year I take as a writeoff.
When I do cost segregation, I’m saying that house isn’t just 27 and a half year property. It has carpeting in it that might last seven years. It has paint on its walls that might last five. It has light fixtures, it has the switches on the wall. All these things, it has a thermostat, it has linoleum, it has tiles, it has all these other things that have less than a 27 and a half year life.
You break those out and you can write them off all in year one if you want, depending on the type of property. If I buy a property, it’s not a problem. You’re wondering if you have the bonus depreciation on stuff you already have for a while, but I think you still can, you can still write it off. You’re still gonna get what I see is between 20% and 25% on cost seg. Have you looked at a bunch of those, Toni?
Toni: I haven’t.
Toby: What I’ve seen is it’s about 20%. If you have a piece of property that is worth $275,000 improved value, $100,000 in land, $275,000 in the improvement, I’d probably get an extra $55,000 deduction in year one which is great if I can actually use that to offset my other income.
If you’re doing other things in real estate and you’re not a real estate professional, the passive activity laws rules say you just have to carry it forward. It’s going to offset your rents, then you’re going to carry it forward. If I am a real estate professional, I can write it off against all of my other income.
You guys have heard me say this a million times if you’ve been listening, real estate professional is a two-part test. You have to meet the 750-hour test and then you have to meet the material participation test. 650 hours in the realm of real estate, it could be construction, it could be a real estate agent, and you have to spend sufficient time to be considered a material participant in your real estate activities and that’s per rental property you have unless you choose to aggregate them as one activity.
The material participation, there’s three tests, 500 hours, doesn’t matter who else was involved, you automatically qualify. The lower end to that is you do all the work, nobody else is a property manager, you automatically qualify. If you have other people managing, it’s 100 hours between you and a spouse, and nobody did more than 100 hours. Nobody did more time than you. That’s material participation. Anyway, that sounds like fun.
Somebody asked, “I have a commercial building, had it for more than 30 years, cost-basis was $150,000 and it was depreciated fully on my personal taxes. I can sell today for $850,000,” so congratulations. “The building is in my personal aim. Is there a method I can move the building to an IRA and sell it?” Usually, you’re putting cash into an IRA. I suppose you can try to contribute something but I wouldn’t even do that. You can 1031exchange it. Just sell it, buy it $850,000 worth of property.
If you want to re-depreciate it, and you want to lock in your gain, you’re going to get nailed in tax if you don’t 1031 exchange this, or you can sell it and re-invest it in a qualified opportunity zone. Even if you do the opportunity zone, you just have a 7 year deferral. You’re still going to be paying tax on it. I wish there was an easy way.
What you may want to do if you want the deduction and sell it, not pay tax, try putting it in a charity as well. You can set up a non-profit, get a huge deduction, carry forward the deduction if you don’t have enough income to wipe that off completely. You carry forward up to 5 years beyond the year of the transfer. You can get a nice, big, fat tax deduction. If the charity sells it, it pays no tax. You still have the $850,000 in your realm but it’s now in a charity.
Let’s go back to the questions we have. Somebody says, “How detailed do you have to be in tracking real estate professional hours?” Use your smartphone and keep it in a calendar, that’s how detailed you have to be. You just have to keep some contemporary as record. I suggest that you use either Spreadsheet or the easiest thing is just to use your calendar.
Can we get the same tax write-offs for travel and meals as before the Trump Tax Plan? Toni, let me hear it from you. Can you give them the answer to this question?
Toni: Travel didn’t change. Your travel expenses are still going to be deductible the same as before. There was a change to meals and you still get your 50% deduction but the employer provided meals did go down from 100% down to 50% with the rest.
Toby: Ouch. It used to be that if you provided meals to your employees saying, “Hey guys, work late, here’s some pizzas.” It used to be write it all off. Now, what is it?
Toni: 50%.
Toby: Oh, 50%. At least you get something. Travel didn’t make any changes. The big change for those of you who like to do meals is there’s no meals as entertainment anymore. You cannot entertain a client, there’s no entertainment anymore. I can’t buy tickets to a baseball game and write them off, it’s gone. If I buy them for a client and I give them, I’m not using it, perhaps I might be able to get by with the gift or an advertising, something along those lines.
Toni: It gets so limited and the deductible amount is $25 bucks per recipient.
Toby: Per year. It kind of sucks.
Toni: It does.
Toby: The entertainment went away. What you always have to make sure is what you’re doing is used to be, “Hey, I’m entertaining John Smith, potential client.” No. I’m meeting John Smith to discuss business, it has to be what you’re doing. It’s all on how you do it. You can still entertain the client, the cost just went up. There’s still a way to write it off, you just can’t write it off necessarily the way that you used to.
I keep thinking of Dorothy like the witch who got squished by a house. Your home and your car are under an LLC, it just fell on him, does the business pay the utility and maintenance bills? This is a weird one.
Honestly, I’m not a big fan of putting cars in LLCs unless you have a fleet of cars, otherwise I’m not doing it. If the house is under an LLC, you have to have a business reason. If I’m putting a house that is a rental property in an LLC, then yes. If this is your personal home and you’re trying to protect the equity, then yes but you’re not getting a deduction for it. The LLC could still pay it, or you can pay it, it doesn’t really matter. It’s just regarded to you anyway. The car, just don’t know why you put in an LLC, unless there’s a business purpose.
Somebody says, I recently heard if you send a gift to your office, I’m not limited to $25, is sending a platter of baked goods? I don’t know anything about that, I never heard that. You send it to your office, you’re not giving it to a third party. You have baked goods for your office, that’d be a 50% deduction?
Toni: Might be.
Toby: Or you just lump it into office supplies?
Toni: You could. The question though, I’m looking and I’m thinking. If you did put real property or an auto into an LLC for whatever the taxation of the LLC is, now it’s an asset of the business and the business should be paying the expenses associated with those assets.
If you are paying those expenses personally out of pocket on behalf of the business, depending on the taxation, what you have is you either have expense reimbursement if we’re talking about C Corporation, or you just have capital contributions that were talking about this regard of partnership.
Looking at it directly, to your point, the real question is do you really want to have that vehicle in the LLC which can sometimes complicate things. If not, then probably can result in more tax to you personally.
Toby: I tend to not like them in LLC, I’ll tell you why. Your insurance tends to become commercial and it’s like twice as much. I get cranky because they were saying, “Hey, other people could be driving and now it’s an employer provided, it could be other employees.” I tend to not like that. Besides, cars don’t cause liability, people driving them cause liability.
If I have Anderson Business Advisors and I buy a car in it, the car does not create the liability, it sits in a parking lot. What causes the liability is me giving the key to somebody and say, “Drive around.” Frankly, I’d rather be driving around as an individual than having a bunch of representatives of my company driving around trying to get me sued. I’d rather not have that.
What are the details that I need to write down when tracking mileage for a business? Technically, you write your odometer at the beginning of the year and the end of the year, and then you’re tracking miles. I’ll just tell you to use MileIQ, it’ll GPS you. Use that, it’s so much easier. Don’t even think around.
Toni: It’s super easy. It makes it much easier.
Toby: MileIQ?
Toni: Yes.
Toby: You swipe left if the mileage is ugly and swipe right if it’s pretty. It’s like an app, that sort of it. Some of you guys know what that means and you’re all dirty dogs. Literally, it says if it’s personal, you swipe one direction. If it’s business, the other. You don’t have to write it down every trip, you don’t have to write the odometer down in every trip. It’s the beginning of the year and once at the end of the year. They want to know how many miles was put in the vehicle.
What they really care about is they’re looking for percentages. If you’re a real estate agent, you say, “Hey, 100% for business.” They’re going to say, “BS. Nobody does that.” If you have 65% business and it’s your only vehicle, they’re going to say, “That’s probably right.” That’s what they’re looking for. Plus, if you have 10,000 miles on your car, and you wrote off 16,000 miles, they’re going to be like, “No. What did you do?”
Toni: Sounds off.
Toby: You heard about the guy who’s actually a lawyer who died. It’s a good story for you guys. A lawyer died, goes to heaven. Saint Peter is up there and he goes, “What the heck is this lawyer here for?” Lawyer is a hypothetical guy. A lawyer dies, he went to heaven. Saint Peter looks at him and says, “Hold on for a second, I got to get all the angels over here, got to check you out.” The guy is looking at him like, “Why? I got something on my tires?” He brings all the angels over and goes, “No, we haven’t had anybody up here who’s 323 years old. The Lord is looking at him, kind of perplexed and things about he goes, “Oh shoot. You’re going off on my billables.”
I write off vehicle usage one way as keeping track of business miles, is there another one? Yes, there is, and that is the actual expense method which isn’t so great. Either I’m doing $0.58 a mile or I am tracking all of my miles and figuring out what expense actually there was–all the gas, oil changes, repairs. Add it all up, I used 50% for business, 50% personal, I write myself a cheque for 50%. That’s not nearly as good as doing the mileage by the way.
If you leave town for business, then yes, you get meals, it’s 50% deductible unless it’s included in your airplane ticket, cruise tickets, train tickets, whatever. I didn’t mean to say cruise, you can actually use a cruise ship for travel.
If a vehicle is being used as an investment only and as a business name, will that be allowed? Yes. Helen, if you’re leasing it to somebody else, you’re going to have sales tax on it too. Now you’re actually using it just for business, you’re not driving it around personally. If you are, you still pay tax on whatever portion of that total mileage, it’s kind of weird.
Let’s say that I have three cars that I lease up to Uber drivers but I drive them myself too. Take a look and say total miles, put in the year, let’s say 90,000 and I put 10,000 on for personal. I have 1/9 of the values that I’m going to have to recognize in all three cars. They’re going to say what’s the lease value of those vehicles? It might be $3,000 a month, I’m going to have to recognize 1/9 of that. I just used a really bad example, let’s just say $400 a month. I don’t have to recognize $400 a month because that’s the personal use of that, I saw the IRS does it.
I have rental properties already, will they be taxed differently if they are part of a C Corporation? Usually, I file with my 1040. If you put them in the C Corp, don’t do that. I’ll just be real clear, don’t do that. It’s not your best interest, capital gains are gone. If you take it out, it’s a taxable event. Putting it in is not going to be taxable but all your appreciation is no longer long term capital gains, you lose all these benefits. You can still 1031 exchange through a C Corp.
Somebody asked me to explain what a 1031 exchange is. I’ll just tell you, a 1031 exchange is a fancy of saying selling real estate and buying more of equal or greater value. If you do that, you don’t have to pay taxes but you have to use an intermediary. You have to complete that transaction within 180 days, there’s a 45-day property identification process. You can do a reverse exchange and go backwards.
I would not put it in a C Corp. If a C Corp is managing an LLC that is owning the real estate and you’re paying a manager fee, that’s fantastic. That money will be taxed far differently, usually it’s used to expense things and get it back to you. It’s like your home office and things like that.
There’s a bunch of other questions that aren’t necessary. Is the LLC owning? Not necessarily. I won’t have the C Corp owning an LLC unless I’m flipping. The only time I do this is if I am buying property to sell it, that’s the same thing as being in a car lot. I’m buying cars to sell them, there’s no such thing as long-term capital gains, installment sales, inventory. I don’t want to be taxed everytime I sell a car, I want to be taxed at the end of the year based off of what’s left in the company. I’m not going to do that individually. I’m going to make sure I’m doing that through either an S or C Corp.
The C Corp, by the way, it files a 1120. Completely different tax form, it pays its own tax out of its profit.
Realtor leased a car for use as a sales agent, rented it out as a turo car. What’s a turo car, Mr. Ron?
What is the deadline to elect escort tax shipment for a single member LLC? That’s interesting.
The escort tax treatment of a single member LLC would have to choose. As a single LLC, it depends on who’s the owner. If it’s you, you actually have to make an election to be taxed as a corporation. The S election techncally is supposed to be made by the 15th day of the third month following the beginning of that company.
Toni: You have 75 days. 75 days from the date of the effective date, the date you’d like the election to be effective. Is that what the question is?
Toby: They are just asking when is the deadline.
Toni: To be able to do the 2553?
Toby: Yes. The problem that you have is the single-member LLC doesn’t mean it’s being taxed as a corp. Usually you have to tax it as a corp. You’re doing the 8832 saying taxed as a corp.
Toni: Got it. Now that their saying, you can go to–
Toby: This go straight to the 2553, 75 days to do it?
Toni: 75 days, and even if you are outside at 75 days, they do give late election release.
Toby: Yeah. If you have a good reason why you’re late and you’re still treated as an S Corp, they’ll let you keep it as an S Corp. A good reason can be–
Toni: You didn’t know you needed to file a form.
Toby: Yeah. I didn’t know. My accountant screwed me up. Toni did. It’s all Toni.
Let’s see, “Rent out my car to the public.” Mr. Ron is talking about hey, I have a car and I’m renting it out to the public. Then I might put it in an LLC, just to keep it separate. That’s different. I’m also getting sales tax and other things when I’m leasing it. Turo might use it, so it might be a third party service, and I’m not driving it. Somebody else is driving it, so now I’m looking at it and saying I’m just going to keep that puppy separate from everything else that’s going on. I might do it under that circumstance.
Alright, do I answer this? When switching your LLC designated–this is bizarre, because you just asked that question right before this. When switching your LLC designation to an S Corp, what accounting changes should you make? Paying yourself unknown deductions.
The tax and bookkeeping is identical for all entities whether you are a sole proprietor, an S Corp, C Corp.
Toni: Okay.
Toby: LLC taxed as an S Corp, LLC taxed as a partnership, a partnership, you get the idea. It’s all the same. The accounting wouldn’t change. The only thing that would change is if you went from an LLC that was a single owner to you or to somebody else and then it switched to an S Corp. Now, we have to worry about if we’re taking distributions, are we paying ourselves a salary?
Toni: The other thing is once you have an S Corp, you can be an employee of that S Corp. If you are an employee, you qualify for an accountable plan. If you qualify for an accountable plan, I can reimburse you for tons of things that I can’t do if you’re a sole proprietor or a partnership.
For example, I can reimburse administrative home office without having to do a home office schedule and filing out my Schedule C. I just get free money. I could reimburse myself for my cell phone, I can reimburse myself for anything in the house that I’m using for the benefit of the business, at least proportional. At least like on my house, a good chance we’ll be writing off 20% as a check from the S Corp for ordinary expenses that goes to you that you don’t have to recognize this tax. It’s free money. We like free money.
Toni: Yeah, free money is great.
Toby: Yeah, and to an EA, which is another way to get much money. Let’s see, “How do I get my realtor broker to pay my S Corp, or LLC or C Corp?”
Allan, this is where it gets fun. A lot of brokers won’t pay your LLC or S Corp or anything like that. What you do is there is a way, there was a tax case where the IRS told us what to do. There’s a letter you provide your broker saying, “Hey, you work for your S Corp. Your S Corp gives you an employment agreement and now even if they don’t pay your S Corp, you can put it in your S Corp. You treat it as though received by the S Corp.” You can’t do that without the letter and the employment agreement. But you do those and you’re good as gold, otherwise you just have them pay directly to your company.
Like here in Nevada, they can pay an entity as long as the entity can […] with the realtor association for licensing.
Toni: With what I’ve seen, it goes either way. I’ve had plenty of clients who play folks who their broker goes ahead and do it. They go ahead and pay it but there’s a way around it so…
Toby: There is a way.
Toni: You just have to ask.
Toby: Yeah, and you just have to make sure you’re documenting a head of time. There’s always a tax case where somebody lost or somebody won and in this case, the guy lost and it was because he didn’t provide a letter like the IRS said. If they would have said this, you would have been fine but it didn’t. All we do is we make sure that the letter we send says what they said it should say. We just use their magic language.
We’re under the exclusive control of the S Corp. Even though you are not going to pay the S Corp, we know you’re only going to pay me. I’m 100% at the service of the S Corp. I’m an employee of the S Corp, you should be paying the S Corp even if you don’t.
“Where do I get the letter?” You got to come to TaxWise, my friend. If you’re platinum, we’ll give you whatever you need so if you’re a platinum service member with Anderson, just email in. If you need the letter, just go right into Tax Tuesdays at andersonadvisors.com.
Let’s keep going on, “What is your opinion on investments in the oil and gas space as a tax mitigation strategy?” This is kind of fun. Not everybody has an opinion. First off, it’s an investment, you can lose all your money in any investment, I’m just going to say stuff like that. Not telling you to do this.
Somebody says, “Does S Corp need to pay payroll taxes?” Not necessarily, only on the amount of wages you take. Everything else that flows down to you, you avoid, Social Security or the self-employment tax. You can also call it old age, death and survivors, and medicare if you want to get technical. It avoids about 14.01% when you actually do the math and it’s really good. S Corps are awesome. Yes, you have to pay some payroll taxes on only the payroll as opposed to a sole proprietor where you pay payroll taxes on 100%.
Toni: Right.
Toby: On self-employment taxes.
Toni: I love S Corporations because it gives you back the control of how much you’re going to put as payroll and how much you’re going to just have come flow through. You don’t have to pay payroll tax on that part of self-employment tax. We have the control back in our hands.
Toby: Yup, and it even gets better. Somebody said something about the 20% of deduction. Yeah, you get to take 20% deduction too on the income out of the S Corp. You do not get a 20% deduction on payroll so you always want to do your math. I’ve broken this thing down painfully in detail whenever we do the TaxWise workshop which we just did one last week. Gosh, it just seems like yesterday but it was I think last week or the week before that. We just did one and we go through this over and over again.
“Do you have to take a salary out of an S Corp?” says Ron. Yes, if you take distributions. No, if you don’t. If I just have an S Corp and it makes $100,000 and I leave it in the S Corp, technically, I don’t have to take a salary. But if I make $100,000 and I take $50,000 out, I need to make sure that I am paying a portion of that as wages. If it’s $50,000, I’m probably paying myself a third of it as wages. But technically, if I don’t take anything out of an S Corp, I don’t technically have to pay myself a salary.
Somebody says, “Will the recording of this be sent?” Yes, you’ll have access to the recording so you can go ahead and listen to it.
“What is 20% deduction? Is it called a 199A deduction?” You can go on our site and look at it but it’s the Qualified Business Income Deduction that was under the Tax Cuts and Jobs Act, so the Trump Tax Act. What it says is corporations get a flat 21% tax if you are a C Corp. If you’re an S Corp, and you pass through the profits, it gets a 20% haircut under many circumstances if it’s any pass through. So, partnership, sole proprietors even qualify but there’s some different tests.
If you draw a profit out the following year and you have no property corporation, you have to take it out as a salary. You’re getting smart, you took the distribution out in the following year but you had no tax, you’re going to create a lost and you’ll have basis. You’ll be able to take it as a loss. You’ve created a loss for yourself. It wouldn’t be that you don’t have profit, it’s just if I take a salary it’s going to be an expense in excess of any profit I have. I’ll still get to write it off.
Let’s go back to this, “What is your opinion on investments in oil and gas?” The way oil and gas, reason people invest in it a lot for tax purposes is that intangible drilling cost, the cost of digging your hole in the earth to pull out the oil and all that goes along with it is 100% deductible against your ordinary income.
If somebody, let’s say they have a salary of $500,000 and they know, “Oh, shoot, I’m in a really bad tax state. I’m in New York, New Jersey, Connecticut, Maryland, California.” Some state with a high state tax and they say, “Gosh, my federal tax is high. My state tax is high. I’m paying essentially 50 cents on the dollar. If I invest the $100,000, I’m going to save $50,000 of it if I end up with some loss. If I invest $100,000 and get a $100,000 deduction, then I’m getting a 50% return right away.” That’s why people do it.
I wouldn’t invest in oil and gas simply for the tax mitigation because then you don’t have deduction on the depletion where you lose that portion of it. You’re going to end up paying the tax in the long run anyway but people do it because they want the deductions now. It’s worth something to them. Even if the investment doesn’t make you anything, I’m getting a nice fat deduction so I could invest $100,000 into oil and gasses but it’s only costing me really $50,000. That’s the way they look at it.
Somebody says, “I have a 1099 job, can I form an S Corp to avoid the self-employment tax? The income in my 1099 is for investment purposes.” Okay, first off if you have a 1099 job, that’s not a job. You’re not an employee, you’re a contractor. If you’re a contractor, could you run that into an S Corp? Yeah and avoid a bunch of self-employment tax. That’s exactly why people do it. Yes you could, great question.
“I have a fulltime job, W-2, and I do real estate investing on the side. How can I use property depreciation to deduct against W-2 income?” Toni, what do you say?
Toni: Well, it depends on your adjusted growth income. If you have depreciation that’s resulting in rental real estate loses, that can be deductible against your W-2 income up to $25,000 and starts to phase out at $100,000 of your adjusted growth income. Or you can qualify as a real estate professional in which case you’ll be able to take all of your rental losses against your ordinary income or W-2 income.
Toby: Right. Since 1986, they closed this wonderful loophole. All the rich guys and gals out there will buy real estate and then they will depreciate really fast, hard, and offset their income so Mr. Doctor out there making $500,000 would investment in real estate so they don’t have to pay tax. They said, “Oh, that’s a tax shell. This is so unfair.”
They said if you are an investor in real estate, it’s passive if it’s investment in real estate. Then they said you can only use your passive losses against your passive income, that was rule number one. If I venture into real estate and I depreciate it, and I end up with $100,000 of loss, I can only offset my rental income with it.
Now, there’s two exemptions. What Toni said is 100% correct. If you make $100,000 then you could be an active participant in real estate which means you hire the manager or you manage the property and you get to write off up to $25,000 of depreciation or loss against your other income. My W-2 income, whatever income.
Let’s say you’re making $200,000, you’re faced out of the $25,000, and you have a bunch of real estate loses. Then, the only way you’re going to write that loss off personally, you can carry it forward into future years to offset future passive income. But if I want to take it against my other income, so I have my W-2 income and I want to offset whatever I have. I can do some accelerated depreciation or cost seg and I get lots of extra loss, then I have to qualify as a real estate professional.
And only one spouse has to qualify, and then you can take it out on a joint return.
Toni: Mhm.
Toby: And again, that rule is really simple. One spouse has to spend at least 750 hours, it has to be their number one use of their professional time. If I have a job, full time job, then I do 2000 hours a year, I’d have to do 2001 hours of real estate or I don’t need test number one. Then test number two is the material participation. The example I always give is if I’m a real estate broker, obviously I need the 750 hours because I’m a real estate broker. But then if I do nothing with my own properties–let’s say I have three other properties and I do nothing, all I do is hire it out, I’m not a real estate professional; I’m not going to meet the material participation test. In that particular case, it would have to be at least 100 a year. If I do nothing, I wouldn’t meet it.
But if I did, it could be one spouse, so let’s say one spouse is a successful lawyer, real life example, making $3 million a year, and the spouse is a real estate agent who specializes in commercial and the lawyer’s buying everything he can get his hands on because he knows that if he depreciates it heavily, he can offset his $3 million of income. That’s exactly what he did, he got it down to zero. He got audited as a result because it was so extreme. He won, because it was clear, his wife qualified. It only had to be one. We have a bunch.
Casino winnings and losses, you can write off your losses against your winnings unless you’re a professional gambler. Am I right? It’s kind of weird.
Toni: Well, yeah. With the doubling of the standard deduction…
Toby: Does that go in Schedule A?
Toni: It does.
Toby: Oh, yeah. Don’t gamble.
Toni: Or do it well.
Toby: Yeah. If you make a whole bunch of money at it, then does that go in your Schedule C?
Toni: That’s just other income.
Toby: “Are self-employed real estate professional property appraisers consider real estate profession as able to meet the material participation test?” Again, there’s a real estate professional test number one, which is 750 hours, and material participation test which is about your properties. If you’re an appraiser, you probably aren’t in the transactional world. That time probably wouldn’t qualify as a real estate professional. The same way as I am a lawyer who does nothing but asset protection and taxes with real estate, but I would never qualify as a real estate professional. I do a bunch of other stuff too. Your appraising isn’t a real estate activity, as weird as that sounds.
Somebody says, “Oh, $7000 of loss.” Keep in mind that whenever you’re doing gambling, you can only take your losses up against your wins unless you qualify as a professional gambler. That’s like a weird test. My guess is that you’re just carrying that forward in future years. Most people that gamble and lose don’t get it as a writeoff.
“What are the common tax deductions that apply to real estate investors?” The basic ones is that you’re buying real estate, you’re going to have real estate taxes. You’re going to have closing fees, you’re going to have mortgage interests. You can have loans. You’re going to have repair expenses, you’re going to have depreciation if you’re holding properties.
By the way, repair expenses, you have a safe harbor of $2500 for the area of the home that’s getting fixed. If you take something that’s broken and fix it, it’s a repair. If you take something that’s long in the tooth and make it new again, then that is an improvement. If I put a new roof on a house, that’s an improvement, that’s not a repair. If I fix a hole in the roof, that’s a repair. I’d write off repairs, I add improvements to my bases, I don’t get to write it off right away.
Other tax deductions, depreciation is a big one. It’s taken the actual structure that it put on in doing it.
Toni: Sometimes, people get confused with the depreciated state. I don’t want to take any depreciation because I don’t want to have to recognize the depreciation recapture will. Whether you take the depreciation or not, you are going to have to recognize the depreciation recapture on that. Take the depreciation deduction.
Toby: Yeah. What Toni just said is actually like a mean thing that they do. Here’s the scenario, husband and wife own a house. They have a vacation home and they rent it out. They say, “Hey, I’m going to rent it half the time I’m not there. The rest of the time, we’re going to spend our summer on the lake, on this beautiful property.”
You’re entitled to the depreciation. Whether you take it or not, the fact that you’re renting that out for more than 14 days a year, the IRS says that’s a rental property, you have to recapture the depreciation whether or not you wrote it off. It’s kind of mean.
Corporate replacement, you’ll be able to write that off. Mr. Ron had $7000 a win. Where will you put that in gambling? Just other income?
Toni: Just other income, yeah.
Toby: It goes on his 1040 page one. Good job, Mr. Ron. How about a loan?
Toni: Just to this question, what I look for if I’m reviewing your return, I’m looking to see if you have management fees on there or if you have other travel expenses on there. If you don’t have one, you should have the other or both.
Toby: Carpet, we’re writing that off just because it’s such a short period of time, we’re bonus depreciating it. Anything less than 20 years, you can write off in year one. If you have carpet, paint, all that stuff, you write it off. You had to call a repair. It’s just a deductible item.
Alright, that’s real estate investors. By the way, one that we didn’t cover is manager fees. You can always pay it up.
Toni: I did.
Toby: Oh, you did?
Toni: Yeah.
Toby: You can always throw the corporation in there to manage the thing and pay it a bunch of money. If you get gain for the depreciation in the year of sale on an undepreciated property, can you go back previously years and claim the depreciation? Think about this, if somebody does not depreciate, they could’ve depreciated it but they don’t, they sell the property, they have depreciation recapture on depreciation they never took. If it’s within three years, they can go back, amend the return, and take the depreciation.
Toni: Yes, actually you don’t even have to go back and amend if it’s multiple years. You don’t have to go back and amend every year. IRS made it a little bit easier for us to just put on a schedule and catch that up.
Toby: You can catch it up. Bruce, good catch. You can write it off.
“What are common tax deductions for a futures trader from home?” MJ, that’s funny because futures traders, first off, you get nice tax treatments like 60% long term capital gains, 40% capital gains, but you don’t get any unless you set it up as a business. You’ve got to have an LLC taxed as a partnership with the corporation as the manager. That topic, there’s a bunch of videos on this site. I’d watch that. You want to make sure that you’re not just sitting home doing futures trading, it’s not going to give you any tax benefits.
If you’re going to do futures trading, what I really would do is do it in a retirement account or I would set up a corporation if I’m a small account, less than 10,000. If I’m over that, I’m setting up an LLC taxed as a partnership with a corporation as a partner, also as a manager.
“When finishing a rehab with the intent to sell, what is the best way to minimize capital gains tax?” Yes. I’m just going to zero that puppy anyway. First off, we have a rehab with intent to sell. There’s no such thing as capital gains tax, it’s inventory. You just sold Cheerios in your grocery store or I just sold a car and I’m in a carwash, how do you want to talk about it? It’s ordinary income. If I want to minimize the capital gains tax then flip houses because there is none. That’s just mean.
What I want to do is I want to have that as an S Corp or a C Corp to minimize my total tax. In all seriousness, what you do is you never do flips in your name, personal name. You don’t want it on your personal return. You’re going to do it under C Corp or an S Corp but I’m going to aggregate them all together and have all of my gains, all of my losses, at the end of the year as opposed to transaction by transaction which you would have as an individual. Plus, if I make that money in an individual, I’m paying self employment tax in all of it, which has a nasty habit of making my taxes weigh more.
Toni: Yeah. Also, go back several questions ago, how do I minimize my tax? Set up a tax deferral vehicle.
Toby: Yes. Since you don’t have capital gains, I can use a 401k now. I could set up a company and I could minimize my tax completely. I’m over 50, I’m jamming $24,000, $25,000 into this. The first $24,000 or $25,000 are gain plus 25% whatever I decided to pay myself. That was kind of fun.
“At what point is the intent established and is it documented somewhere?” It’s facts and circumstances. They look at what you do. If you buy houses all the time, you fix them up and sell them, they’re going to call you a flipper, you’re a dealer. If I do it once it a while, then they’re going to look at the total activity that you do and they’re going to say, “What is your primary intent?” They’re going to look at it from facts and circumstances.
Toni: Yeah. It is documentation as well because you actually can change the intent. If you purchase a property with the intent to sell it, let’s just say the market took a dive, now is not the best time to sell it so you change the intent of that property to hold it and wait for it to appreciate, now I’m changing it from inventory to a capital asset. By just documenting it and showing the industry’s saying this, the market’s saying this right now.
Toby: You got to be careful. I’m not going to disagree with you. I’m just going to say, there’s a case out there. In 2006, a guy bought a building. He was going to fix it up and sell it. Then, 2007 happened. All of a sudden, they couldn’t sell it. What the court did, because this was actually a court case, is they looked at every year. Every year, he would get an appraisal on the building. He would say, “Is it time to sell? Is it time to sell?” He sold it in 2017 and it ended up being a wonderful tax court case.
Toni: Did he change it into a business property?
Toby: When he bought it, he was intending to sell it. It was held in the same entity the whole time. What they said is was that a dealer property or was it an investment property? I think he did an installment sale. My guess is, forget about the amount of those, a few hundred thousand, is they nixed his ability to recognize that over time. He got nailed with a tax on money he never received, yet. He will receive it but it’s always fun when they do that. It was 10 years of hold.
You’re going to want to make sure that if you’re flipping, here’s the way you do it. It’s really easy, actually. It’s what all the accountants will tell you. You buy your flips in a corporation, you buy your holds and you use LLCs. By the way, your corporation is a tax designation. You can be an LLC taxed as an S or C Corp. You’re doing your buy and holds, it’s a flow to your return on your Schedule E, either as a disregarded entity or as a partnership. That way, the IRS knows exactly what you’re doing. If you accidentally buy something in a C Corp or an S Corp that you’re going to flip, then you decide you’re going to hold it, you sell it to your holding entity or vice versa.
If you buy it and you think you’re going to hold on to it for a long time, sell it and grab your long term capital gains before you fix it up and make it into a flipper. There’s nothing worse than losing long term capital gains which have a capital of 20% by making it ordinary income where your capital is 37%. You just use those two entities and treat it just like you would if they were just buddies that you know and not just you. I would sell it.
You can even do that with your house. We talk about this a lot. People that have their houses forever, not much value. They didn’t pay much for it and now it’s worth quite a bit. They want to use their 121 exclusion which is the, “I don’t have to pay tax on my house up to $500,000 of capital gains when I sell it if I’m married, $250,000 if I’m single.” You sell the house to your S Corp and then let the S Corp hold it. As long as you’re never going to sell it, we don’t really care. Your basis steps up so you can depreciate it to a much higher amount. It ends up being a really good way to do it. We’re going along.
“I do my flips in LLC but that LLC is just part of my C Corp, is that fine?” Yes, Chris. The tax designation of the LLC is the C Corp.
“Will an LLC help reduce rental property taxes?” The answer is rental property taxes, probably not. Unless you have a corporation that’s in with it. We could always play games with this. How is that LLC taxed? If it’s rental properties, I don’t want it to be taxed as an S or C Corp, but I probably want to have a manager managing that then I can reduce my taxes. It’s kind of fun. Anything you want to add?
Toni: No. I think that’s pretty straightforward.
Toby: Toni’s such a good accountant. She wanted to say it depends on how you’re going to tax the LLC. I’ve ruined it for her.
Toni: Well, you kind of said that.
Toby: I know you wanted to say it. She started laughing. Anytime we see LLC, I would have worked with C Corps involved. The C Corp would be the manager, the C Corp has another tax designation. I could pay management fees. The rent would no longer flow onto my return and be taxed in a C Corp level.
Let’s say I had a bunch of profit, the rents were positive. I was making $20,000 a year. Let’s say I’m a taxpayer in the highest bracket, that $20,000 a year is going to get nailed at 37% plus my estate tax. If I kick it over to the corporation, then the corporation pays 21% on it. It’s going to pay $4000 as opposed to much higher. There’s lots of ways to get money out of a corp that’s tax free.
“Which is more tax-advantageous, a 1031 Exchange or a Charity Remainder Trust?” Want to nail this one?
Toni: Here I go again. I think it depends on what the asset is. If it’s real property, then you have the opportunity to use a 1031 Exchange. The 1031 Exchange in the Tax Cuts and Jobs Act is limited now to only real properties.
Toby: That’s a big one. 1031 Exchanges are only for real property now, no longer for business inventory.
Toni: You want to pick up the Charitable Remainder Trust?
Toby: No. You do the Charitable Remainder Trust.
Toni: You’re doing the Charitable Remainder Trust.
Toby: Alright. Here’s the big difference. A 1031 Exchange is a deferral. I’m kicking it out until the end of time. If I die owning that real estate, the basis steps up. If I 1031 Exchange properties my entire life, I’ll never pay tax on the capital gains or depreciation recapture. When I die, the basis steps up and my heirs will no longer pay taxes on any of that growth as of the day of my death.
In a Charitable Remainder Trust, just think of it as what it is. It’s trust with charitable charity as a remainder of interest. I get a deduction based on the value of whatever I put into that Charitable Remainder Trust or what it’s going to be worth in the future. If I give let’s say it’s not a house, what if I give a bunch of bitcoin? That would be kind of fun. Bitcoin is technically a capital asset. It just jumped up 300% this year, it keeps doing weird stuff.
Let’s say that I gave a Charitable Remainder Trust to a bunch of bitcoin. I get a deduction based on a percentage. I’m going to say close to 10% of the value. It’s not huge because they look and say, “Hey, how long is this thing going to be in trust before their charity gets their interest?” It’s going to be spent down. I’m going to get income off this thing my entire life. Most Charitable Remainder Union Trust, I’m getting an amount every year that I get to receive or I can roll forward and not pay tax out of it. I want to make sure that I have the right to receive income out of this thing.
Let’s say I have bitcoins worth $200,000. I threw it in a Charitable Remainder Trust. I’m probably going to get about $20,000 deduction this year as a charitable deduction. It goes into trust—the entire $200,000. Let’s say I sell bitcoin and turned it into US dollars, no tax. No tax. Then, as it grows and as it makes money, I might be kicking out a certain percentage of that. Let’s say 3% or something like that a year. I’m going to pay tax only on that amount that I received, the income that is generating. When I pass, the remainder interest, the remainder holder is a charity. Technically, it can be my own charity.
Some people use it. The reason they’re using it, if they have highly appreciated assets. It’s pretty cool. What’s more tax advantageous? Frankly, I’m going to tell you a 1031 Exchange is always going to be better. Sure, in Remainder Trust you’re going to have income your whole life. Frankly, they’re a bit of a sticky wicket, we don’t do too many of them because there’s such a complexity to it. Nobody really wants to give it all away. I’d rather just give it to a charity now and take the full deduction. Then, if I want to pay myself income, I can rather than force myself to do it. I tend to stay away from Charitable Remainder Trust. I’d rather just go straight to the charity. Then, I’ll go ahead and give the assets to charity.
My same example, $20,000 with the bitcoin, I’ll give it to a charity. I can write the full $20,000 off. Even if it’s my charity. Now, I turned that into cash. I got my $20,000 and I’m doing what I want to do. Maybe I can give it to my church or whatever. It’s often times better to do it that way than paying a taxable event on a bitcoin and give in the dollars, me having to recognize the capital gains than me giving it away. I’m getting both.
If you guys get a pen out, you’ll realize what I’m saying and go, “Whoa!” I didn’t take money out of a corporation without having to pay taxes. You reimburse yourself under an accountable plan. You’re going to write off literally anything that you incur personally for the benefit of that company including education, cell, utilities, internet, car, a home office, 280-A, equipment, your computers, all sorts of fun stuff. Even if it’s a C Corp, even your medical, dental, and vision. Even your long term care, yes, you can write off.
Somebody asked this way long time ago but I didn’t answer it. Long term care policies, you have restrictions on what you can write off as an individual but you still have to exceed 10% of your adjusted gross income. If it’s through a C Corp, I can write the whole thing off if it’s qualified long term care.
“How often should you take a distribution from a holding LLC?” As often as you like but not on a regular basis. Somebody says vitamins, prescriptions, yes. Yes, maybe. The vitamins, you just got to make sure a doctor gives you a prescription that says you should take them. You want something in writing from a doctor on that. Then, it qualifies.
“What about an S Corp?” No. S Corp, if you pay yourself stuff that is health related, it’s considered income to you, it’s considered wages. You can still witeoff the insurance premiums, individually, your self employed insurance premiums but all the other stuff the corp pays, deductibles, noncovered items, all that is actually income. It has to be a C Corp.
“You’re going to flip corporations. Can you have an LLC taxed as simply paying yourself salary or reduce the employment tax?” Your salary won’t reduce the employment tax because you’re still paying it. It’s not just the self employment tax. You’re paying the employer and the employee sides of old age, death, survivors, and medicare. That’s not going to do it. What you do is you pay yourself a very small salary. Then, the distributions are not subject to the self employment tax.
Let’s get back to this distributions from a holding LLC. You don’t want it to be a pattern because then a corp can say, “Hey, you’re always giving money every month. You need to keep giving money any month.” You want to make sure it’s sporadic. There’s no tax event when you’re taking a distribution from a holding LLC. It’s disregarded or taxed as a partnership. It’s like a safe where you can put money in it, take it out, put money in it, take it out.
Somebody says, “What about athletic club membership for a C Corp?” Listen, if you have to get a doctor to prescribe it then, yes. Otherwise, no. Athletic club memberships, I wish they were deductible but if your doctor says, “Hey, listen. You’ve got some stress, girl. You need to go in there and push some iron.” Get them to write it up, then you can reimburse yourself. You could be a beast. My wife does all that stuff. My wife, she kills it. She goes in everyday. She says, “I’m in the office.” She does it, yes.
“What if any are the tax benefits for a real estate investor in Florida to use a trust to hold real estate?” That’s a great question because it illustrates a point. A trust, you want to make sure that you know what trust you’re using.
“Are there any tax benefits for an investor in Florida using trust to a real estate?” There’s only one that I can think of. That is when you use a Land Trust and you’re using an LLC to hold the beneficial interest, it’s a rental, and I have a corporation as the manager. Or, if I’m flipping property, then I’ll use the trust and point it towards a LLC taxes in an S Corp or a C Corp. The trust itself gives you not tax benefit.
Trust, usually, are going to be revocable trust and we’re probably going to ignore. I really don’t want to get too far into these things. Even if you have an irrevocable trust, I sometimes use an asset protection trust. I set them up and make them intentionally defective for tax purposes. Not to create an extra tax return.
Frankly, trust taxation, if it’s trust in the states, it’s taxed really bad. What is it? It’s the highest tax bracket here at $11,000, you’re already there. We don’t want to do that. We want it to flow down to you.
“How should money flow from personal to business back to personal in the most tax efficient manner?” Alright. See, here’s how it works. Let’s say that I put money into a holding company and take it back out. Zero tax. No benefit. Let’s say that I put money into a C Corp and the C Corp ends up reimbursing me, I create a loss in the C Corp. No benefit to me other than I get money back out to me. The money’s tax free but it’s not a deduction to me now that the deduction’s stuck in the C Corp. If it makes any other money, that’s good. Now, it’s not going to pay tax on it.
Let’s say that I put money into an S Corp. Then, it reimburses me for a bunch of expenses and it creates a loss, fantastic. I get those losses. The answer becomes this horrible thing, the two words you guys hate hearing, which is, “it depends.” How should money flow back and forth? You got to work with the tax professionals, say we want to get money where.
This is a good example. If I have personal money, I put it in a corporation, the corporation makes some money, puts it into a 401k, the 401k grows for 30 years. Then, it starts paying me out, it’s 70.5 minimum distributions. I pay my rate then as pretty light tax. That’s the really tax efficient manner to get the money back at it. I’ve had decades of tax regrowth. That’s pretty good. I did that by taking my money and dumping it into a corporation so it could make some money. Every little situation’s different.
Somebody says, “Should the management corporation be an S Corp or a C Corp?” It depends on whether you have an S Corp or C Corp floating around, what your tax bracket is, and what your tax appetite is. It really gets down to, I hate saying it depends, but I say it a lot, it really does, it’s facts and circumstances. The IRS is going to tell you the same thing when they look at that.
I’d look and see what your tax appetite. If you want to know your tax appetite, this is a good transition. Your Tax-Wise Workshop. I went over on June 13th and 14th. What a great group that was. We had over 100 people, even online, we had a full house, live. We did over 30 tax strategies in detail. You can get that recording of both that one and the one we did on January which was kind of the beginning of the year. In November, we’re going to do an end of the year tax planning Tax-Wise. You can get that whole thing, all three of them, including attending the livestream. You can watch in November the live class and ask all the questions you want. You can go to andersonadvisors.com/3for1. It’s $197. You can get it all. You can get all three.
I started that in January. I happen to think it’s probably the best deal in town because I quite literally had people go to this in January and already, I’ve had $178,000 winner where somebody says they were able to get that type of tax benefit. I had a guy this weekend who had gone to one and found $130,000 of deductions this year that he’s actually going to be able to use every dollar on. He’s like, “I didn’t even know you can do that.” Guess what? He learned one thing.
I always tell people there’s 31 deductions that we went over like tax strategies. I said, “Pick three. Pick three. If it doesn’t pay for itself, I’ll give your money back, no problem. This will absolutely put a ton of money back in your pocket. It’s $197.” It’s ridiculously low for what is two days of intense tax deductions and tax strategies.
If you guys like the Tax Tuesday, we break them and make them into podcast. Here, you guys can go back. Somebody asks for the address. I can give it to you as well. It’s andersonadvisors.com/3for1/. If you just email us too and say, “Hey, I want to do the 3for1,” we’ve got hundreds of people that do it. The response has been great. I wish I could say thousands but that thousands of people go through our workshops.
Not everybody loves the taxes. Some people just like to go to the workshops and think about it but not everybody loves taxes. I love taxes. Toni, you love taxes?
Toni: Yes.
Toby: She loves dealing with them. Then, you can go to iTunes, Anderson Business Advisors. You can watch and listen to a bunch of the old Tax Tuesdays and this one as well. We have a very special guest here with us, with Toni. She’s not always with us.
Toni: This is my second one.
Toby: This is your second one? Jeff likes to sit here and he’s talking loudly with his eyes. He doesn’t vocalize. I could tell he wants to say things all the time.
You could do that on Google Play. You can do Anderson Business Advisors, jump on the podcast. Oh, I forgot about this. We’ve been doing this for the last couple of months. Go to the infinityinvestingworkshop/sign-up/. You get a free code to do an 11 part how do I find an EA. You call up a tax group like us and you say, “Do you have any EAs?” Let’s see what else, you’ve done jobs telling me those over the last 10 years. I have some clients here, they’ve been with us 20, 10, a lot of years.
Infinity Investing, this is to get rich slowly. If you like more of a methodical approach towards making money and looking at things, you use that code FREETAX. It’s an 11-part series. It’s very much something that I designed and built for younger people, especially 20, 21, 18, before they get in developing a bunch of bad habits. They want to understand what an asset is versus what a liability is from a very easy to understand but hard to screw up way, talk about the losing loop, how to use when you’re buying liabilities with liabilities, and you’re able to figure that one out. You realized when somebody’s duping into something.
This is great. It is free. When it says free tax, it is free. There’s no strings. It’s an 11-part series. I think that I have another five hours of financial stewardship built in there. I have a very simple philosophy. The simple philosophy is you treat it like it’s somebody else’s and you quit doing good few things with your money. If I win money down at the casino, I treat it very differently than if I did something else.
If somebody paid for it, I’ll give you a credit on that. I’ll give you a credit on that. I forgot that I had this in there. Sometimes I keep stuff away and I forget that I’m going away.
Somebody says, “Needs versus desires.” We actually break it down mathematically. This is funny. Infinity Investing in a nutshell is this. There’s a certain money that I live on a daily basis. If that money comes in without me having to work for it, then I don’t ever have to work again. If I live off of $200 a day and I have $210 coming in from rents, royalties, dividends, interests–something that’s passive–then, I never have to work again. I could live an indefinite period of time without having to do a bunch of work. That’s infinity.
When I look at your net worth, I don’t care how much you have. I care how many days you can live without working. That’s it. If it’s less than infinity, then we got work to do. If you can do that an indefinite period of time, fantastic. Then, we worry about giving it away and how you create a legacy where they can’t screw it up because you just can’t screw it up. It’s about 16% likelihood that they’ll actually be successful with your money. It’s really, really small.
Federal rent checks, I don’t know what that is. Never heard about it. Chances are it’s fake when somebody says, “Is that real?” I don’t know, it sounds weird. What I’m thinking of, that’s called a hud. It might be Section 8. That is real when that’s paid for your property. The beautiful part of a hud is it can be for profit or not for profit. You don’t want to pay tax on it, you don’t have to.
Replays. If you are a platinum, you get all these replays. It’s all over Facebook. I’ll look it up, Chris, and Mr. Ron, I’ll figure this one out. That’ll be on my todolist, the federal rent checks. I’m pretty sure it’s probably going to be Section 8, I’ll bet you. I’ll do a little thing on it next time.
Replay’s in your platinum portal. If you’re not platinum, it’s a whopping $35 a month. Be a platinum member of Anderson, there is a signup fee. A lot of times it’s waived if you’re already a client or if you’re doing other things with us. You can always just ask, TaxTuesday@andersonadvisors.com. Get in, free stuff. Follow us on social media. Go to Facebook and YouTube. Ample opportunities to interact.
I tend to answer any question anybody asks me. I don’t really care if you always come on here or ask it via the Tax Tuesday. We’ll answer it. We’ll do our very best to get to it. As you can tell, we answer a ton of questions. We always say this in an hour but I think we went a little bit over every single time.
Sorry, Toni. She’s sitting here. I gave you an hour. You took an hour and forty-five. Can’t get it back.
Toni: It was fun.
Toby: You ask and you might receive. If you ask Patty, we’ll see what she does.
TaxTuesday@andersonadvisors.com or visit us online. Do the Google, do all that fun stuff. This will become your favorite thing to do every two weeks. Yes, we have some weird groups that do the Tax Tuesdays parties. I hope they drink a lot during it because we didn’t drink at all.
Toni: We didn’t.
Toby: Next time, we’re cracking a bottle and we’re getting a little crazy. Alright, guys. We really appreciate you joining us. Anything you want to add, Ms. Chatty Cathy?
Toni: No, I think I’m good.
Toby: It’s like my cat. You’re sitting here and look cute. Every now and again, they go maah.
Toni: I didn’t see your cat.
Toby: No, you’re better than my cat. My cats are awesome. Have you seen peaches?
Toni: No.
Toby: What? Oh my god, I’ve got the best cats. Hey, that’s how they write the law. Those drunk third graders. They write it in crayons.
When somebody says, “Is this the same material as in the November?” No, it’s a little more. We fill in some of the blanks but absolutely it’s the same philosophies. It’s just that I did it all, it’s the 11-part series. There’s no audience participation so it’s an 11 hours of content or 11 parts of content. It might be over 11 hours. Anyway, there’s tons there.
Until next time guys, I really appreciate you joining us. Share it with your friends. There’s never any cost to doing a Tax Tuesday. Feel free to bring them in and ask many questions.
Thank you again, Ms. Covey for coming here and spending some time with us. It’s not the easiest thing in the whole world for an accountant to come in and answer many questions.
Toni: Because it depends.
Toby: Leave it at that. Thanks, guys.
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, a great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets.
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