Tuesday, March 3, 2020: Was it super for you? It depends on facts and circumstances. Who and what is best for you? Toby Mathis and Jeff Webb of Anderson Advisors answer your tax questions related to mental health care, short-term rentals, and retirement because life is about more than just money. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
Highlights/Topics:
- Are there tax rules that allow farmers to accelerate depreciation for farm equipment? Farmers can take Section 179 and bonus depreciation, but they have a slower recovery
- How do you keep track of your reimbursable expenses before your corporation makes a profit? Make sure the corporation is reimbursing you for all your expenses and report them at the corporate level as loss
- What tax rate do I have to pay on an early withdrawal from my IRA? Some exceptions, such as age and financial hardship, but the marginal tax rate is about 22% plus 10% penalty
- How can we write off the tuition for our training? If already in a field or career, tuition for training should be written off to business; if not, write off as a startup expense
- My sister and I are partners in our LLC. She is now on disability. How can she receive profit from the business now? No material participation to receive passive income
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Resources:
Individual Retirement Arrangements (IRAs)
Capital Gains Exclusion/Section 121
Real Estate Professional Requirements
Rollovers as Business Startups (ROBS)
Full Episode Transcript
Toby: Hey guys, this is Toby Mathis.
Jeff: And Jeff Webb.
Toby: And you’re listening to Tax Tuesday. This is a Super Tax Tuesday for super Tuesday. If you don’t know what that means, you’ve been living under a rock. We’re just going to jump right into a lot of questions today because we want to make sure that we’re getting it.
The first thing you should do is always make sure that you’re engaging with us on social media if you like this type of content and if you want to get your questions answered, there’s nothing better. Send in questions to taxtuesday@andersonadvisors.com. That’s where we pick the questions for every Tax Tuesday.
Just to give you an idea, usually in every Tax Tuesday, there are about 200 questions, and then we get a ton that gets emailed in. If you need a detailed response specifically to you guys or to your situation, you probably need to be a Platinum or a tax client. You can always try to ask here, but again, it’s too deep, it’s probably not something we’re going to dive into on this.
It’s fast, fun, and educational, we want to get back and help educate. Let’s go over some of the questions we’re going to go over today. We already have some stuff here. We have rules now. Yes, we have rules. Aloha, Mark and I’ll answer some of the questions that have already been up there.
Here’s an easy one, first question that’s not even a standard question. Somebody asked online, “How to assign an LLC taxed as an S Corp to your living trust? It’s really easy. You actually just do a simple assignment. I actually do a one-page assignment for all of my entities that are going to be held by living trust and it goes from your name individually to your name as trustee of your living trust and there’s no tax hit.
Here we go, let’s just start diving into some questions. First question we’re going to be answering tonight is, “I’m looking to enter the short-term rental industry through rental arbitrage.” Sounds like they’re going to do Airbnb. “If I were to put my Alabama LLC inside my trust, is the income distribution protected against lien? Should I add another layer by creating a Wyoming LLC as the single member of the Alabama LLC?” We’ll go over that.
“Are there tax rules that allow a farmer to accelerate depreciation for farm equipment?” “How do you keep track of your reimbursable expenses before your corporation makes a profit?” and, “What tax rate do I have to pay on an early withdrawal from my IRA?” We got these straight off of the pretty little spreadsheet to these. Sometimes they clean them up, but for the most part, they’re as people ask them.
“I moved my home and the business (that I run from my home) from Illinois to Florida in June 2019. Can I deduct my moving expenses?”
“How do capital accounts get handled in trust? Specifically, do they stay with the trust when the beneficial interest is sold?”
“How can we write off tuition for our training? My sister and I are partners in our LLC. She is now on disability.” Oh, excuse me, this seems like it’s two questions. “How can we write off tuition for our training?” and then, “My sister and I are partners in our LLC. She is now on disability. How can she receive profit from the business now?” I have a feeling those are actually two questions, but I’ll answer both.
“I’ve heard it’s not worth taking the bonus depreciation unless you plan to purchase yearly. Is it worth doing a cost segregation for $141,000 property that rents for $1250 per month and taking bonus depreciation?” I’ll answer that.
“What is the proper way to account for expenditures made to improve a warehouse building? Should expenses above a certain amount be capitalized versus expensed? Does it depend on the nature of the expense, like HVAC, flooring, lighting, etc.?” Guys, you’re asking some pretty good questions.
“I’m looking at selling a car wash I own and doing a 1031 exchange. Can I roll the money into a real estate fund, like an Opportunity Zone fund or does it have to be a hard asset? If I roll the money into an apartment building in an opportunity zone, which I sell after more than 10 years, what’s my basis for the sale? Is it the same basis if I donate the property to a non-profit instead of selling it?” Interesting questions. The reason I grabbed this one is because it’s three-parter, and usually I would say, “No, let’s not dive into all of these,” but it’s covering actually about three different issues that I wanted to hit on.
“We are thinking to sell our owner-occupied property to a C Corp. It was set up by my husband using a contract for deed to get $500,000 of capital gain tax-free. How should I structure the tax plan to get the max tax savings benefits?”
“I’m president of a C Corp. Can I deduct the long-term care premium for me and the officers of the corporation?” We’ll dive into all this.
“We purchased a house in 2019 and lived in it for three months. After moving out in July, the house was available to rent. We then decided to undertake a major renovation/addition without renting it out. Although all the expenses need to be added push up the basis, can we do a cost segregation to push our income down?” Interesting question and I’m sure Jeff’s going to want to weigh in on that one.
“As a new C Corp in which I’m the sole officer, if I cannot afford to pay a reasonable salary, can I submit items to the C Corp for reimbursement? If I do, wouldn’t that raise a red flag with the IRS since I’m drawing compensation in an indirect way?” Interesting question.
“Do you have to use the accrual method for books when you start dealing with loans for the company? Is there an advantage or disadvantage using cash or accrual accounting?” Jeff, that sounds another one like it.
“If my corporation has a promissory note to myself, but the interest is less than $600, do I have to give myself a 1099? I still claim the interest on my personal taxes, correct?”
“If someone is in a memory care facility lockdown 24/7 is that tax-deductible?” We’re going to go all of these.
Somebody said, “Hey, why do you always read all your questions?” Because we are looking at where we’re headed. The only reason I read this out, David, is because I want to make sure people see what questions we’re going to be answering and they may stick on to hear a certain question as opposed to just sitting back.
Jeff: Exactly.
Toby: Other fun stuff and this is serious in the sense. You heard me say this before, we have a bit of an issue and it’s not the coronavirus. The big issue that we have is we have massive amounts of suicide going on with these service members. Our mental health facilities (God bless them) are insufficient for what’s going on. We as people, have to decide whether it’s important to us.
There are over 600 service members a month who are taking their own lives after going out and defending our country. If you know anybody that’s in that situation, please give them this information. You can text, you can call, there is chat online, there are all sorts of services that are available to them. The thing is, they probably will not do it themselves.
You also know that I’m a big believer in the 1 Veteran Foundation. It’s a company that we work with. They do a great job of matching veterans who have PTSD with service animals. They get it done for a fraction of the cost of what these things cost out there. If you want to support them, please do, 1veteranfoundation.org.
Interesting note, last time I did this, somebody called me up the following week and said that week, one of their friends took their own life who had come back. In that moment of feeling horrific, they decided that they wanted to do something to change it. I’ve had that conversation with so many people. Please. I know we’re talking taxes, but please, think about doing some things to help our service members.
First one, “I’m looking to enter the short-term rental industry through rental arbitrage.” That’s Airbnb. That’s somebody who rents a property long or buys a property and then leases it short. “I get a house on a monthly basis,” and when I hear arbitrage, I’m thinking that they’re probably renting it. “I rent it for $2000 and then I rent it to other people for $200 a night,” or something like that. The big question is, “If I were to put my Alabama LLC inside my trust, is the income distribution protected against the lien? Should I add another layer by creating a Wyoming LLC as the single member of the Alabama LLC?”
Let’s unpack this real quick. I’m going to jump on this one. It’s more on the asset protection side. The first one is, if you are the property owner, you’re always going to have a certain amount of liability just by owning that property. Our recommendation is, if you’re doing short-term rentals (which is seven days or less), it’s going to be considered active income.
If it’s active income, you want to make sure that it would be taxed with social security tax. We want to avoid having all the money being treated as active income. We would have the real estate separate from the host. When you do these short-term rentals (I’m just going to use the terminology), you have guests, you have host, you have landowner, all these fun stuff. You as a landowner, you put it into an LLC and it leases it to the host. The host is generally going to be an LLC taxed as a corporation or a corporation proper. That’s who’s dealing with all the guests.
This is why it’s important, because the guest, if they have an issue, the question is who are they going to sue and what is the issue? What are their rights? Let’s say it’s discrimination, they’re probably not going to get after the landowner. They’re going to be stuck with the host.
But let’s say they fall down the stairs and they say the landowner is negligent, they’re suing the host and they’re going to try to go after the landowner. That’s called inside liability, that’s the liability you have just because you own something or because you’re conducting a certain type of activity. So, then we look and say, right now, if it’s making money, can they attach that money? You’re saying, “Here’s the lien.” The question always becomes who did they ever liened against and what does that particular entity make?
For example, if we have a host who is renting from the landlord and the rent is $2000 a month, and they get something against the landlord, they may be in line to try grab some of that $2000 a month. That’s going to be their win or they’re going to try to get from the actual piece of the real estate. If it’s a lien against the host, that’s easy because the landlord just boots the host, and now they have nothing they can get. They’re not going to keep making money if all they’re going to do is take it.
Now, when we bring in the Wyoming LLC. That doesn’t help you at all for inside liability. Where Wyoming LLC comes in, is if somebody’s trying to take your assets including your interest in this business, this arbitrage business, if they want to take that, we can make it to where they can’t take it. All we’re saying is, “Hey, we have a Wyoming LLC. Under Wyoming statutes, the most they could ever get is a lien against that LLC.” If that LLC owns an interest in an LLC that runs Airbnb or it owns an interest in an LLC that owns some other real estate or other businesses, they couldn’t take your interest away. The most they could ever get is a lien against that. As a result, most people don’t because it’s really expensive to go get a judgment against somebody and attach it against the LLC. That’s where it really comes down to.
There are actually three pieces here, there is the landowner, there is the host, and then there is the individual owner of the LLCs, and we want to create separation from all of them. I know I gave you a little bit of a convoluted answer. It depends on your circumstances, but quite often, in this type of business, you’re going to have the host be its own entity. If you are renting, that’s all you need to do, is have that host entity. If you’re worried about the host entity, it has a whole bunch of properties that it’s doing this with, by all means, put that into a Wyoming LLC so nobody can take it away from you.
As I said, it depends. That’s always the answer. Facts and circumstances. What’s best for you, there’s no such thing as cookie-cutter.
All right. “Is there a tax rule…” I just love that type of stuff. “Is there a tax rule…”
Jeff: I bet my mom from Kentucky sent this one.
Toby: Yeah. I thought they actually fixed other tax rules that allow farmers to accelerate depreciation for farm equipment. Before anybody sends me any hate mail, my dad was from Mobile, Alabama, and all my relatives. So, when I went into that, my brother’s in Slidell, Louisiana. I would give him the same ribbon.
Jeff: Farmers are allowed to take Section 179, they are allowed to take bonus depreciation. The only rule that counters this is that farmers have a slower recovery period.
Toby: Got moved to five years.
Jeff: They didn’t move it. It’s from 7-5 years on new farm equipment starting 2018.
Toby: But before that, it was 150%.
Jeff: It’s still 150%. It’s a little slower but you still […] all over time.
Toby: What Jeff is basically saying is there are two exceptions to the general rule. If you buy equipment now, it’s a five-year property. If it’s a five-year property and it’s equipment, you could elect to treat it as 179, which allows you to write-off up to $1 million. It’s indexed for inflation so I don’t know what it is this year, but it’s like $1 million immediate deduction. If that goes over $2.5 million of equipment, then you’re phased out.
The other rule is you have bonus depreciation. This begs the question, why would you ever do 179 when you can bonus depreciate. Bonus depreciation allows you to take anything as less than 20 years of property and write it off. If you are a farmer and you want to accelerate the depreciation for farm equipment, you can write off 100% in year one even if you financed it, even if you have paid it all off.
Jeff: Now, if you build a barn or any kind of an outbuilding, that’s going to be a 20-year life, which is shorter than the other building.
Toby: That’s not going to be eligible for business.
Jeff: That’s not going to be eligible.
Toby: But what you can do on those, too, is cost segregate it and take it into pieces.
Jeff: S Corp.
Toby: “How do I keep track of reimbursable expenses before the corporation makes a profit?” Right up your alley.
Jeff: As you’re going along, you want to make sure that the corporation is reimbursing you for all your expenses. You don’t want to save them up or reimburse them down the line. What’s going to happen is you’re going to take those expenses at the corporate level as a loss. Even though it doesn’t have the money to pay you the cash, it can pay you into the form of a shareholder loan. You’re still being reimbursed for it and eventually (hopefully), you’re going to do well and you’re going to get reimbursed for that amount that you’ve loaned the company at its expense.
Toby: How do you keep track of it? Just like you would any other expense. Can it reimburse you? Not unless you give it the money to reimburse you. It’s either going to be an IOU, a loan to the company, or it’s going to be a contribution to the company. It’s going to be one or the other.
Jeff: We actually had people ask, “Should I loan the company money so I can repay myself?” and it really doesn’t work.
Toby: You just do it as a contribution? Or you just wait for—
Jeff: Just wait for it to make money.
Toby: You just sit there and it owes you the money and you’re waiting for it to make some money. You just track it, you just have to keep a written record of it.
Somebody asked, “Can you take 179 if you don’t have enough profit?” Mina, you can’t create a loss with 179. Your 179 cannot create a loss, but it can take you to $0. A bonus depreciation can give you a loss.
This is kind of interesting. Somebody asked a really weird one, “Can you discuss the IRS Safe Harbor rule for claiming loss from a ponzi scam? What is needed to validate a claim? This is crypto platform-related.”
Jeff: Unfortunately, in 2018, the casualty losses from Ponzi schemes went away. The only casualty loss left is for presidential disaster areas.
Toby: But if you were a victim of a Ponzi, you would still get a capital loss. You don’t lose it all, you just carry it over.
Jeff: You don’t get it. We ran into this. Somebody had their Bitcoin wallets stolen.
Toby: Oh my God. They don’t even get to credit it as a loss?
Jeff: No, because it’s considered a self-loss. Not an investment loss.
Toby: And you don’t get to take that at all?
Jeff: No.
Toby: Learn something new every day. That’s crazy.
Jeff: That is crazy. I don’t agree with it, but that’s what our research has found.
Toby: Yeah. You shoot in an email with that, too. We can dig into it. I don’t doubt that Jeff is correct because I remember seeing something about somebody.
Jeff: I would certainly like to be wrong.
Toby: Do you know what it was? You’re right, but it was out of a business and they were able to write it off as a business theft.
Jeff: Yes.
Toby: If it’s you individually, you may be out of luck. If it’s you as a business, you might be okay. I want to see that and that’s something you may be right for a little discussion with the IRS because I’m sure that they’re not wanting to have inequitable solutions. But that’s just crazy. I remember that those rules went away. It’ll be like the […] folks, they don’t get to write it off even if it was stolen.
“Can you take bonus depreciation on equipment?” Yes. Bonus depreciation is available for anything under 20-year life. The way the IRS treats it is anything you buy, anything that’s acquired on a building, if it’s a personal property, it has a useful life. If it’s a structural company, it has a useful life. Everything has a useful life to the IRS and they assign it. They say, “Hey, everything is close to this.” If it’s under a category that is less than 20 years, you can bonus depreciate it under 26 USC 168(k).
There are lots of questions online. I may pick one here. “If a C Corp needs to be folded, how does one handle a 401(k) sponsored by the corporation?” Corporation goes under, does the 401(k) go under?
Jeff: No, it does not. It is separated from the corporation.
Toby: Yeah. Loses its sponsor, but it’s still there. So you could still run it or more likely someone’s going to roll that into an IRA or into a 401(k).
Jeff: There’s actually a federal government agency, I can’t remember the name of it right now, but the whole pension guarantee, but not if it’s a corporation, whose whole purpose in life is to support pension funds once the sponsor has gone belly up.
Toby: I’m going to keep chipping at you guys on this service members stuff. I just think it’s horrible that this is a great country and we can’t seem to get our mental health stuff going. That’s what’s filling a lot of issues. That’s filling a lot of homelessness, everything else. I’ve worked that field a little and had some personal experience with a lot of people that I know, and it’s not a great system right now. It’s really overloaded and difficult. Anyway, I’m just going to gripe about it a lot.
Somebody says, “Is selling an owner-occupied duplex. How do my 121 and 1031 exchange? I’m getting different answers.” That’s a really good question. Basically, you have a duplex and the way it works is the property is treated as two different properties.
Jeff: You split that property in half.
Toby: Split it in half. You’re going to do your Section 121 on half of the income, assuming that they’re about the same size. If they’re different, then your appraisal will break amount. You get your 121 exclusion (which is the capital gains exclusion) and you would 1031 exchange the rest. That’s going to take a very good facilitator since actually not the entire property. All they have to do is do the paperwork saying, “Here is the portion that’s 1031.”
Jeff: It’s always a good idea to ask your qualified NME or you ask some questions and see if they get that glazed, looked in their eyes.
Toby: You just ask them. I know of some good ones if you need them. Let’s see. “What tax rate do I have to pay on an early withdrawal from my IRA?”
Jeff: It will be at a marginal tax rate. If you’re making (say) $80,000 a year, you’re probably in the 22% bracket. You’re going to pay a rate of tax about 22%. The other side of that, if it’s an early withdrawal without any kind of exception (there’s a bunch of different ones for first-time home buyer and medical expenses, you’re also going to pay a 10% penalty on that early withdrawal. It could be quite expensive.
Toby: It can be very expensive. Here is the general rule, it’s the “Jeff, hey it stinks” rule. You’re going to get hit with a 10% early withdrawal and your income tax, and then there’s the exceptions. The exceptions are if you’re over 59½?
Jeff: If you’re 59½, it’s not an early withdrawal.
Toby: Then you don’t have the 10%. You’re still going to have tax on it.
Jeff: Right.
Toby: Somebody said to me, last that we did something different in Platinum. He said, “Patty or somebody, grab a hold of that.” Let’s take a look at what was sent in. Not everybody is omnipotent, but that’s a fairly straightforward question.
Jeff: One of the things we often hear was, “Why you took that money out?” It’s because of financial hardship.
Toby: Then that’s an exception. There’s a whole bunch of exceptions. You have your first home, you have 59½, you have if it’s a medical expense then you weren’t covered, or you’re out of work for a while and you’re getting basic insurance, then you can do it. There’s a bunch of little ones. Military folks can pull it and avoid the 10%. 72(t) which means, when I hit 55, I think I can do the 72(t), where I just choose to annuitize it. I’m just going to take a set amount forever over a period of five years more. Then I can just do that. There’s a whole bunch of exceptions.
The other one is if you really need money, take it out from an IRA. Roll it into a 401(k) and borrow half of the money. There, now it’s free. You don’t have any tax on it. The way that works is you roll your IRA, which you can absolutely roll any IRA other than a Roth, which we wouldn’t be having this conversation if it was a Roth. If it’s a traditional IRA, you roll it into 401(k), you are allowed to borrow half the money, up to $50,000 per participant. If you have an IRA, your spouse has an IRA, somebody that you know has an IRA, they can roll it into a 401(k) and you could borrow half that money, up to $50,000. Husband and wife could borrow up to $100,000. That’s an option as well. Then you don’t have to worry.
Somebody has said, “Isn’t it better to take a loan out against your retirement account? Did that to invest in tax […].” Yeah, absolutely. It’s AFR rates which are around 2% right now, is what you’re paying back here, your own retirement account.
Jeff: You can’t just do it against your IRA. You can’t use your IRA for borrowing or any type of collateral.
Toby: Somebody says, “Hey, do you have someone who will do cost seg in Colorado?” Absolutely, Mina. Shoot me or Patty will grab you or Susan will grab your information. Let us know and we will absolutely get you somebody awesome for Colorado. Anywhere in the country, we can get you taken care of. We don’t do it, but I have really good people that do and have done I don’t know if hundreds, but dozens of them for sure. Done hundreds of analyses to see whether it works.
“I moved my home and the business that I run from my home, from Illinois to Florida in June. Can I deduct my moving expenses?”
Jeff: With the Tax Cut and Jobs Act, they killed the moving expense completely. There are some exceptions to the military.
Toby: That’s it?
Jeff: You can deduct the cost of moving the business assets, but that’s about it.
Toby: That’s absolutely the case. What you do is you do your analysis of how much of your home is the business asset and I would probably be looking at that, saying what percentage of the moving expense would therefore be a reimbursable business expense, or you could always have somebody give you a quote on moving just the business stuff to Florida to how much would it be and then that’s the amount that you can reimburse yourself from the business. The business would take it as an ordinary necessary business expense.
“If I want to sell my stocks as a person with long-term profit, therefore large taxes,”—that’s not necessarily the case; you could be 0%, 15%, or 20% on long-term capital gain—“and then to invest this money into my C Corp property and flip, what is the best way to reduce taxes?”
Irina, if you’re going to sell stock then you want to reinvest it into something else, you’re going to pay the long term capital gains on the stock. Usually, what we’re doing is we’re looking at lost harvesting if you’re going to have gains. If you have any losers, it’s time to sell them and take that loss against your long-term gain. Hopefully, that’ll offset some of the tax.
If you don’t have any losers, you’ve just done really well, and you just have a whole bunch of profit, then it’s bracket management. Are you in the highest bracket? Are you in the middle bracket? Can we get you down this year? Let’s just say you’re in the highest tax brackets, you’re looking at 20% or 23.9% depending on if you’re over $250,000, then you have to look at your state.
There are some things you’re going to look at. We’re going to say, “Here’s what you’re looking at from a tax standpoint and then is there a way to avoid it?” The answer is yeah, you can do a qualified opportunity zone. If you’re going to flip, you may want to flip in on an opportunity zone to an opportunity zone fund. Then you could defer that tax, and then you’re going to defer it six years.
I don’t want to give you convoluted and crazy stuff. Just saying you have options to defer it for six years. You have options of ways to offset it. You have a lot of different options. With a little bit of information, we could give you some really good guidance.
Jeff: The way the market’s been for the past week, this might be a good way to harvest some of these losses, especially if you got gains.
Toby: If you have gains, what you do is sell all the ones that have crapped out here lately.
Jeff: The mark was down to 3% today.
Toby: Yeah, and here’s the deal, you can’t buy it back within 30 days. When you have losses and you want to take them, then you just wait to buy it back.
Jeff: That’s a good point because some people get the gains side confused, too. I can sell that, recognize a gain and go out the next day and buy the property.
Toby: At the end of the year. You know why we do this. We sit there and we look at people and we’re like, they have a loss and they have a bunch of stocks that have run and they’d be like, “Yeah, but I’m going to keep them.” I’m like, “So? Sell it and buy it right back 10 seconds later.” “Then I won’t get to use it.” “No. Yes, you can. There’s no wash gain rule, it’s only the wash loss.” It’s when you sell it and take a loss. If I have a big loss then I know I can sell something, push the basis up, and not pay any tax, then I’m going to sell it now.
“We set up a C Corp, used some individual contractors on a rehab, but didn’t get the info required to send them the 1099. What are my options? They need to be sent by January 31st.” It sounds like they have some contractors and they didn’t 1099 them. What do we do?
Jeff: You should follow the 1099, even though they’re late.
Toby: What if they’re not responding to them and they just say, “Hey, I’m not going to give you any information.” You should’ve done the W-9.
Jeff: You should’ve done the W-9.
Toby: W-9 for an individual.
Jeff: Correct, before you ever paid them a dime. Even if you don’t have their social security number, you still probably have their name and address. IRS still wants us 1099.
Toby: Fill it out as best you can.
Jeff: IRS is going to try to match it up with other information they have.
Toby: And you’re talking to the guy who’s gone through the big, massive payroll audit with the IRS. They used to do these at random; I think 50,000 companies. One of our companies was one of them. If you don’t 1099, you could be responsible for the tax. Out of 700 vendors, we had two that we couldn’t verify, were corporations because they’d gone out of business. It was landscaping and a magician.
Jeff: The magician.
Toby: The magician ended up getting second on America’s Got Talent. We were watching him going, “You cost me $750.” That’s all I could say every time I saw him on TV. $750! It was like, “Hey, give him a little check and go away.”
Jeff: And people always often talk about that. If you don’t file the 1099, the penalty is $50. That’s the late filing penalty. Which goes up over time. It could cost you several hundred bucks a 1099 for not filing them.
Toby: It could be a double whammy and the person could have actually paid them, too. In our case, we’re like, “I’m sure they paid.” But it doesn’t matter, the IRS will double-dip. We need those social security dollars.
Somebody else asked a question, then we’ll go back to these. “I loaned IRA money to someone who is not able to pay it back. Some of the money was in real estate, but the house has a bank mortgage. What do I do now?” Joseph, is it secured? Then you would sit there and say, “Hey, the note is not being paid back.” Maybe you’re in second position, you sit back and wait for the house to get sold.
If you haven’t heard, the banks were really good about doing this after 2008. They’d let you get rid of that note, you’d go bankrupt, you do all these things, but the lien was now removed and they would wait for you, and wait for you, and wait for you, then people would sell their houses six years later and they’ll end up paying back the bank. They’re like, “It’s never over until it’s over.” If you invested that money or loaned the money from that IRA to somebody, make sure that it is secured.
Let’s jump back into these. The moving expenses, that’s an unfortunate answer and you could thank congress. They hammered us on the miscellaneous itemized expenses or deductions on your Schedule A. Went the way of the dinosaurs. They’re extinct, they’re gone. All those things we use to write off are pretty much gone as individuals.
Your employer doesn’t reimburse you, you can’t write it off. If you’re a teacher, you can get a $250 amount that you can write-off. Or you’re buying books for your class and reimbursed expenses, you can’t do anything about it. We usually say, “Set up another company, find a way to generate some income, and then offset it so you can actually write some of those things off.:
“How do capital accounts get handled in trusts? Specifically, do they stay with the trust when the beneficial interest is sold?”
Jeff: The purpose of the trust, which is the body of the trust, the assets of the trust, belong to the trust. Technically anything going on with the corpus, any gains, stuff like that, stays with the trust. The income side of it, if it’s a rental property and they’re making money, that would go to the beneficiaries.
Toby: You actually have a power of appointment over income that is different than a power of appointment over your interest in the trust. You don’t sell the beneficial interest of a trust. Generally, you are a beneficiary. I suppose you could do that with a land trust if that’s all you’re holding, in which case, anything that you have is a beneficiary; you sell to somebody else, everything’s gone. Otherwise, if you have an account inside of a trust, let’s say Jeff is a beneficiary and Jeff passes, the beneficial interest wasn’t sold, then it goes to somebody else. It goes to Toby, the next in line as a beneficiary.
Jeff would actually have the ability to give away the income that was in that trust that was for his benefit, but these things are all governed by the trust agreement. You can take away that right just as easily as you give that right, and you say there’s no power of appointment period or there’s a limited power. Usually, when they’re doing a limited power, that’s what they’re talking about. It’s like, “Jeff can’t change who’s next in line of the beneficial interest. But he can certainly give away what he earned if he didn’t take it.” If there’s $100,000 in there, you made $1000 for Jeff. Jeff could give the $1000 that he’d made to somebody else, but he couldn’t change who’s the next beneficiary in line. It’s irrevocable, usually.
The only time that this is different is if you have a land trust or personal property trust, where the beneficiary is the one who has the right to control the actual asset itself. But then what you really have is the trustee owns it in title only, the actual owner is really the beneficiary. I always look at child actors, that’s essentially what they’re doing. The parents are holding the assets for their benefit, but it’s still going to be the kids when they get at a certain age that the kids sell it, then everything is gone.
All right, keep going. There are a few really good questions that we’re going to jump into here that are out there. “How do I write off tuition for our training?” Without knowing much more. I’m going to assume that this is probably a seminar where somebody’s learning real estate or these things. Let’s say that I’m already in real estate, I have a real estate. Maybe I’m a realtor and I go to training. I’d rather not do that. Even if I’m a sole proprietor, I can still write that off.
If I’m not in that business, then I would grab it as a start-up expense, and I would make sure that I was setting up the company as quickly as possible so that as little of that training occurs pre-incorporation as possible. I really would rather have it be an ordinary necessary business expense, and I wanted in that company. That’s how you write it off. Literally, you’re really going to want a company, unless, as a sole proprietor, that’s what you do for a living.
There’s a really good case that was out there which illustrated the point. Somebody who didn’t set up the entity, the tax court says you’re not in business until you’re actually doing the activity. This individual learned to do flipping. Spent a lot of money throughout the year, and then in December got his first property. The court said that’s when you started your business. That’s when you can start writing things off. Everything you incurred before that, he couldn’t. Now he couldn’t grab those as a startup expense in the corp, but by the time he went to tax court, it was more than three years later. He’s toast. Anything you want to add on there?
Jeff: No, but I was reading the case earlier today where a young lady was a paralegal for a law firm, decided she wanted to become an attorney, took those steps. and the court turned her down for the deduction because she wasn’t in the field of practicing law.
Toby: Yup. It has to be for something that benefits you and that business. The example they give, when I was going through college, I went to CLU and I had a whole bunch of Boeing guys, that’s where Boeing always sends its executives to get their MBAs. Boeing could write it off because they were bettering the skill set of those executives. I could not write it off because I was not an executive with the company.
The paralegal isn’t a lawyer so she can’t write off the legal classes because it was creating a new profession for her. If a lawyer had gone and taken some classes, they would’ve been able to write it off. That’s where it is. It always comes down to that stuff.
Anyway, let’s go to the next one. “My sister and I are partners in our LLC. She is now on disability. How can she receive profit from the business now?” I assume that you’re saying without costing her her disability. Otherwise, you just keep going. Even if she’s disabled, you just receive profit the same way you would otherwise.
If because she’s disabled she’s not able to participate in the business, she’s going to have no material participation. She’s going to get passive income, but it’s still ordinary income. If she’s receiving disability payments, then I believe you get up to $1260 a month. If you go above that it reduces your disability payment. You do have to be careful.
There are certain types of income, like rents, royalties, dividends, and interest that do not affect sole security or disability benefits. If you have an LLC and that’s the type of income that’s making, if it’s making dividends or rents or something like that, then you don’t have to worry at all. But if it’s an active business, like this partnership owns a McDonald’s, then you have to worry. But again, if it’s making a whole bunch of money, then we don’t really care. If it’s making passive income, then we don’t have to care nearly as much.
Somebody says, “Hey I performed a ROBS transaction.” This isn’t a question (by the way) that’s in the preset question; this is online. A ROBS is a Rollover as a Business Startup, which means that they took a 401(k) and invested it in a C Corp that they also own. They’re partnering with their own retirement account. Yes, you can do that. The IRS says you can. “The corporation where I am the president shareholder. We’re getting an SPA loan for a residential assisted living business.” Fantastic. “Do I have to pay the 10% penalty for withdrawal?” No. “Do I have to report the rollover as earned income?” No. The 401(k) owns a piece of that business. It just owns stock.
“I have a real estate license and I was told it’s best not to represent myself as a buyer […] as I cannot have personal gain from my own ROBS Corp.” I don’t know if that’s actually the case. I believe, the prohibited transaction was actually avoided because you both became partners in a business. If that corporation in your 401(k) would continue to do transactions, you’d be a disqualified party by virtue of you being a shareholder. But once you set this thing up, and you set it up correctly, you can’t put more money in it, but it certainly can operate.
I don’t necessarily think that would be a problem. What I would do is I would email that in and see if there are any cases out there, but that’s the type of thing where you want to be a Platinum member because we’re going to have to give you a straight-up answer.
Let’s see. “Do I have to report my loss, the first year of my LLC if I don’t have any income?”
Jeff: This is a little bit crazy. Your LLC is a partnership. You technically don’t have to refile that partnership return if you have no income or expense.
Toby: Wouldn’t it have a non-payment? If it’s a partnership it’s going to be a failure to file.
Jeff: No, a partnership it wouldn’t apply to. S Corp or corporation, it would.
Toby: Really? If I have a 1065, don’t I get penalized if I don’t file a tax return?
Jeff: Only if you were required to file taxes.
Toby: Only if you’re required. If I don’t make any money then I get to say, “Meh.”
Jeff: Yeah. We’ve had clients do that that they had some setup fees or stuff like that, not a whole lot of money, and that’s sad.
Toby: Jeff would say, “If you’re a partnership you could punt. If you’re an S Corp you should file.”
Jeff: Absolutely.
Toby: The penalty for not filing on time or not getting an extension or anything like so is $195 a month.
Jeff: It’s gone up. I think it’s $205.
Toby: Jiminy Christmas. It’s a lot of money per month, your failure to file so don’t not file.
Jeff: I remember when it was a fraction of that.
Toby: Yeah. I remember when it was really low. It was still annoying but here’s what they want, they want you to file your return. It’s probably better to file your return so you can take your loss. I don’t know. If I had a loss in a company I’m filing that return because I want the loss.
Somebody says, “I have an LLC but treated as a disregarded entity. Do I lose the protection in a lien situation?” No. One doesn’t have much to do it the other way. What you have is whether they’re going to honor the separateness of the company of the LLC, and in some states, they’ll pierce in a single-owner LLC situation. You tend to want a state that has a statute on it that says, “Hey, this is how we treat it.” Usually, they’re trying to hold you responsible for the company debts, not vice-versa.
Let’s keep going. “I heard it’s not worth taking the bonus depreciation. It’s actually bonus depreciation unless you plan to purchase yearly.” What they’re saying is, “Hey, if I have this property worth $141,000, should I take the bonus depreciation? Because it’s probably not worth it unless I do this every year, and I buy another piece of property every year.”
The rule of thumb is whatever the appreciation or the improvement value that’s on that property, the non-land value, you can write off about 30% of it if you’re doing a good cost segregation. You’d be able to write that off in year one. If you have these types of losses that’s considered a passive loss unless you fall under one of the exceptions.
Exception one is active participation. You get up to $25,000 and it phases out between $100,000 and $150,000. A lot of people make too much to get that $25,000. If you make less than $100,000, there you go. You could actually offset $25,000 of your other income. You’re going to get about 22 cents on the dollar of deduction benefit.
The other way to look at this is, “Hey, I’m making $1250 a month, how much of that would be taxable to me?” We don’t care about paying principal on a loan or anything like that. Usually, what I do is, I just say $1250 times 12 divided by 2. I take 50% of whatever the gross rents are, so if I have $1250, I’ll do the math here, times 12, that’s $15,000 a year of gross rent. I would say I’m probably making about $7500.
Let’s say that I did a cost segregation on $141,000 property. Let’s just say the land is worth $41,000 and the improvement value is worth $100,000 just to make this easy. I have a $30,000 deduction that I could take right now and I don’t qualify as active participation.
The other exception is if I’m a real estate professional, but maybe I’ll say, “Hey, nah. I just want to offset the income from this property.” That’s kicking me down $7500. I’d have to look and say, “What tax bracket am I in?” That’s $7500, how much tax am I paying that every year?
Let’s say I’m in the 22% tax bracket or thereabouts (probably do higher but I’m just going to go this route) so you’re paying about $1650 a year in taxes. If we did a cost segregation, you’re not going to pay that $1600 and some odd dollars a year for four years, at least four years. Is it worth doing a cost segregation? It depends on if the cost segregation is $1500, yeah. I lost 1½ years, I’m going to gain a little bit for 2 years, and then I’m still going to be writing it off over time.
I always say that there’s not a hard and fast rule; it’s facts and circumstances. You guys hear me say this probably too much, so it’s going to depend on your situation. I always say there are only three rules of tax and that’s to calculate, and calculate, and calculate, so we have to do that.
Somebody asked a question, “I’m trading options, selling puts, selling covered calls. Are there any tax consequences when I buy the close, I call or put, or roll out of the call or put? Can you explain?” You can do that.
Jeff: No, go ahead.
Toby: Anytime you do an option, if I buy an option or sell an option, if it expires or if I sell it, that’s when it’s taxable. The rest of the time it’s not. Let’s say that I sell an option and I bring in $100, that’s not taxable yet until that position is closed out. If you buy it to close that’s when it occurs. Now you’re going to be looking at the difference between what you got paid and what you had to pay, and you’re going to pay tax on that amount. Generally speaking, it’s short-term.
Jeff: Right, because we’re not going to know what the end result is. You’re going to have to give up your stock or you’re going to have to make good on that put that you sold.
Toby: Same thing.
Jeff: Yup.
Toby: That’s always the deal. Again, let’s say that I’m selling a call. I’m not a big fan of buying, I’m not an active trader. Some people are really good at it. Timing the market is always going to give me a headache, so I tend to sell calls. If they expire, the amount that I made in the beginning is taxable. If they expire worthless, the amount that I’ve made was taxable. If somebody’s calling me out, then the amount that I received for the call is taxable and the gain that I have on the securities is taxable. It’s always that, but it’s not taxable until I called out.
I could bring in money today on something that will not be taxable for over a year; if I sell a leap, I get the money now. I don’t have to tax it for a long time that’s why I like them. I hope that makes sense to you guys. If you’re not a trader you can just ignore everything I said. Let’s go back to a few of these.
All right, Jeff. This one looks like fun. “What is the proper way to account for expenditures made to improve a warehouse building? Should expenses above a certain amount be capitalized versus expense? And then the nature of the expense like HVAC, flooring, lighting, et cetera?”
Jeff: Yes, it does make a difference. When I was with another firm, we did a cost segregation of a warehouse construction that was a refrigerated warehouse. Due to the nature of it, we were able to write off 80% of the construction cost.
Toby: You did cost seg it, right?
Jeff: We did cost seg it with a larger firm; big for a farm. Especially in a case like this where it’s commercial property, things like HVAC (which are now deductible subject to bonus depreciation), flooring, lighting, you want to be able to break those costs out. I would strongly suggest if this is a considerable renovation or improvement that you cost seg this.
Toby: Yeah. Cost segregations just mean we take the structure and we separate it from all the components. The components have a shorter useful life. For example, I always use carpet just because carpet usually sucks after a year. If I have carpet it’s not going to last 39 years in the commercial building; it’s going to last maybe five. When you cost seg it, you can use the typical life expectancy of carpet (which might be five years), and you can write it off either over five years or choose to bonus depreciate it and write it off all this year.
When you’re doing a warehouse building—by the way I own a couple of those—I know what it means to have the refrigerated stuff. Holy cow, Jeff, it’s not easy. We have a third floor, one of our warehouses, it’s all refrigerated. There’s a lot of equipment, things like that, that go into it, that if you don’t do anything and they’re just attached there, you’re going to write it off over a really long period of time as opposed to just writing it off now.
The first thing you do is do what Jeff just said, and that makes sure that you are cost seging. The other thing you can do, depending on what type of warehouse this is, if it’s a big huge one, you can ignore this but if it’s a little one, you have a safe harbor of any expense that’s below $2500 you can choose to make that an expense. Even if it’s an improvement, it doesn’t matter. You can choose to treat it as an expense. You put $2000 in and you’re putting it an electric system or something that’s going to benefit the building, you could choose to expense it.
Jeff: And you’ve got to be cautious. The reason you want to do a cost seg is not to only get the expense, but in a commercial building, there’s a lot of property that you wouldn’t consider to be equipment or separate whether it’s truck docks, or doors, things of that nature that could be broken out into much shorter lives in that horrible 39-year life.
Toby: Dang, that’s just crazy. That’s the structure itself. Speaking of crazy, here’s the one that I looked at and go, “How the heck did this get over to me?” Usually, I have my staff pulling stuff out making sure that the very specific stuff is rolled out into Platinum or something. The little zipper ones that we can just hit we can do as part of the show because they are a lot of fun. They’re little ones that give us a chance to give the options. Here’s one that was very interesting. “I’m selling a car wash and doing a 1031 exchange.” Let’s just right out the gate, you can’t 1031 exchange a car wash. You can 1031 exchange the real estate that has a carwash business operating on it, but you can’t 1031 exchange a car wash anymore.
Jeff: Unfortunately with a car wash, most of what you would consider a building is equipment.
Toby: Which is also another issue. We’re selling this thing and let’s assume that we’re selling a business. “Hey, it makes $5000 a month so we’re going to sell it for $30,000 and then the real estate we’re going to sell for $300,000,” or something like that. “Can I roll the money into a real estate fund like an opportunity to zone?” Yes, you can. Even if my car wash is $60,000 and there’s $300,000, I could choose to take the $60,000, put it in an opportunity zone, defer that tax, because when I do it in an opportunity zone, there are different components of it. You have the full of the original amount, you have a step-up in basis on that original amount, and then you have an additional step-up in basis in the total investment in year 10 or anything over. If you own it 10 years, at any time you choose to, you could step it up to fair market value.
Let’s just assume that you, again my scenario where I sell the car wash for $60,000 and the real estate for $300,000, I could exchange the real estate and push my basis of my first property into the new property. I don’t have to pay any tax; I don’t have to worry about it at all. I take the 60 and put it into a real estate fund in an opportunity zone, and I meet all the other fun stuff of what that is doing. I will be paying tax on that $60,000 subject to the opportunity zone rules, which means in six years it’ll be a taxable event, and I will pay tax on that $60,000 with one little step up. At year five, I get a 10% step up. I’m going to pay tax (follow my logic here) on 90% of that $60,000 as whatever it was. If it was long-term capital gains, I’m going to pay it at long-term capital gains rates. I have lots of planning opportunities there, but I’m going to pay tax on it.
Let’s say we keep it in there, and this is where it gets interesting, in 10 years, because I deferred portion of that income, whatever I bought in that opportunity zone with that $60,000—I could have leveraged it up, I could have taken loans out—in ten years, I don’t have to pay tax on that any of that gain ever again. If that thing’s worth $1 million, fantastic. If in another 10 years it’s worth $2 million, I don’t have to pay any tax. If it hits—I forget the exact year, 2047 I believe—2047, then I will step up my basis to the fair market value on that date. I don’t have to sell it, I would just have a new basis of whatever the fair market value is. If I sit on this thing for close to 20 years or more than 20 years and it goes way up in value, I don’t have to sell it to get my step up.
“Is it the same basis if I donate the property to a non-profit?” It’s again, the same thing. If I have a car wash at $60,000 and I have my real estate at $300,000 and I give it to a non-profit, the nonprofit’s not going to take the for-profit business, first off, because it’s going to be subject to Unrelated Business Income Tax. The real estate I would take and you get a donation based on its value, it’s $300,000; it doesn’t matter about basis. You get a donation on this fair market value, assuming you owned it for more than a year. If you didn’t own it for one year then it would be whatever your basis is. I would assume that’d be pretty close to the same thing. Isn’t that fun?
Jeff: That is fun.
Toby: I always look at those and I’m always like, “Hey, this is really cool.” If you take the whole amount, so let’s say that we don’t even have the real estate but we just have the car wash and it’s worth half a million dollars, yeah, you could dump that right into an opportunity zone fund within 180 days. Then you have another 180 days to deploy it into an opportunity zone property. You put it into an apartment building, you have to meet the rules. That means you have to improve the value of that apartment building, you have to double the improvement value, you have to put in at least as much as what the value of the apartment building itself—not the land, just the building itself. You deploy that within 31 months, boom, now you qualify, but you will be paying tax in six years on that.
Jeff: One thing that’s important when you’re doing a sale of any business is to really give a lot of thought to what you’re selling and for how much. We’ll have people come and say, “I sold my car wash for $100,000,” and we’re like, “Are you sure? Because I think you may have sold the operations, you may have sold the land, you may have sold the building and equipment, and you got to decide how much all that cost. Then you have to come to an agreement with the buyer as for those cost allocations. Some of those will benefit you and some will benefit the sales, that’s part of it.”
Toby: That’s why you always want to have your accountant involved if you’re buying or selling a business because it’s not what you make it’s what you keep. If you’re selling an asset that’s going to be ordinary income to you, you’re going to be pretty upset as opposed to selling the underlying business itself, which may be long-term capital gains or even installment sale and you start spreading it out over many years. There are all sorts of things you can do.
A bunch of questions online. “How do you delay taxes for six years? That’s the opportunity zone.” That’s if you invest in certain areas and it has to be capital gains. Then somebody says, “Hey, it’s $50 the first 90 days, $100 thereafter for the 1099.”
Jeff: Then willful, it’s like $299.
Toby: Somebody is saying… we’ll take a look at that question. This is going back to one of our earlier questions about the first position and you’re in the second position with the IRA and somebody says, “What do you do if you force the sale? What happens?” Anybody who has a lien can force the sale. If I have a lien on your property in your real estate I could say, “All right, let’s sell it.” The way it works is at the auction, you get so much money. The first gets paid first and then the second gets paid.
The first, we usually go bid whatever it is owed on the property because that’s what it gets no matter what. It’s not coming out-of-pocket, it gets the property. The second, we’ll probably want to be there bidding up to whatever the total between the first and the second equals. They wouldn’t want to pay for the first; it’s just going to give all the money to the first and now the second doesn’t get anything and it’s done, it’s cooked. It doesn’t have any more security. Usually, when you go in there as the second, you better be prepared to pay up to the total amount that the first is owed plus the second plus whatever you’re owed. That goes for if you’re in the third position, too.
“When doing a loan on real estate from an IRA, what is the best instrument to secure it?” Deed of trust or just basically mortgage. “Can you write off MBA tuition?” It depends on the business. Let’s say that you’re a president of your own S Corp and it’s going to benefit your business, an Executive MBA, can you write that off? Yeah, absolutely. You could certainly do that. The EMBA is what you’re talking about and that’s why they’re actually pretty popular because businesses can go out there. You’re getting trained and you’re getting more valuable at the same time.
Jeff: That can fall under what they call the working condition fringe benefit that you need to increase your expertise with that MBA. The company more or less forces you to pursue that, and they can even reimburse you for it.
Toby: If it’s you and your company, could another company forced you to do it? Yeah. If a third party could have done it, so can you.
“As a partner, the LLC can’t pay a silent partner a shareholder dividend?” No, a shareholder dividend is a corporate deal. If you have an LLC that has a silent partner, I guess if you have a silent shareholder, you could pay a dividend. If it’s a C Corp, you have a dividend. If you have an S Corp, it’s a distribution and it’s going to be taxed at your ordinary rate. The question is whether you’re at maturity participating in the business. If it’s a partnership, it’s just a distribution. If it’s a sole proprietor, then it’s nothing. You threw some terms together there, Susan. This is why it’s fun to talk because we could actually walk you through that.
“Are HSAs a good vehicle to reduce your tax burden, grow money, and anything else?” Yeah, absolutely. I think so. You have to have a high deductible plan and I forget the limits. I want to say for a family, it’s not huge.
Jeff: I don’t remember what the limits are, but it’s a good way to tuck money away for a medical emergency that’s deductible in the current year.
Toby: Home-office question, “Is it better for my C Corp to deduct the expenses of its office in my home or to reimburse me?” Reimburse you, Carol.
Jeff: Absolutely.
Toby: Reimburse you without any hesitation. If you have a C Corp, you want an accountable plan, you get to reimburse, you don’t have to report that anywhere, which is going to become relevant as we get to another question.
“We are thinking of selling our owner-occupied property to a C Corp using a contract for deed to get the $500,000 capital gains tax-free. How do I structure the tax plan to get the max tax savings benefit?” Jeff, what do you think?
Jeff: By owner-occupied I’m assuming they mean primary residence. Not knowing for sure what they’re going to do with the house and the C Corp, I probably would prefer to put in an S Corp if I’m going to make a rental property. One thing I think that’s important here is it needs to be at an arm’s length transaction. You can’t just arbitrarily decide how much the sale price is going to be especially between related parties. I would suggest using an appraiser. Usually, if you tell them why you’re looking for an appraisal; they’ll work with you too.
Toby: You could do a broker value of opinion.
Jeff: Could you?
Toby: Yeah, I think you could do. The appraisal is the bazooka and it depends on how hard you’re pushing it. Here’s the rule, by the way. They’re talking about the $500,000, that’s for married couples selling their primary residence that they’ve lived in two of the last five years. That’s section 121 of the Internal Revenue Code. You’re always going to hear them say, “The home gains exclusion,” or something like that. For a single person, it’s $250,000. If you bought a house for $100,000 and it’s now worth $300,000, you could avoid $200,000 of capital gains if you sell it. That’s all this is.
They have a house that’s gone up in value and you better be leaving the house. I would not do this if you’re going to be staying in the house. What most people do is they say, “I’m going to turn my house into a rental,” and they leave a lot of money on the table by doing that if they don’t take advantage of 121. Let’s say you bought a house for $250,000. It’s worth $750,000, you’re going to rent it, it’s going to make $5000 a month or something, and you just convert your house to a rental. The amount that you can depreciate is based on the $250,000. It’s not what it’s worth unless you sell it. Now you have a step-up in basis to the new entity.
Under those circumstances, I bought the house for $250,000, it’s worth $750,000, I can reset my basis to $750,000 if I sell it to another buyer. That other buyer can be an S Corp, or a C Corp, an LLC taxed as an S or a C Corp. I wouldn’t do it as a C Corp. Generally speaking, I’m going to do it as an S Corp. The reason being is because if I sell the property, I want to get long-term capital gains. In C Corp, I’m never going to have capital gains ever again; it’s just going to be income. I could get hurt there.
I sell it to the S Corp at $750,000. I now get to use up my entire $500,000 capital gains exclusion. I tell the S Corp to please pay me over a long period of time, that’s why I’m going to do an installment sale, and then I’m going to elect out of installment sale treatment in year one and take the entire amount as capital gains to me, even though it hasn’t paid me back yet.
What I just did is I’m going to have a tax-free income stream coming in for a long period of time as it’s paying me back. I now have a $750,000 basis in a piece of property so I can depreciate it at the $750,000. That is absolutely 100% okay to do. Good tax practitioners understand it. To make it even more fun, you could actually do that. Technically, if you have even more gain you could 1031 it just something to. It gets fun. You’re looking at me like I’m from—
Jeff: No. I agree.
Toby: We’re getting late into this. “I am the president of a C Corporation. Can I get back long-term care premiums for me and officers of the corporations?” What say you, Jeff?
Jeff: The corporation has two choices. They can either reimburse you through your 105 plan or they can pay those long-term care premiums directly. Either way, they get to deduct the full amount. There are no limitations like there are on your personal return or self-employed.
Toby: You just can’t discriminate. You save yourself and officers of your corp? Yeah, but just make sure that if you have the rank and file that they’re also allowed to participate.
Jeff: Surprisingly enough, I think this is the one area they can discriminate in.
Toby: On long-term care premium?
Jeff: On long-term care premium.
Toby: I don’t think you can do it on a reimbursement.
Jeff: Probably not.
Toby: Right, so if maybe the company purchased it as an executive compensation plan, then you could possibly.
Jeff: That makes more sense.
Toby: I’m just going to tell you guys, it’s going to be really tough to get long-term care. What you’re probably going to end up doing is getting life insurance with a rider on it for long-term care because most of the insurance companies have been burned to death under the extreme cost of long-term care.
When I looked at the data the last time, over a third of long-term care policies had claims made against them. Just to give you an idea put that in perspective, about 2% of life insurance contracts term have claims made and about 6% of car and home insurance, and all these are all in the single digits. This sticks out like a thumb. The two that stick out like a sore thumb are long-term care and indexed universal life, whole life policies. They have large amounts of double-digit claims made against them. That’s because they stick around for a long time and they have some inherent value.
“We purchased a house in April of 2019 and lived in it for three months. After moving out in July, the house was available for rent. We then decided to undertake a major renovation/addition without renting it. Do we add all the expenses to the basis? Can we do cost segregation to keep our income down?”
Jeff: I think you could do the cost segregation to keep your 2019 income down. My only concern was it looks like it was available for rent and then it wasn’t. My concern was the IRS coming back saying, “No, this was never available for rent.”
Toby: Yeah, I’ve done this once or twice before. Here’s how it always works. There’s a whole bunch of different rules. It’s always a complicated answer. You bought the house in April and it was personal property. You don’t get anything except adding to basis when you improve the property and then when you sell it it’s when you get the tax benefit. If I make it into a rental property, then the day that I moved it into a rental property, which is when I make it available and I’m showing that I made it available or I rent it. Now it’s the value, it’s the fair market value or whatever I paid for it, whichever is less. Within three months, it’s going to be the same. I don’t think you’re going to have any issue there. Now you have the ability to start depreciating it once you make it available for rent.
There are seven or eight factors that the IRS looks at when you don’t actually have rents coming in. The receipt of rent is a pretty easy one, but that’s only one factor. They look and say, “Where were you living? What was your real intent? Did you have two other houses and you’re making this one available to rent just so you could depreciate it?” All this stuff they look at. “How much advertising? Did you use professionals?”
I’ve seen the more they actually denied it, this was really horrible, the one case that I remember sticking out like a sore thumb was, they had a house and the daughter died. The parents were so distraught that they couldn’t live in the house anymore. They put it up for rent but they didn’t really advertise it. It was like they only wanted the best renters so nobody ended up renting it, though it was available for rent. Two years later they sold it and they lost a bunch of money when they sold it, it was in the down market. They wanted to take that as an ordinary loss. If you know what happens in your house if your personal residence goes down in value you get no loss, it’s personal property.
The IRS contested it, the dogs that they are. No offense to the IRS but that’s pretty bad. These guys moved out of a house because they couldn’t live in it because their kid died, and you’re going to mess with them over the loss. They just said they didn’t try hard enough to rent it. The IRS won on it. I was like, “You got to show that you actually tried to make it in.”
If you make it into a rental now and you make sure that you rent it and you show that, “I tried to rent it but we couldn’t get enough because the house was too old-fashioned, dilapidated,” fill in the blank, that the realtor said, “You need to fix it up.” Get that email, put it in your file. Get that writing, put it in your file. Show that you made it available and you get that it wasn’t right for the market so you fixed it up. Then yes, it can push your 2019 income down. That was a long one.
Here’s the other thing. Your 2019 income can only push down your passive income unless you’re a real estate professional or unless you’re an active participant. Otherwise, those are passive losses that aren’t going to help you out at all; you’ll just be carrying them forward. After all that, you guys always trigger three or four issues in these little questions. They always seem so innocuous but they trigger so much stuff, so I got to deal with people that do real estate. It’s great for these types of programs because it’s so wild. People out there with tax like this, really like taxes, this is tax crack. This is your good stuff.
“As a new C Corp, in which I am the sole officer, if I cannot afford to pay a reasonable salary, could I submit items to the C Corp for reimbursement? If I do, wouldn’t that draw a red flag from the IRS and some drawing compensation in an indirect way?”
Jeff: When we talk about a reasonable salary, the only thing that really applies to is the S Corporation, not the C Corporation. The C Corporation has another little tricksy thing where the IRS doesn’t want you retaining too much of your earnings, your profits in the company.
Toby: Unless you’re Apple.
Jeff: Or Microsoft.
Toby: Or any other company that keeps billions of dollars under its balance sheet.
Jeff: That usually isn’t a worry. Most people have a reason for keeping the money and they’re planning on buying additional investments or so forth. Even if you’re not drawing a salary, you still want to submit items to the C Corp for reimbursement. That’s one of them our big reasons for setting up C Corps. They may be managing other things, but the C Corp has some opportunities in it that other entity types don’t have.
Toby: Yes, it can reimburse you. Here’s the thing, when you look at compensation under the Internal Revenue Code, it includes wages and fringe benefits. A reimbursement is a fringe benefit that is taxable unless there’s a code provision that says that is not. So, we look at the code and it says it’s not. There’s actually, what is it 26 CFR? The regulations 1.62-3, if I’m not mistaken, allows you to do a reimbursement plan. It’s not included in the employees’ wages, it’s not subject to self-employment or withholding or employment taxes.
What this means in English is there is no red flag because the C Corp just shows as an expense and you don’t report it on your return, so it’s literally invisible to the IRS. It’s one of the best things you can have. If you submit the items to C Corp for reimbursement, don’t worry for two seconds. That reimbursement is actually compensation, but it’s non-reported or taxable compensation.
The other area where you see that pop in is when you have 280A is a great example. If it’s reimbursing cell phones and all that fun stuff, that’s all under that category. We really have two. By the way, you could also reimburse yourself for things like an administrative office in your home. There are all sorts of ways to get money out. Even if it creates a loss for the corp, it doesn’t matter, you just carry it forward if it’s C Corp. S Corp, you could create a loss for you. As Jeff said, you have to always worry about how much money you’re taking out.
Technically, you don’t have to take a salary out of an S Corp. You only have to take out a salary out of an S Corp if you’re taking distributions out of the S Corp. The rule of thumb is at least a third of that distribution should be in the form of salary. If you’re taking no distributions, you don’t have to worry about it. We can reimburse you all day long and even create a loss.
I know we’re way, way, way behind. I don’t even know how many more questions we have. Let’s go to this one. “Do you have to use the accrual method for books when you start dealing with loans for the company? Is there an advantage or disadvantage to using cash or accrual accounting?”
Jeff: Most of our clients and we recommend that they use the cash method. The big advantage behind the cash method is you can control your profitability more with it.
Toby: Accrual just means that if I meant to do money and I report it as though I received it. If I owe somebody money, I report it as an expense even though I haven’t paid for it.
Jeff: Large, large, large companies, whether you’re Apple, they have to use the accrual method.
Toby: Anything over $5 million you’re required to use accrual.
Jeff: Even for home construction, I think they can go up to $10 million in revenue and still go on a cash basis.
Toby: There are a few little exceptions. Eventually, you get big enough, you’re forced to use accrual.
Jeff: The one thing is with cash and accrual, you’re either cash basis or accrual basis. You can’t do this hybrid basis where I’m going to treat this under cash and I’m going to treat some other item as an accrual. The one exception is the pension contribution.
Toby: You can treat that as cash even though you’re accrual. We just love this stuff. In a nutshell, if I pay something as a cash basis taxpayer, that’s what I can write it off.
Jeff: Yeah, that’s a good point.
Toby: If I’m an accrual-based taxpayer, then the day that I owe it is the day that I can write it off even if I haven’t paid it. You’re required to be accrual at some point depending on the size of your company. They’re going to eventually push you over because as Jeff said, that’s more accurate.
Jeff: The way you can control income is, say it’s the end of December, you can wait until January to send an invoice to somebody who may owe you money, and that’s perfectly fine. It moves it to the next year. Once you receive that cash you can’t hold on to their check and not cash in until January.
Toby: Here’s somebody who’s asked a really good question. On this issue, we’re just going to answer these two. “If a payable runs higher than a receivable, would that suggest using the accrual method?”
Jeff: Typically, you don’t have payables or receivables on cash method. If you’re working with QuickBooks, QuickBooks will convert those receivables and payables, if you’re doing it right, I don’t always do it right, but it will convert it to cash method and we’ll see those receivables and payables disappear.
Toby: Yup. They’ll be listed as something else […] stuff like that. They will note it but it won’t be. The answer to your question, John, is if you have greater receivables, being your payables are higher than receivables and you need the tax relief, then yes it would make sense to go accrual if you have that option. Can you change from one or the other? I think it’s annual you can do a change of accounting method.
Jeff: Correct.
Toby: Once you do it then are you stuck with it for more than a year or could you do it backward?
Jeff: I’m not sure about that but when you do change those methods you have to account for any differences in the methods going backward.
Toby: Yup. Somebody says, “Does the officer have to pay the tax on the premium?” I think it was on long-term care. No, if it’s part of a 105 plan like Jeff was talking about, that’s a health reimbursement plan then it’s non-taxable to the officer.
“I’m using my wife’s corporate health insurance. Are the premiums deductibles and copays expenses?” Basically, can the C Corp reimburse me for those? Yes, it can. A C Corp can actually reimburse you for anything that came out-of-pocket.
Somebody says, “What about LLCs for those types of reimbursements?” An LLC is not a tax type, so if that LLC is taxed as an S Corp or a C Corp yes, you can. Technically, you could even do it as a partnership, depending on whether you’re a material participant in it, so it depends on what that business is doing. If it’s real estate, then no. If it’s a traditional business, then yeah, probably.
Guys, there’s a whole bunch of other questions out there. “In my corporation, as a promissory note to myself but interest is less than $600, do I have to give myself a 1099? I still claim interest on my personal taxes, correct?”
Jeff: Yes. The 1099, that would be a 1099-INT and the trigger is not $600 it’s $10. If you pay yourself an interest of more than $10, you have to issue about 1099-INT.
Toby: If you have more than $10 of interest, then yes, if it’s more than de minimis. The de minimis is $10,000. If you have a loan of more than $10,000 to your company, then it’s required to pay you some sort of interest. If it’s more than $10, then you’re going to have to do a 1099.
Jeff: The important thing is the last thing he says about, “I still claim the interest on my personal taxes, correct?” Whether you get a 1099 or not, you’re supposed to cop up.
Toby: If it’s paid you.
Jeff: If it’s paid you, you’re supposed to report.
Toby: Now, the corporation gives you a 1099 if it’s paying you more than $600, but if it’s the other way around, then you don’t have to give a corporation a 1099, just so you know.
Somebody says, “Hey, I thought an S Corp couldn’t reimburse medical reimbursements.” It can. You have to report it as wages. Technically, you’re right. When we do a medical reimbursement plan, I’m going to use a C Corp but an S Corp can. If you’re greater than 2% shareholder you have to include it as wages.
Jeff: That’s health insurance. Other medical reimbursements they can’t claim at all.
Toby: Yeah. It gets stinky, stinky. Use as wages.
Jeff: Health insurance can reimburse and report it on your W-2, but other medical out-of-pocket expenses they can’t do it all.
Toby: If they reimburse you as wages, right? It’s going to be considered compensation. It’s not that it can’t give it to you it’s that if it pays for something to you, it can’t call it reimbursement.
Jeff: There’s really no benefit there because it doesn’t get included in that self-employed health insurance.
Toby: It’s just going to be taxable, so meaning, you’re right if this is yours you’re going to use a C Corp. Let’s just make it real simple.
Here we go and then we’re going to get off this line. “If someone is in a memory care facility locked down 24/7, is that tax-deductible?” I assume if you’re paying for it and Jeff you know this one off the top of your head.
Jeff: What is tax-deductible is the medical or skilled care portion of that. These facilities are usually good. When you sign in to them, they’ll give you a piece of paper that tells you how much of your expense is going to be deductible. With an assisted living facility, it’s going to be a much lower percentage of your total cost, but with a skilled care facility, what this is probably is with a 24/7 lockdown, it’s probably going to be the majority of it, 80% or more.
Toby: That you’re going to be able to reimburse.
Jeff: That you’re going to be able to.
Toby: You would write that off. If you’re somebody who’s already gone through this and been going through this, then it’s a medical expense. That would still go on your Schedule A. It’d just be any amount over 7.5% of your adjusted gross income.
A lot of older folks, maybe in the lower-income brackets, just because their only income, they’re being forced that is the required minimum distribution, maybe some social security, this will lower that. This will actually reduce it. A lot of people don’t realize that you can actually write a lot of this stuff off. If you have a C Corp, it can actually reimburse you. If you have somebody and they’re dependent, then you could do it.
There is no limit on the medical reimbursement amount. In fact, under the Affordable Care Act, you had to remove all limits. You couldn’t stick a limit on it. We used to put $10,000 in there so we didn’t have anybody get caught accidentally.
Here’s one last thing. Somebody just said, “Hey, I paid legal fees and I didn’t think the 1099 was necessary to the firm. I realized it was and I requested the W-9 and they said, “Nope, we’re not going to do it because we’ve already paid our taxes,” which means they didn’t report it. The little dogs. “Should I 1099 them now even though I’m late.” Yes. Even if you don’t have their tax ID, use their address and everything else. Let’s make that easy for you.
Guys, you’re going to hear this one more time for me, go support our veterans, oneveteranfoundation.org. Twenty-two, on average, 600 veterans a month commit suicide. We got to stop this. Nobody else is doing anything about it. This one particular group does service animals for veterans, but by all means, go find your own if you don’t want to use ones that we like. I just happen to know that the suicide rate goes to zero when you have a service dog with a veteran member.
Always feel free to go to our andersonadvisors.com/podcast and go listen to some of the old Tax Tuesdays. Our replays, if you’re a Platinum member, you’re going to find them in our portal, you’ll be able to find them. We always send them out here.
For those of you guys who asked a bunch of questions, Mary says, “Hey, does cost seg benefit on a single-family?” I know we went over that. Yes, quite often it does. You calculate things. You figure out what it actually looks like. By the way, for cost segregation, I have a guy who will do all the analysis for free and give you the numbers. We’ll work with you to make sure that you know whether it’s a good deal or not.
Speaking of the podcast, go to iTunes and you can see all these things that we throw up there. I put all my Tax Tuesdays in there. Me and Jeff, we always put our stuff up there. We’re pretty much open books. Jeff’s a CPA and I’m a tax lawyer, but all we do is we sit here and play with taxes all the time. You can go to Google Play. You can always follow us on social media.
Somebody says, “There’s a group in Texas.” Yup, absolutely. There’s more than enough so you can always take a look at those. By all means, feel free to join us on social media and interact. A bunch of guys are responding to the veterans stuff. It’s a huge issue and I hope that we knock it out. I know we’re talking about taxes but life’s about more than just money and a lot of these people don’t feel the need to live and they need to know that we’re not just abandoning them. They’ve gone through some pretty heavy stuff quite often that puts them in that situation.
We had somebody here who was a minister’s assistant or chaplain’s assistant, I should say, that was in a Humvee that got blown up. Everybody else passed and he managed to survive and even had a bullet in his helmet. When it was all said and done and here’s a guy that’s a really great guy, years later and you have a thunderstorm and his eyes get as big as saucers. This is not something where they sit there, you could be the toughest dude, the toughest chicka out there. What goes on between that eight inches between your ears can be pretty devastating.
Questions? taxtuesday@andersonadvisors.com or visit us at andersonadvisors.com. If you have questions, just shoot it on Tax Tuesday, we get it, we push it around. I appreciate you guys. I appreciate all the questions. If I didn’t get your question, I’m so sorry. I know there’s a bunch sitting in there. I’ll see if we can’t pull them down and get answers to you even though you didn’t get them live, we’ll go through them. We get about 200. I think we went well over 200 questions tonight. We’ll make sure that we get you some answers and maybe we’ll grab a few of them. There’s a bunch of good ones. I appreciate you guys. Until next time. This is Toby.
Jeff: And Jeff.
Toby: Have a great rest of Super Tax Tuesday.
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