Tax season is near. Toby Mathis and Jeff Webb of Anderson Advisors answer your bookkeeping, real estate, and other tax-related questions. Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- What happens when you donate a business vehicle that you used Section 179 on in 2019 and 2020 and then you donate it to a non-profit organization in 2021? If you take Section 179 before five years of ownership, you will need to recapture the gain
- I have a rental in Phoenix, Arizona, that I am installing solar on. I’ve seen that I would qualify for the 26% federal tax credit as well as take the depreciation for the remaining amount that is being financed. Is this accurate? You can take a 26% credit for personal solar, but a deduction lowers your income; for business purposes, you can take 26% plus depreciation
- If I invested in an Opportunity Zone last year with capital gains, I understand the taxes are deferred until 2026. Are those taxed at 2020 rates or 2026 tax rates? The 2026 rates because the income, not the taxes on that income, is being deferred until 2026
- I’m selling a house that I inherited. I am on Social Security disability. Will the sale of the house affect my status? A sale of a home or any property has no affect on your Social Security; only early retirement income impacts your disability status
For all questions/answers discussed, sign up to be a Platinum member to view the replay!
Go to iTunes to leave a review of the Tax Tuesday podcast.
Resources:
Solar Investment Tax Credit (ITC)
Real Estate Professional Requirements
Old-Age, Survivors, and Disability Insurance (OASDI)
Anderson Advisors Tax and Asset Protection Workshop
Anderson Advisors Tax-Wise Workshop
Anderson Advisors Infinity Investing
Full Episode Transcript:
Toby: You’re at Tax Tuesday. If you’re looking to hear some stuff about taxes, you’re in the right place. If you want to hear about GameStop, not so much. We got people from all over the place, you got to tell me where you are. Put in where you’re from, we do hear about GME and AMC. Do you want to learn about a short squeeze? We could talk about short squeezes today. Although everybody’s an expert in it now. We got people from all over the place. We usually have a pretty good showing on Tax Tuesdays. I know it’s not tax season, but we still have people showing up.
Jeff: And it’s getting close.
Toby: Nice hat.
Jeff: Thank you.
Toby: Look at that, we have Portland, Quakake, Pennsylvania. Who else sold you $5 a share? About one share and I’m just going to hold it forever until it’s worth nothing and then I could say that I too was part of the resistance. If you guys don’t know what’s going on, GameStock, you borrow it from somebody, you sell it and then you have to replace it. If it goes way up in value, then you have to replace it at a higher price. If it goes down in value, you can buy it back for less than what you sold it for and you get to keep the difference. There it is, done. You can borrow lots of shares. Actually, I can lend you two shares or three shares, so they had more flow out there than anybody.
We have lots of questions, let’s jump right on in, Jeff. Ask your questions. There are a bunch of questions that are already popping up. Do the question and answer feature because we have a couple of accountants that are on our list. Let me see who’s on there right now. I saw Piao and Susan’s on there, Mathew Moore. They’re not going to answer tax questions. Patty, she’ll point you in the right direction. We got Christos on, and Eliot, and Piao, and Tabia. If you have tax questions, if you have bookkeeping questions, ask them. No cost, you just get answers. I can’t say whether they’re right answers, they’re answers.
Jeff: We try not to get wrong.
Toby: We’ll be wrong definitively. They’re answering the question so fast, I don’t even get to read off the questions. You can send in your questions. See that little Tax Tuesday down here? Tax Tuesday is your magic email, you send stuff there. That’s where we pick the questions that we answer every other week. We also have a whole staff that goes through those questions to make sure they get the answer or pointed in the right direction. We always say it’s fast, fun and informational. The idea is to give you guys a really good hour of content. Let’s see what we got.
Opening questions. “What happens when you donate a business vehicle that you use Section 179 on in 2019 and 2020, and then you donate it to a nonprofit organization in 2021?” Interesting question, not what you probably think.
“I have a rental in Phoenix Arizona that I’m installing solar on it. I’ve seen that I would qualify for the 26% federal tax credit, as well as can take depreciation for the remaining amount that is being financed. Is this accurate?” We’ll go into that. I love solar.
“If I invested in an opportunity zone last year with capital gains, I understand the taxes are deferred until 2026. Are those taxes at 2020 rates or 2026 rates?” Good question.
“I set up my medical LLC in late December. My current job has been paying me personally since April, directly deposited into my personal credit account. My latest paycheck for December’s work was directly deposited to my LLC business bank account in the first week of January 2021. I just found out my current employer reported my earnings for 2020 April to present under my LLC. What do I need to do?” That’s a long question, but we’re going to break that one down. I picked that out for a reason. It illustrates a few points.
“I own a 501(c)(3).” No you don’t.
Jeff: That’s the first thing I said when I saw that.
Toby: Nobody owns it. It’s the public’s, but you control it. But I get your point. “I pay my daughter with W-2 to do some other work.” Perfect, fantastic. “This 501(c)(3) is tax exempt. Do I need to file Form 941—employer’s quarterly tax return—and Form 940—employer’s annual unemployment federal tax return—or should my daughter simply file her personal tax by using the W-2 I created?” Good question, another fun one.
“I’m selling a house that I inherited. I’m on social security disability. Will the sale of the house affect my status?” This is a good question. I know it’s not typical since we’re usually dealing with just investor and business questions, but still it’s something people should understand, so we’ll go into that.
“How does a partner report outside basis on a tax return?” As soon as I saw this, Jeff, I pulled it just because for you.
Jeff: Thank you.
Toby: For example, a surviving spouse gets the stepped up basis of her deceased spouse’s partnership interest in a general partnership. The surviving spouse’s basis is higher stepped up than the other partners in the partnership. “401(k) CARES Act distribution reporting, I put the CARES Act request in on 12/28/2020, received CARES Act check on 01/12/2021, then deposited the check on 01/14/2021.” The timeline is they put in a request. They get the check a couple weeks later. Now the question is, “Do I report the CARES Act funds on my 2020 tax return or on my 2021?” Good question, we’ll dive into it.
“I have a single family house I bought as primary residence in 2019. In 2020, I rented it out. In 2019, there were legal fees, closing costs,” so when they first bought it. “Can I now claim these fees as improvements to raise my cost basis?” We’ll dive into this one.
“I have other rentals that I’ve had for six plus years and never claimed the closing costs. How or when could I ever claim to up my basis?” Really good question. There are a lot of folks that I think will be impacted by the one. It will help a lot of folks.
“I bought a house in 1998, lived in it for two years, then moved and turned the house into a rental. I wish I knew what I know now,” probably they wanted to sell it. “I rented out for 20 years and then moved back in as a primary residence, what is my tax situation?” Good question. It’s all statutes so we’re going to dive into these. We have a lot to do now. Let’s dive in. Are you ready?
Jeff: I’m ready.
Toby: And hey buddy. I don’t know if I even said hey. I was playing with the screens. You guys don’t see the screens everywhere, but it’s just Jeff and I in a room.
Jeff: We’re Toby Mathis and Jeff Webb.
Toby: We’re trying to make things work. I’m one of those guys who are just looking for the on button and there’s no button.
Jeff: Not our usual start.
Toby: Jeff and I are like three offices away and all we ever do is nod at each other. We talk all the time.
Jeff: Sometimes we even say, what’s up.
Toby: People still come to the office once in a while. Gosh, Covid’s messy.
Jeff: Yeah.
Toby: It’s just wreaking havoc unfortunately. I hate all the fear that comes out. But we’re not going to talk about Covid. We’re not going to talk about GameStock. We’re not going to talk about Nokia, Blackberry, AMC, Silver, or doggy coin, whatever it is. Everybody’s gotten nuts on Twitter.
“What happens when you donate a business vehicle?” Kars4Kids, they got to you. Kars4Kids, donate your car today. “What happens when you donate a business vehicle that you used for Section 179 on in 2019 and 2020, and then you donate it to a nonprofit organization in 2021?” Jeff, what do you do?
Jeff: Actually, if you take the bonus or Section 179—this is my understanding—two bad things can happen. One, if you’ve taken Section 179 and you have not gotten through that first five years of ownership (like in this example), you’re going to have to recapture all that Section 179.
Toby: What does that mean, Jeff?
Jeff: That means you’re going to have to report a gain on the transfer of that vehicle.
Toby: Let’s put this in English. We bought a car for $10,000. We’re going to divide it up over five years. We’re going to take 1/5th every year, just for the sake of…
Jeff: For simplification.
Toby: Yup. We have $2000 a year that we’re writing out. We did it for two years. In year three, we give it away to charity. We’ve taken a deduction of $4000 of the $10,000. You’re saying you have a tax hit of that $4000.
Jeff: Correct. The whole purpose of this is the IRS doesn’t want you doing exactly this, taking a huge deduction for a vehicle you just purchased, then turn around and deduct again as a contribution.
Toby: But you would get to write off the value of the vehicle.
Jeff: Absolutely.
Toby: If it’s a $10,000 vehicle—still a $10,000 vehicle—I would have $4000 of income, but I would have $10,000 of deduction.
Jeff: Yes.
Toby: What if the fair market value of $6000?
Jeff: Then that is the greater of your cost or the fair market value of the vehicle.
Toby: All right, same situation. I would have $4000 income and I would have $10,000 because that’s what I paid—deduction. It depends on where you bought it. If I’m in a C-Corp (for example), the rules for 2020 at least went up to 25%. I think they extended that at the end of this last year in 2020, so in 2021 you have a 25%. I know that, as an individual, you get 100% deduction against your just gross income.
You get to do that through 2021 as well. All that means is that if you are an individual, an S-Corp, or partnership, so you’re a sole proprietor, S-Corp, partnership, it’s going to flow under your return. You’re definitely going to get to write it off. You’re going to have $4000 of income or whatever portion you wrote off and you’re going to have a big deduction you don’t have to worry about it. Sometimes, we have to worry about it if 100% is cash. Actually, I have to think about this real quick. Is this going to be the 60% AGI?
Jeff: Yeah, it should still be 60%.
Toby: So you’re still going to get to write it off. It’s going to be on your schedule A and it’s going to be proportionate. Now, somebody’s asking a pretty good question about a personal car that was donated, then you didn’t take any deduction and you’re donating personal, so you’d get an appraisal on it. If it’s less than $5000, would you have to do the appraisal?
Jeff: No.
Toby: You would just go out there and get a Kelley Blue Book or something. If it’s over $5000 like in their example, Jason has $4999. You guys can’t see it but if somebody says, “What if I donated a personal car?” Then you have to get the value of it.
Jeff: No, if it’s a donation, most nonprofits are going to turn around and auction that vehicle off. You sometimes have to wait to get that value back. That is actually what you can donate.
Toby: They’re always trying to get your car. You’re going to get a minimum of $500. I think you get a minimum amount, so if you have a beater I’ll come going to [00:13:00].
Jeff: It wasn’t really asking this question but bonus has the same situation but for a different reason. Anytime you gift it, you’re now dropping below that 50% business use mark which means you’re not eligible for a bonus.
Toby: Well, 179 would make you recapture all that as income. Bonus depreciation, you wouldn’t have the recapture necessarily, would you?
Jeff: I think you would still have to possibly amend your old returns or something.
Toby: Really? I thought that if your bonus, you’re just no longer… That’s going to be another question that we’ll ask ourselves next time. If I have the bonus depreciation, that’s one of the reasons why I’d push the bonus depreciation instead of 179, as I would necessarily have the income recognition, would I? It dumped the CPA. I don’t know exactly how that would be treated. We’re going down rabbit holes
“I have a rental in Phoenix, Arizona.” A really good question, by the way, anytime you talk about solar; this illustrates a good point. “I am installing solar in my rental and I’ve seen that I would qualify for a 26% Federal tax credit and I can take depreciation. Is that true?”
Jeff: It is.
Toby: You have personal solar and this is where people get goofed up. On your personal solar, they extended it. It was supposed to go down to 22%, but at the end of the year, the Covid Relief Bill, they extended this thing out to 26% which is what 2020 was. You could take a 26% tax credit, and this is really important to understand. A tax credit is like cash, it’s dollar for dollar against your tax bill. A deduction lowers your income, so it’s worth whatever your tax bracket is at. If you’re at a 25% tax bracket, you get a deduction. For a dollar, it’s worth $0.25.
The personal solar sits in one section and then you have business solar in another. I think it’s 38 and 48. I can’t remember off the top of my head, but I think it’s Sections 48 and 38. What it says is 26% plus you can still depreciate it because it’s a business asset. That depreciation is going to be a calculation of the cost including the setup, the installation cost minus one-half of credit. If I have a $10,000 solar system that I put up and that’s the install and the panels, then I get $2600 tax credit and I’m going to get a deduction of $8700.
This is where it gets cool. Sometimes, you might be putting $2000 down in financing $8000 for that $10,000, so you actually end up with money in your pocket as a result of putting solar on your property. You’re going to recognize income because you’re going to sell the energy to the tenant. You’re going to have an income and you’re going to have the deduction carrying whatever the costs are. Eventually, you just have a nice little extra revenue stream. You’re going to use that revenue stream to pay off whatever the credit was, whatever you borrowed.
Jeff: The only stipulation for when to take the credit is when it’s placed in service, but the IRS probably doesn’t have a bright-line test for that, so you’re looking at is it generating electricity?
Toby: You could actually do the credit once it’s started and you have 10% completion. People at the end of the year, the only reason I know this is because all the solar guys are like, if you put it in December and we get this much done, you can take the credit this year.
Jeff: Now, does that work for both the principal residence and the business?
Toby: My understanding is that yes. There’s always an energy geek that’s on. I can’t see them. “How many years do you take the solar deduction over?” That’s a good question. Usually there’s one energy person that’s like I did this, but we’ll see if they surface. Because we have 168(k), which is bonus depreciation, means that we could take the equipment either over one year or five because it’s placed in service. If we have this credit of $8700, we would just take it over five years or we just take it all.
Jeff: I find that to be an incredibly short timeline for something like that.
Toby: You know what? Solar doesn’t dissipate. The ones that were put into service 20 years ago (I think) are still out there. They don’t wear out. But we listen to what the IRS tells us.
Somebody said, “Didn’t Toby say it was $0.26 on the dollar?” No. I said if you were at the 25% tax bracket, it’s worth $0.25 on the dollar for a deduction. I was just stating the difference between a tax credit. Tax credit, I owe the IRS $5000 and I get a tax credit for $2600. I take $5000 minus $2600. The $2600 tax credit is just like cash. Now, I only owe $2400 to the IRS.
A tax deduction is the income. I have $100,000 of income, but I have a $5000 deduction. Now I owe tax on $95,000. That’s all it is. A big difference from how it plays out, but a simple distinction. There’s people banging on the IRS here. The IRS is in deep doo-doo.
Jeff: I tell you what, it’s even hard to get through to them right now. They’re so understaffed.
Toby: How about paper returns? We’re still trying to dig out of June and July. It seems like they’re not even opening stuff.
Jeff: I don’t think it’s going to help that they’ve delayed the start date for e-filing, February 13th, I believe.
Toby: February 13th. They ought to just give us until July again, push out all the due dates that are April 15th, put it into July. Two-thirds of accountants said they appreciated that last year. I don’t know who the one-third is, but I say that we ostracize them. We kind of answered the question.
Let’s see, capital gains on a sold home. “Wife and I married six months ago. She lived here for five years. We have not filed taxes for 2020. If we sell personal residence and the profit is over $500,000 are we covered for $500,000?” Paio, this is fun. I want to see what you’re typing. Here’s the rule. The two out of five rule is, I live there and it’s my property. It’s in my name. You may have an issue with the in my name for the two years.
Now when you sell it, it’s in your name. You’re probably going to be okay. Did you live there for the previous two years? Yes. I would say you’re probably going to get it, but you want to just do a little verification on it. Have you ever seen that?
Jeff: I have. Sometimes it works out. Sometimes it comes in between the $250,000 and the $500,000 number.
Toby: Yeah, you got to look to see what the gain is, actually. It may be a moot point depending on how much gain you have.
“Paper returns are hilarious. It’s so easy to fluff the numbers on them.” No, paper returns are just like—
Jeff: Actually, that’s not true because they have to enter all that information in.
Toby: They’re going to take whatever you do on a paper return. They’re going to stick it into a computer and then they’re going to send you letters. They’re going to say, why is it different? That’s what you think. This is how people that get into tax arguments. They still put it in a computer and in our experience, we had to do paper returns. There are still states where we have to do paper returns on the amendments.
“If I invested in an opportunity zone last year with capital gains, I understand the taxes are deferred until 2026. It’s treated as sold on December 31, 2026. Are those taxed to 2020 rates or 2026 rates?”
Jeff: They’re taxed to be 2026 rates and the reason is because you’re not deferring the taxes, you’re deferring the incomes that will be taxed in 2026.
Toby: But they’re going to keep their nature. If you had short-term capital gains, it’s going to be short-term capital gains, ordinary rate, whatever that might be. If it is long-term, it’s going to be a pain for people. We’ll see what the tax rates are.
Jeff: It would be 85%.
Toby: That’s actually a pretty interesting issue because they’re talking about making the highest tax rate 39.6% for long-term capital gains where people make over $1 million. If you did an opportunity zone, there’s a good chance it’s huge. I’ve never really liked the opportunity zones. I know that there are people out there really pushing I’m going to get it, and I don’t talk people out, but I’d rather have some certainty. At least in the real estate realm, I tend to look at it and say 1031 exchange to me is a little bit better. At least I have control and this is why. I don’t have any control now, I’m recognizing all that deferred gain in that year, 90% of it at least in 2026.
Jeff: We’ve seen them where they couldn’t do the 1031 because they sold something other than real estate. This locks up your money for a long time.
Toby: Yeah. Which is fine. Again, I have a feeling that the people that are going to be screaming at their accountants are the really rich ones. You have a lot of income and they’re going to say, wait a second, I would have paid $200,000 for $1 million, and now I’m going to get hit with $400,000 per million, and I got an extra five years, that’s it? You could say, but you got an opportunity to do GameStop.
“I set up my medical LLC in late December. My current job had been paying me personally since April, direct deposit to my personal checking account. My latest paycheck for December’s work was directly deposited to my LLC business bank account the first week of January 2021. I just found out my current employer reported my earnings for 2020 under my LLC,” so I assume medical. I’m going to assume that this LLC is taxed something other than a disregarded entity. It’s just regarded entity, it’s moot. If it’s an S-Corp, we have a little bit of an issue. Dive into it.
Jeff: I read into this one, I wanted to ask lots of questions. First off, was it your employer or was it somebody you were contracted with? Because just changing from an employer relationship to that independent contractor relationship, I think has some dramatic…
Toby: I’m thinking it has to be a contractor.
Jeff: Beforehand. I thought so, too, because I don’t think the employer could just—
Toby: Usually a doctor contracting with a hospital, and they’re paying—without a doubt—a 1099. They’re reporting it. The date that it’s actually set up is after the date of the earnings. I’m bifurcating that out. I don’t know how they do it on a business, it’s all reported to business, I would just say I took a distribution for the amount that I had received prior. I don’t think it makes much of a difference. If I’m an S-Corp, I don’t think I’m sitting there avoiding the self-employment tax. You’re going to lose that argument because it wasn’t in existence when you earned the money. I might just call it a payment. They paid you as a 1099.
Jeff: I think if you were an individual, 1099 person, and they put it in your LLC which is taxed as an S-Corporation, you’d probably saved yourself quite a bit of money on the self-employment taxes.
Toby: Do you think you could still avoid the self-employment tax in this scenario where it didn’t exist? You would do it.
Jeff: Yeah. I think I would go ahead and do it because I think the employer could claim that the checks issued to the personal name were not correct.
Toby: I see what you’re saying. They started in April. At the very end of the year, they set up their business. I would disagree with you. I would pay it all out to the employee.
Jeff: If I go back and read that very first line where he set it up in December.
Toby: Yeah, he was talking the year before.
Jeff: Yeah, that’s it.
Toby: Somebody’s asking whether they’re withholding some things. You have to assume no because you’re not going to do witholdigns with an LLC. It’s going to be an employee. It’s going to be an individual. Everything here is telling me it’s a 1099 and instead of doing two 1099s, they’re doing one 1099 for the entire amount of the year and they just picked the latest instead of the individual’s social security or whatever they were using. They said, give me your business, so it’s up to the taxpayer.
The money that’s received from April to December would be to pay that as a Schedule C and then the date you set up the LLC, assuming it’s an S-Corp, from a tax standpoint—remember that LLC don’t exist to the IRS; you tell it how it’s going to be taxed—I’m going to take a portion of that in the S-Corp and say, hey great. I got some tax-free money. Meaning that I don’t have to pay old age, disability, survivors, insurance, or medicare. If it’s a single-member LLC, it doesn’t matter. It’s a moot point. Single-member LLC is just disregarded to the individual, then it doesn’t really matter.
Jeff: If it’s a single-member LLC, it’s not an S-Corporation or a Corporation, I probably wouldn’t do anything. It’s all going to be reported in the same spot. If it is an S-Corporation, I think I go back to the employer and ask them to correct the 1099.
Toby: Really? You’d do that?
Jeff: I won’t like it.
Toby: I’d just pay myself up, but yeah, you’re turning on your relationship.
Jeff: I see what you’re saying. Pay some amount directly to your Schedule C.
Toby: Yeah, I would just say I paid myself Schedule C. Somebody says they messed up, make them correct it. It’s easier said than done, sometimes, but it’s up to you. If it’s a big bureaucracy, I’m probably just taking it. If it’s a small hospital, I would go in and say is there any way you could break this out? They’re going to look at you like you’re from Mars. That’s just my experience.
Tax & Asset Protection Workshop, because it’s so much fun to do these. We just did one on Saturday. I hope some of you guys were on it. Clint and I are probably going to do all these this year because we’re yin and yang. He likes his areas and I like my areas. I like diving into the tax and it comes off really well, so it’s always fun.
Somebody says, “I was on. Amazing content and sign-up.” We get a lot of clients doing these, but more importantly, we educate a lot of people because this world is really simple. There’s A, B, or C, you just have to know how to do the calculation for A, B, or C.
For example, I’m a doctor, we instinctively say S-Corp. The reason being is you’re probably living off of it and you’re going to save yourself about 10% if you can avoid some of the old age, death, and survivor security tax. You get to do an accountable plan, you get to do a whole bunch of other tax write-offs, and you can adopt the 401(k). You could even do a defined benefit plan if you’re a high income earner, and you can start really pushing some stuff into the future as far as income recognition.
If you want to learn about that stuff, come to the Tax & Asset Protection Workshop. We have one coming up on February 27th. I know it’s a long way out, but plan to do it now. You do get a recording of it so you don’t have to sit there all day, although I would recommend you put some time aside. What’s cool is if you have other people that work with you, to do it together. Meaning, that you have a couple people sit around and bounce the ideas off each other.
Jeff and I could probably pick any question and we can argue over with. You think it’s arguing, but we would say, oh what about this? Then, we’ll go look it up and find out. At the end of the day, it doesn’t matter what we think. It matters what the law says.
Sometimes the law is grey and we’re just making the best decision we can. That’s why you have tax courts. That’s why you have the Supreme Court because not everything is set out already. That’s why you have revenue rulings. That’s why you have the regs. That’s why you have private letter rulings. These things would not exist if there was black and white in the tax world.
You’re doing the best you can based on the guidance, and you can choose, do I do the way that puts money in my pocket or do I do the way that puts money in their pocket? They’re both right. I just chose the one that keeps the money in my realm as humanly as possible.
Anyway, that’s free. Go on in aba.link/tap227. That stands for Tax & Asset Protection 227. You come on in, they’re a lot of fun. We’ve been teaching them for the better part of close to 25 years. Things move all the time. There’s probably hundreds of tax law changes every year. We don’t stay up on every single one. We’re just looking for the relevant one for our clients, so the Tax & AP Workshop is where you can go. Do once a year, brush up, they’re a lot of fun. Absolutely go in there and keep building up that knowledge.
All right, any other questions here? “If you do a revocable trust and put your residence in it, do you lose your homestead benefits, lower taxes, and protections from suits?” No. If you do a revocable trust, it’s the same as you from a tax standpoint, and there’s not a single state where you lose your homestead exclusion.
Homestead exclusion in a nutshell is I sue Jeff, I want to take everything that Jeff owns. Homestead exclusion says you can take all these stuff, but you can’t take the equity in my house up to a certain amount. If Jeff lives in Florida or Texas, it’s unlimited.
Remember OJ Simpson had millions of dollars of judgments against him, multimillion. I think it’s over $60 million now. They still can’t touch his house. That’s a homestead and they can’t touch the NFL Players Union because there’s the risk of protections. There are certain assets that nobody can ever take from you, and the homestead is really important.
Not all states have big homesteads, like California, it’s less than $100,000. Here it’s $575,000. All states are a little different, so there’s no one size fits all on that. Know that putting it on a trust is not going to do away with that if it’s just a living trust, guarantor trust, if it’s land trust.
Somebody says, “Can I see all the questions?” We’ll get to it. I don’t share out the Q&A. Some of the answers get shared out unless somebody is disclosing personal information, in which case we make it invisible. Same thing on the chat. I don’t want your name sitting next to something where it can be used against you. I want you to ask questions without fear.
All right, this is your favorite. “I own a 501(c)(3).” There are no shareholders in a 501(c)(3). That’s one of the requirements, that they can’t inure to the benefit of any individual; the profits that is. “And I pay my daughter with W-2.” Fine, whatever the 501(c)(3) is doing is paying somebody’s daughter, that individual’s probably in control of the organization. This is Hillary Clinton and Chelsea. This might be Hillary. “This 501(c)(3) is tax exempt. Do I need to file Forms 941 and 940 on this? Or should my daugther simply file her personal tax return using a W-2?”
Jeff: If you’re paying payroll, you have a requirement to file these reports even if you’re not withholding taxes. Even if your child is a minor that’s not required to have social security withheld on him, you still have to file these reports. It’s normally quarterly for the 941 and annually for the 940.
Anytime I’m in this kind of situation, I prefer to be working either with a payroll company or some kind of software that does payroll for me because these reports are so easy to mess up. The W-2 is easy to mess up. Filing these reports is not going to have the effect on your daughter filing her return with the W-2 unless there’s some withholding on that, but that should be on the W-2 also.
Toby: There are a couple of ways to and do this depending on how old your daughter is. If they’re an adult and they have a business, you can pay the business and let her deal with all that stuff outside. Just contract with the business. If they’re younger or this is what they’re doing and they are an employee and you’re controlling their time, then make sure that you’re running it with payroll service like you said.
We do have limited payroll for doing four or less a year through Anderson. You really want something where you can just do it periodically, maybe once, twice, four times a year. If you’re going to do every other week, then you need to have, what’s ADP and some of these other…
Jeff: ADP and Paychex.
Toby: There’s a ton out there, you just look. Somebody says, “The person who owns the 501(c)(3) needs to get some contract. Make sure you’re doing your books.” Yeah. 501(c)(3)s are awesome, by the way. I love them. One of my favorite things in the world is when you start doing things where you don’t pay tax, it’s funny how it compounds. I use Hershey’s, I use IKEA as an example. I use organization.
Most of the big ones, you can’t get out of the way once they start going. My experience is most people, it’s a one way street. Money’s going into them, and energy and time. If you get your family involved, it’s funny how these things grow. Usually over a three-, four-, or five-decade time period, you’re going to see substantial growth, like explosive growth, which you called exponential growth. It doesn’t grow linear when you’re not dealing with it.
“I’m selling a house that I inherited. I’m on Social Security disability. Will the sale of the house affect my status?”
Jeff: The answer to this question is a sale of a home or really any other property that is capital gains has no effect on your social security disability. The same for if you’re in early retirement. It doesn’t affect it. What does affect it is earned income such as you got a W-2 job, you’re self-employed, or you have a partnership. Things that are being taxed either by self employment or withholding tax. Those will affect your disability and they will affect your early retirement income.
Toby: You have the SSD which is not needs-based and it won’t have any impact on that one. You have an SSI which is needs-based and the only thing that’s going to impact, if you’re living in the house, I don’t think they look at the value of it. If you inherit a house, it may cause you to lose benefits for a little while because they have a $2000 asset limitation. You’ll have to get rid of the inheritance at some point to my understanding, but they are different words. There’s disability and there’s SSI where you don’t have the ability to work. They’re two very different things.
Jeff: I will throw in a caveat when you sell Medicare, in particular, how much you pay is based on your taxable income, your AGI. It could affect that. I could cause you to have a year of higher finance.
Toby: Is that one where they take out the passive? There’s a couple where they say interest dividends, capital gains, passive income, they don’t.
Jeff: Maybe true, but I don’t know.
Toby: That’s also social security, if you’re getting social security. I know they exclude some of these things for social security as well. Social Security Disability, Jeff’s 100% right. It’s not needs-based so it doesn’t get affected by your assets. If you sell it, it shouldn’t. If you’re on a needs-based support, then it will have an impact on your ability to qualify for the needs-based until you become needy again, which is after you sell it and deplete it, then it helps you.
“I participated in a tax contributions program that my employer offers. Can I convert it to a Roth IRA or Roth 401(k) and up to what amount?” A tax contribution, assuming it’s a 401(k) program and the question you have is can I convert it. The answer is there’s no legal reason why you cannot. It’s going to depend on your employer’s program.
Number one, does your employer allow in-service distributions? If they do, then the next question is do they have a Roth 401(k) component because technically, you can actually put $57,000 a year into a Roth either an IRA or a 401(k), as long as you are in service distributions. That would be the big question. Most employers are not going to allow that.
If they do not have the Roth component of the 401(k) and all you can do is roll it out to a Roth IRA, you could still get the same impact that you want. In-service distribution is, I have not left the employment and I want to distribute the money out of my plan into one of my own plans.
Here at Anderson, we have a 401(k). If I want to move the money in my 401(k) to an IRA, I need to leave employment. It’s once you’re down, once you retire, unless the plan says, hey I can do an in-service distribution. When we do solos, we always put in in-service distribution.
Somebody says, “I perked up hearing $57,000. How do you do that? I thought the max is $6000.” Here’s the rule. Can we go down that path? Am I late again? No, I only picked ten questions this time so I should get to do this.
Here’s how it works. When I put money into a 401(k), I want you to think of buckets. There are three big buckets. There’s a Roth bucket and let’s pretend it’s 401(k). Let’s pretend that Jeff has a Roth bucket in front of him and I’m over here and I have two buckets in front of me. One is for the employer contributions and one’s for the employee deferral.
The deferral is the employee takes their paycheck and defers it into a bucket. The employer portion is just a check from the employer that goes in, and I can deduct that up to 25%. What if I paid myself a total of $57,000 in a year and the employer contributed that same amount into the employer deferral bucket? Are they allowed to do that first off? The answer is yes. Do they get a deduction? The answer is no.
I didn’t even take the 25% because I’m still in the year. Let’s say this was in 2021 and I just did this. You know what I can do? I could roll this from my bucket at any point into Jeff’s Roth 401(k) bucket. I need to have the Roth bucket and I need to have in-service distribution. Did I ever take a deduction? No. So what’s the tax consequence? There isn’t.
The money is now sitting in a Roth bucket. It was paid with after-tax dollars and 100% legal. The IRS actually tells us how to do it. We used to think that we better take that bucket and roll it into a Roth IRA. My recommendation is still doing that, but I could still roll that out. I just never took a deduction, but I have the amount that’s payable out to me.
I simplified it. I made it really, really simple. There’s probably a couple other T’s to cross, but that’s how you put a larger amount into it. “I don’t see the buckets on the screen.” No, I’m pretending. Look at my hands. There’s a bucket over here. We’re visualizing buckets. Kind of fun; more fun stuff because I’m trying to get it done close to on-time.
Jeff: I’ll hold you to it.
Toby: That was my New Year’s resolution. It’s not to do two-hour Tax Tuesdays every time. You’re supposed to do an hour. We’ll see how close we’ve come. You can always follow us on all the social media. Clint is actually really good. He actually breaks down that same strategy in a video so you can go look at it. If you go here, check out Clint’s. Clint has a separate YouTube channel because he’s Clint, but he does really good on the real estate side. He does more exclusively on the real estate side. You can go over there.
Somebody says, “Can you do a 1031 exchange with a company like Spartan Investment Group?” Spartan does storage units, private placements. They also do RV parks and some of those types of investments and private placement is a fancy way of saying private investment opportunity. You can put money into it, but it has to go name-to-name so it’s really, really tough to do a 1031 exchange into an investment unless they are willing to do it as a tenant in common interest.
If they are willing to do that, which I don’t know for Spartan—I kind of doubt it, honestly—then you’d have to keep it in something else. Spartan, great investment, but I don’t think you’re going to be able to do it. Whenever you roll out of a syndication, the problem is it has to go name-to-name, so the entire syndication needs to go, get replacement property, and it’s kind of tough.
“If a lady bird deed is used to leave a resident to an older child when the owner passes, will the child lose the tax benefit not paying on the inherited property?” Do you know the answer to this one?
Jeff: I don’t even know what a lady bird deed is.
Toby: It’s usually trying to keep the property from the child so that it’s not counted towards the child’s income or somebody is trying to get it out of their asset base. I’ll actually go look at it. I might be mixing my ideas up. If I make a gift or if I’m leaving something, I don’t think I’m going to get the step up and basis which is what I’m thinking about.
Barbara, what I wanted you to do is send that in so I can go verify that I ‘m thinking about the right type. I immediately start thinking of something that’s going to a child after I pass, where I’m giving them a right after I occupy, but I might be thinking about the wrong thing.
“What if you purchase a building with solar on it already. Solar installed in 2016. Any credit benefit to me as solar panels are transferred to me with the purchase of the building?” I don’t think so, Joe.
Jeff: No, you may still be depreciating if it’s a rental property, but there’s not going to be any credit. The credit has already been received by whoever installed them.
Toby: Yeah. “Could you talk more about how a Wyoming single-member holding LLC is taxed as a disregarded LLC, and how do I, the owner, make money?” Somebody is asking about [00:54:55]. Wyoming is just a state. From a tax standpoint, single-member LLC just means it’s ignored. It literally means exactly what it says. It doesn’t file a tax return. It files it on yours. If I want to take money out of it, it’s no different than having a safe in your house. If I put assets in the safe, is there a tax implication? No. I take tax out of the safe. Is there a tax implication? No. I can put money in, take money out.
The only state where there’s an issue is in Pennsylvania and it’s for real estate taxes, in which case they want to charge you a transfer tax. From a Federal tax standpoint, you don’t have to worry about it. Somebody says PA sucks. I grew up outside of Philadelphia in a place called Media. Pennsylvania for real estate, it’s still a great town, but they try to hit you; they want those to transfer taxes. They’re like a vacuum cleaner.
“Can I claim bonus depreciation for a light SUV business new vehicle in 2020? It was $18,000.” What say you, Jeff?
Jeff: You can, but the bonus is going to be limited as to how much you can take.
Toby: I think it’s $10,000, right?
Jeff: Yeah.
Toby: There’s a limitation, but it depends on how heavy it is. It says light SUV. If it said heavy SUV, you might have been able to claim it all. It got to be over 50% business usage and you got to track those miles. I tend to tell people to do the mileage reimbursement. You’re going to save yourself some headaches unless the company bought it and it’s being used for business, then maybe you do it. You have employees driving it. If it’s your car and you’re calling a business vehicle, it’s got to be over 50%. You got to track those miles and it just becomes one of those things.
Let’s see. I’m going to go at the end of the bottom here. There’s a whole bunch of questions. “Can I use 26% of more than one rental property on the solar?” Yes.
“I have three rentals that I wanted to put it on. Can I use them?” Yes, and it’s just tax credit. If I put $50,000, I get 26% of that. I get a $13,000 deduction and then I also get to write off. Somebody said, “I thought there’s a limitation on the deduction?” There is. You take $13,000 of the $50,000.
Jeff: The depreciation would be on half.
Toby: On half, so the $13,000 it will be $6500. I would get a $43,500 deduction that I can take either over five years or over in one year. They’re tasty guys. I’m telling you that. There’s a few things out there where the juice is worth the squeeze.
Here is your favorite question. As soon as I saw outside inside basis, I said Jeff would probably eat this up. “How does a partner report outside basis on a tax return? For example, a surviving spouse gets the stepped-up basis of her deceased spouse’s partnership interest in a general partnership. The surviving spouse’s basis is higher stepped up than the other partners in the partnership.”
Jeff: That’s all correct. You want more than that? What this is is a 754, that’s a code section. It’s a 754 step up in basis and it also has to do with section 743.
Toby: What is basis?
Jeff: Basis is your cost in an asset.
Toby: Is there inside basis and outside basis?
Jeff: There’s inside basis and outside basis. This always confuses me because it’s completely opposite of the way I thought it would go. Inside basis is a sure basis in an investment. Outside basis is your basis inside the partnership which just doesn’t make any sense to me.
Toby: If I put $100,000 in a partnership and that partnership invests in a building, and it has a basis in the building, my basis in the partnership is $100,000, my basis in the building is whatever that basis is my proportion of it.
Jeff: And how do you get different basis? The prime way to do this is buying another partner’s interest or something like that. You’re still going to have a basis that’s assets inside a partnership, but you’re also going to have what you pay [01:00:36]. They put another asset or maybe multiple assets on the books that are just for you. It’s depreciation just for you for that increase in fair market value. The other partners don’t share in that, only that specific person who inherits it, the interest gets it.
Toby: Let’s go through this. When somebody passes away, their surviving spouse—it depends on the state in which you live—if you’re in a community property state, your basis on all of your capital assets are going to step up to the fair market value on the date of passing. The easiest way to make sure you do this is to put it in a living trust so you never have to worry. Or depending on the state where you live, they may have the ability to hold it as community property.
I learned this on one of these. Actually, somebody was telling me the right answer, and I was like, hmm, being a dummy. You can do that, like in California they have holding it as community property.
There is the ability—on how you hold it—as to whether you’ll get the step up. Otherwise, if I’m separate property and my spouse owns an individual interest, I don’t think the whole thing’s stepping up. I think just their portion is going to step up.
Jeff: Just their portion of the assets, correct.
Toby: If we’re in a community property state and we own it together, the entire basis steps up when one spouse passes.
Jeff: This is where the step up you get from the spouse dying, like you would for any asset. That is a step up in your inside basis. Say you have a property that ends inside the partnership as $100,000 value. When you inherit it, it’s now $150,000. You’re going to get a step up on your portion of that $50,000.
Toby: Right, you’re going to get a portion of that. It gets weird. People are always like basis, basis, basis. From a tax standpoint, what do I have to pay gain on? If I have, and whether I have taxation when I receive monies from it.
For example, Jeff and I go into a syndication together. I put in $100,000, Jeff puts in $100,000. Let’s say that we buy a $1 million building it goes up to $2 million. First, we started off by taking our $200,000, getting a loan for 80%, for $800,000. Now it’s worth $2 million, so we take out an additional $500,000. We take it and distribute it out to ourselves. This is where your outside basis you have to know it.
Somebody says, “What’s a syndication?” It’s we’re investing together. We’re in an LLC together. My basis and Jeff’s basis, under the facts I just gave you is $100,000. Did we increase our basis when we got the loans? If we are not personally obligated on those loans, we did not. Which means if I receive money in excess of my basis, I’m going to have to pay tax on it.
Let’s say that we both took $500,000, so each took $250,000. The $100,000 that’s our basis we can take back out always tax free, and then with the additional $150,000 might be taxable. It might be taxable as long-term capital gains if we don’t have adequate basis to take that money. How do you increase your basis? You’re on the hook. You’re personally guaranteeing that loan. Now, my basis goes up in a partnership.
Jeff: One thing I will say about in a situation such as this one—inherent of partnership interest and all—you want to make sure that whoever is preparing your partnership tax return knows what the heck they’re doing. A good, reputable CPA because this can get extremely screwed up.
Toby: Yes. Somebody says, “Personally obligated is personally guaranteed.” Yup, and it will say on the new K-1s. It’ll say whether it’s guaranteed, whether you’re recourse or non-recourse.
Jeff: There’s also if a mortgage is securing a property. Even though the partners aren’t personally liable, that is called qualified non-recourse financing, and that adds to your basis.
Toby: That can, even if you’re not on the hook for it. What if I’m passive?
Jeff: It’s still going to give you basis, so that’s going to be your at-risk versus your passive loss issues.
Toby: So if I am a doctor, I put $100,000 in, as it’s going up they go get a big loan and distribute it out to everybody. My basis isn’t going up, is it?
Jeff: It depends if it’s secured by real estate.
Toby: If it’s real estate, yes?
Jeff: Getting loans to divvy out to your partners is a problem in itself because now you’re talking about debt-financed distributions.
Toby: And if I’m on the hook then I’m okay, but if I’m not on the hook that I’m not.
All right, 401(k) CARES Act distribution. Follow me along here, guys, just for a quick second. Somebody last year, a little over a month ago, said to their employer, hey I hear that I can get early distribution under the CARES Act from my 401(k), IRA, 457, 403(b), whatever it is. I don’t have to pay early withdrawal penalties. Can I get some money? They said at the very end of the year I want $100,000. The employer says okay and they write a check. But it took two weeks to get that check cut. They sent him a check, you take that check, and that individual deposits it on 01-14-2021, so just a couple weeks ago. Do I report the CARES Act funds on my 2020 return or my 2021 return? Jeff?
Jeff: You would report this on your 2021 return because that’s when you received the check for it.
Toby: It’s the date of receipt on this one.
Jeff: Right, it’s the date of receipt, which would be January 12. Let’s say, for example, you received it on December 31st, but you didn’t cash it until January 1st. Then it’s received on December 31st.
Toby: If I write a check to a charity, for example, under the same scenario, they approved it, but it would be the date that the check was cut. If there’s a date on it for 12/31, then even though I deposited in the nonprofit two weeks later, I’d still get a charitable deduction. But that’s not the rule here. The rule here is the date of receipt. There are some exceptions (I believe) to try to push it back, but I don’t think it’s going to matter.
For this individual, at the very end of the year, on 12/22 I believe it was, Congress passed this other COVID act where they extended (I believe) for 180 days the early withdrawal of $100,000. Cumulatively of $100,000 if you’re in a national disaster area. I believe that if you have shut down during the national disaster area from COVID.
You should be okay if the reason that you’re asking for the CARES Act distribution is because you were impacted. The rules shifted slightly. It used to be to say it was because of COVID. Now, I believe we actually have to be in an area, but I believe the entire United States is still covered.
Under that situation, it behooves you to have it recognized in 2021 because you’re taking that income and recognizing it over three years. You can choose to recognize it in 2021, but you can spread it out over 2021, 2022, and 2023. So long as you pay it back before the end of the third year, you don’t have to pay tax on it at all. You can amend your previous returns and get the tax money back, but you never have the penalty ever, period.
Don’t fret, whoever sent this in. It may be okay. I think it’s 2021. I wouldn’t fight it. If they didn’t extend that, I’d be fighting and I’ll be trying to find a reason to have it classified under 2020.
All right, a few other questions. “Can my cash basis S-Corp deduct the amount paid for inventory on hand at year-end?”
Jeff: No, primarily because of what you said. It is inventory on hand. You need to report that as an asset on your books.
Toby: And the way I always look at it is you’re always doing inventory at the beginning of the year or end of year inventory. Whatever amount you purchased, then you subtract end of year inventory from the beginning of your inventory, add that to it, and that’s your deduction for the year. It’s the way I always liked it.
Jeff: And if it’s stuff like office supplies or small supply, inventory, stuff like that, you can usually deduct that, but if it’s inventory that you’re reselling, you’re not going to be able to deduct that.
Toby: Somebody says, “If I take a non-recourse loan against my fully paid for rental property, can I deduct interest on the loan from rental income and use the funds for whatever I want?”
Jeff: It’s not going to be deductible on that rental property because it wasn’t used on that rental property. You may be buying another property and that’s where it would be deductible. If you’re just doing it to pay yourself out, that’s going to be an issue. It then becomes a personal loan secured by a rental property.
Toby: Yes, it always comes down to the question is the use of the funds. If you’re using it to have a big party, to pay for kid’s college and stuff like that, you’re going to have to find other ways to write off that interest.
What usually happens is I have my personal bucket of money and I have my business bucket of money. I’m using up all this money on my businesses and then I pull this out because I need to fill up my personal bucket. You’re going to be writing off all the interest over here, anyway.
The classic example is if I use a HELOC against my home and I use it to do my investment properties. I can’t write it off as mortgage interest deduction anymore because under the Tax Cut and Jobs Act, it has to be acquisition indebtedness or used as improvement on that property. But I used it over here to acquire more rental properties. I can now deduct that interest, and you just kind of look at it.
If all I’m doing is filling up this bucket, at the end of the day I’m going to get to write off that interest. The question is which way is best for you? That’s why you sit down with your accountant and say what’s the interest over here? What’s the interest over here? Which one’s better? You don’t want to be using high interest personal debt for personal expenses because you can never write them off. If you’re doing that, use that high interest to buy business. Again, properties or something else that’s business-related so you can write off that interest on the business.
“Are all credits of equal…” Yeah, credits are equal in value because it’s your tax dollars. I’ll put it this way. Jeff and I each have taxable income. Jeff may make twice as much as me, and he’s paying a higher tax rate. End of the day, his taxes come down to a dollar amount. Jeff may owe $30,000. I may owe $20,000. A $100 tax credit is worth the same to us. He’s going to lower his tax bill with $100, I’m going to lower it with mine.
Tax credits are worth the same no matter to whom. That’s why they’re so valuable. It’s because if you don’t have any taxes, the tax credit… depending on whether it’s refundable or non-refundable. If it’s refundable, then I get a check from the government; the earned income tax credit. Some of those people are actually getting a check from the government for the kids. Maybe somebody else, if there might be a tax credit or is not.
All right. I have another question, maybe two. “I have a single family home I bought as a primary residence in 2019. In 2020, I rented it out. In 2019, there were legal fees, closing costs. Can I now claim these fees as improvements to raise my cost basis? I have other rentals that I’ve had all these years and I never claimed their closing costs. How can I ever claim this and add it to my basis?”
Jeff: Yes, you can. You heard of us talk about change in accounting methods numerous times. This is not that. This is what they call a change in estimate. You just adjust the numbers on your depreciation schedule and go forward. There’s nothing to go back and amend from prior years. You just correct in the current year and move forward. And yes, you should have these closing costs. If they’re not already included in your basis, you need to add them in.
Toby: Here’s the beautiful part. With the way that depreciation works, you may depreciate it. You may write it off. It’s not a you have to. Oftentimes, they just leave it to you and if you don’t know any better, you don’t take that and add it to your basis. The dirty secret is they can add it back in, make you pay tax, and recapture it if you never wrote it off. It gets ugly.
You go to sell and the next thing you know is you’re getting this recapture on something you never wrote off. You want to make sure that you’ve taken that and you want to catch up. I didn’t know if you decided this, but if you had it for six years you would actually catch up and take all the depreciation the previous years. It’s like cost segregation in a way. You’re just grabbing all the stuff that you should’ve been writing off.
For this individual who wrote this in, you definitely want to go back because that gets added in. The only type of stuff you get to deduct immediately is points and closing, unlike the loan costs. Otherwise, legal gets added into basis 100% of the time. You’ve got to make sure that you’re doing that.
“I bought a house in 1998,” this is a really good one, “lived in it for two years, then moved, and I turned the house into a rental. I wish I knew what I know now.” Basically they’re saying this 121 exclusion, this capital gain exclusion when you sell a house, maybe they wished they had sold it. “I rented it out for 20 years and then moved back in it as my primary residence. What is my tax situation?”
Jeff: What you need to do is you need to live in it for two years, starting from when you moved back into it.
Toby: The rule is actually funky.
Jeff: Is it? Correct me on this.
Toby: This is weird. There’s qualified use and there’s non-qualified use. In non-qualified use, what they say is if it was in the last five years, non-qualified use, throw it out the door. As long as you lived in it two of the last five years, you’re okay. If it’s prior, then you take the entire length of ownership.
You bought this in 1998. It’s kind of weird. You take the total years. This is 1998 and we’re in the year 2021. We’ll just say 2020, so we have 22 years. How much of that time was non-qualified use? You lived in it for 2 and then you had 20 years. You have 2022nd and you’re going to get a proportionality. I can never remember whether it’s 20 goes into 22 or 22 goes into it. It’s basically whatever that is. You’re going to get 1.2, 1, whatever is 0.2, you’re going to get it the capital gain. It’s a proportionality deal.
Then, you look at your total capital gains. Let’s say I bought the house for $200,000 and now we’re way in the future and we sell it for $500,000. You have $300,000 of gain. What portion of that is eligible for qualified use would basically not even 10%. It’s going to be a fraction.
Jeff: Something like 4%.
Toby: No, it’s less than 1%, 0.9%. It depends. They said they rented it out for 20 years. It means they just moved back, so it was 2 out of 22 years. It’s 0.9%. You take the 0.9% and multiply it by that $300,000. I know this is funky, guys, but you would do this, 0.9% times $300,000. You get $2700, and that’s the proportion of the gain that you can exclude.
It means you’re paying tax on the vast majority of it. It kind of sucks. That’s how you actually do it. What ends up happening is the longer you had it is non-qualified use, you have all that depreciation, everything else. What I probably would say to you is you need to not sell the house and try to use the 121 exclusion. If you move this back into personal property, you’re going to have issues when you sell it. You’re not going to get to exclude the gain.
Jeff: The other thing I thought about is he said he’s been running it for 20 years. This house is mostly depreciated. It’s going to have very little basis left.
Toby: He’s been writing it off. What you do in this scenario is you 1031 exchange this, or you could have massive depreciation. But he moved back in. The worst thing you could have done is move back in. The best thing you could do is not sell it, sit on it, wait for it, when you pass away your basis is going to step up and whoever gets it is going to have a reset button. If you’re going to sell it, move out, make it into a lease, and then sell it as a 1031.
Julia says, “I thought he should move back in two of the last five years.” But they stuck in that little time bomb, in the code that says non-qualified use. If you go and look, check out all the examples they give you. They’re almost all like this where somebody had it for a rental for 10 years, moved into it, thought they could live in it for 2 years and then avoid all the gain. It’s proportionate.
If it’s in the last five years, like I had it as a rental, I moved into it, I lived in it, then sold it in that five-year stretch, I lived in it, rent it for three years, then sold it, it doesn’t matter if it was in the last five-year stretch. But if I rented it, then moved in, I have to be worried about it. They’re going to look back and they’re going to say non-qualified use. They take a look at the last date that you lived in it, and if it’s within that five-year period, you’re okay. If it’s beyond that—I had a rental and I have lived in it—then we have to be very careful.
Don’t worry. We can always do the numbers before you sell to make sure. But like Jeff said, it’s not easy. I think I’m right on this, that it’s $2700. If you had like $2 million for the gain—
Jeff: It’s actually $27,000.
Toby: Is it $27,000?
Jeff: It’s 9%, not 0.9%.
Toby: Oh, is it 9%? I guess you’re right.
Jeff: Still not a lot when you’re considering $1000 of gain.
Toby: Yeah, so it’s 1.2 goes into 1 about 9 times. You’re right, so it’s $27,000. The reason that I bring this up again is because there’s a misnomer that it’s a proportionality of the $250,000 exclusion or the $500,000 exclusion. Not so. If this was a $3 million gain and you were single, you get the entire capital gain exclusion. But it’s not. Again, you get a proportion of the actual use and you end up doing that.
“What if it was a rental in an entity and he rented it from his entry [01:26:20]?” Stop doing that. I might find a lawyer to backdate. No, because it is still self use. It’s not going to help. What we care about is did you live in it as your primary residence? What is the use of it? What we care about is, is it an investment property? If it is, we can always 1031 exchange investment property.
The great example is I’ve been living in a house, it went up in value $2 million. I have this capital gain exclusion. How do I avoid tax on it? You convert it into an investment property and I can 1031 exchange because I’m just rolling my basis. It’s not like I’m stepping up. Even in that scenario if I meet the requirements of 121, I’m stepping up my basis for whatever my capital gain exclusion is.
Again, I have a house. I lived in it for 10 years. It went up in value by $1 million. Say it’s me and my spouse, so I have a $500,000 exclusion. I make it into an investment property, I sell it for that million. My basis is going to step up to whatever I paid for it, so it’s $250,000 plus the $500,000. Now, I have a $750,000 new basis. I’m only going to have to worry about $250000 that I’m rolling under the 1031 into the new property. Anyway, lots of fun stuff.
“What if you lived in it five years, made it a rental, and moved back for five years?” You still have to look at the total qualified non-use. If that guy had it for 20 years, then the more years you live in it, the higher the percentage goes up. You just live in it.
“What if I never lived in the property? Rented it out for the first 10 years, then moved in as a primary residence. Will I still have to aportion?” Yes. That’s the precise situation that 121 is trying to address. They’re saying you’re trying to get a big tax benefit. We’re not going to let it happen.
“Does 1031 exchange into another investment property? Or can you get a primary residence?” Julie, you go 1031 exchange—great question first off—investment property to investment property, but then I could make that into a primary residence after I establish that it’s an investment property. If I sell an investment property, buy a new investment property, wait six months, and then move into it, I’m okay. What I can’t do is sell an investment property, buy a primary residence, move in.
121 even addresses this. They say if you 1031 within five years, we have a waiting period. I can’t do this 1031, make it my primary residence, do a 121 exclusion when it pops up in value, and then do it again two years later. You have to wait five years if it’s a 1031 exchange.
“Only six months okay?” Technically, you don’t have to have somebody living in it at all. As long as you made it available for rent. There’s actually a case where they made it available for rent. What we say is make sure that you’re establishing it, so if you’re a nervous Nellie, do it for a year. Otherwise, it’s clearly an investment property if you rent it to somebody and then move in for six months. It’s no longer a personal residence, that’s for sure.
“What if we buy a second home, summer cottage home, rent out your house for six months, and then come back? Is it still our primary residence or do we lose our exclusion?” It’s actually a month test. It’s 24 of 60 months has to be your primary residence, so you don’t lose your exclusion. You just have to be careful of whether you hit 24 of the last 60 months.
Jeff: And the months don’t have to be consecutive.
Jeff: Exactly. You could live in it for six months, rent it for six months, live in it for six months, rent it for six months, live in it for six months, rent it for six months, you now have 24 months of the last 48 months. You could sell it and still do it.
You guys are awesome. Lots of questions asked; 157 questions asked that I could see. There are still some open questions. Guys, we’ll still go through your questions to make sure, but I’m going to say good job today. Did you enjoy this?
Jeff: It’s great.
Toby: All right. People are used to just sitting here doing these without having to see our face. If you like these, you can always go back and listen to the previous ones. The questions are usually pretty well-laid-out, but you see we answer a lot of questions that pop in via chat, too. It’s just one of those things.
I would just suggest that you just say, hey I’m going to do some mind food once in a while you’re driving; it’s not too bad. You can listen to it, a bunch of our guys do. There are always questions that we don’t know the answers to, so if that’s you, you’re oftentimes going to have to say we’re going to have to research it. The tax laws are nuanced and they’re ever-changing. It’s not an ego thing. It’s just usually we can get you a pretty good point in the right direction. Sometimes we have to take a look at it. If you have a personal situation, then you’re going to be platinum or a client for us to take it on an answer some pretty extensive. These are basic questions, we just answer them at no cost.
Anyway, go on in and listen to the podcast. If you like the replays, you can also listen to them if you’re a platinum client. Platinum’s a whopping $35 a month. If you’re not a platinum client with Anderson, you should be. It’s unlimited Q&A. You can get on the phone with our attorneys and our advisors. If you want to become a tax client that’s a separate retention, but you could still ask tax questions via the platinum portal.
All right, questions taxtuesday@andersonadvisors.com. Feel free to always send them in, and visit Anderson Advisors. There’s always a ton of free information up there, plus you can see when our events are coming up. Again, we have a lot of different classes. We like to teach and if you are in the mood for learning some new skills, by all means jump on. If nothing else, Jeff thank you.
Jeff: Thank you.
