Toby Mathis and Jeff Webb of Anderson Advisors answer your tax questions related to Land Trust Property Tips, retirement plans, partnerships, real estate, wills, and trusts. Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- Are there any restrictions on being a real estate professional (REP) during retirement? No, if you are retired, not working anywhere else, and spending a substantial amount of time working on rentals; depending on amount of losses, you may not have to be a REP
- Why would someone invest in a Publicly Traded Partnership (PTP)? How are they taxed? Is PTP a good option to invest in for diversity? Be careful, some PTPs are complex, but as far as traxation, there’s nothing special about PTPs – look at them from an investment, not a tax perspective
- I have converted my primary home to a short-term rental (STR) this year.If I complete 100+ hours of material participation and more than anyone else, can I deduct the losses from my W-2 wages (active income)? Yes, but if it’s rental income and you accelerate depreciation, you could lose your REP status
- I plan to donate my timeshare. Does that relieve me of my maintenance fee yearly? There are two types of timeshares – right to use and for deed; the nonprofit may use them personally, within the entity, or sell it to a third-party – know who is taking over the liability/responsibility of the asset
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Resources:
Free Tax and Asset Protection Workshop – Aug. 28
Infinity Investing: How The Rich Get Richer And How You Can Do The Same by Toby Mathis
Real Estate Professional Requirements
Section 121 – Capital Gains Exclusion
Coronavirus Aid, Relief, and Economic Security (CARES) Act
Old Age, Survivors, and Disability Insurance (OASDI)
Anderson Advisors Tax and Asset Protection Workshop
Anderson Advisors Tax-Wise Workshop
Anderson Advisors Infinity Investing Workshop
Full Episode Transcript:
Toby: All right. Welcome everybody to Tax Tuesday. My name is Toby Mathis.
Jeff: And I’m Jeff Webb.
Toby: You are listening to Tax Tuesday where we’re bringing tax knowledge to the masses. Happy Tuesday.
Jeff: Happy Tuesday.
Toby: You don’t seem that enthused, Jeff.
Jeff: We started tax season.
Toby: You’re a little tired? Or is it you’re so excited?
Jeff: I’m so excited. I want to be […].
Toby: Jeff’s exuberance is boiling over today. I’m just teasing. We got a bunch of folks on today. I’ll go through the rules and we’ll jump right on in because we’re going to try to keep you here for just an hour, which is always a battle. You asked your questions live via the question and answer feature. If you see the question and answer feature, that’s where you ask questions that are very specific to you.
If you’re responding to something we’re asking, use the chat because then we can have a conversation. I can already see people saying hey. We’ll practice. In chat to let me know where you’re at. What city, what state, what area, whatever you want to use as a descriptor so we can figure it out? Vancouver, San Jose, oh my gosh, they’re going so fast. Kansas City, Boise, Jacksonville, San Diego. Oh my gosh, they’re going too fast. Boston, I see Vegas.
Vancouver, Chicago, Queens, Iowa, Seattle, Jacksonville, DC, Palo Alto, Brooklyn baby. Craig from Las Vegas, Anacortes. I always say this, probably. I think you’re always saying Anacortes and I always say this, where my mom lives. Puyallup, yes, I can speak it correctly.
Lancaster, not too far from where I grew up. San Antonio, New Jersey, Dallas. You’re obviously accustomed to you asking every time. I just like to know, there’s some Lake Havasu. Got off the lake and said, hey, he’s a little sunburned and came in and said, you know what I need? I need the—how do you say it—the salve? How do you say something that cures your sunburn?
Jeff: The salve.
Toby: The salve of tax knowledge to cure your sunburn. We don’t even charge for it. Jeff’s a doctor, kind of. Plays one on TV. All right. We have Troy, Eliot, Christos, Piao, Ian—a bunch of tax professionals here to answer your question. If you have questions, don’t be shy. Go up there and throw them in the question and answer. Our guys will answer them for you. We will not be sending you a bill for this.
We just do it because everybody that’s on here from the Tax Department said that they were tired of doing tax returns and they wanted to answer your questions for an hour. Is that fair? I think it was something like that. No. It’s just because they’re good people, they always come on, and I’m always surprised at how many really great tax preparers we have on. We have tax attorneys, CPAs, even the head of bookkeeping, Troy, who rocks coming in and answering all your guys’ questions.
If you have a question that’s not on today, if something hits you during the middle of the week and you’re like, wow, that’s a really good question, by all means, send it in via taxtuesday@andersonadvisors. We answer your questions. If you’re getting into something that’s very specific to you and needs engagement, then either become a tax client or a Platinum client. Right now, I think your only option is going to be a Platinum client because tax is absolutely getting hammered around taxes.
It would be the Platinum feature, $35 a month. Talk to your rep if you want to know how to become a Platinum member. This is fast, fun, and educational. We want to give back and help educate. We have been doing these for years now and they’re fun. Let’s just jump right on it so you can have a good idea of what we’re doing.
“Are there any restrictions on being REP during retirement?” That stands for real estate professional. “My father is retired from the Postal Service and spends more than enough time materially participating in repair, maintenance, and general work in rentals.” We will answer that.
“Do I have access to my Roth 401(k) contributions and the way I do Roth IRA contributions before age 59 ½? What if I separate from my employer and roll the Roth 401(k) into a Roth IRA? Do I have access to any of these funds before age 59 ½?” We’ll answer that. Good question.
This one’s a long one. I picked this one for you just because it said RMD 60 times and I said, Jeff loves RMD. “I’m 68 now and I have an inherited spousal IRA (she was about five years younger than me). I know that I need to start RMDs on my IRA when I hit 72. When do I have to start taking RMDs,” required minimum distributions, by the way, that’s what RMD stands for, “from the inherited spousal IRA? When I hit 72, or when she would have turned 72, which would be when I hit 77?” We’ll dive into all this when we’re answering it, by the way.
“In settling her estate I chose not to roll her IRA account into my IRA account so that I could delay taking required minimum distributions from the value in her account as late as possible. This meant that I could delay taking RMDs on her value until she would have turned 70 ½, at which time I would have turned 75 (almost 76).” We’ll dive into that. That one has a lot of pieces. I picked it for that reason. Sometimes I grab really long ones because there are some little nuggets in there that we want to explore.
“Why would someone invest in a publicly traded partnership? How are they taxed? I don’t hear you guys talking about them in any way, either positive or negative. I wonder if a PTP (publicly traded partnership) is a good option to invest in for diversity.” We’ll go into that, absolutely.
“I have converted my primary home to a STR (short-term rental) this year.” It means like Airbnb. “If I complete 100+ hours of active participation and more than anyone else, can I deduct the losses from my W-2 wages (my active income)?” Good question. We’ll answer that.
“How should someone set up the business for Airbnb?” That goes hand in hand. It just happened that there was one after the other. It’s a good question.
“If you take regular depreciation then replace the window, roof, and large items such as A/C, and want to take component depreciation for these items,” don’t worry, we’ll explain that, “do you have to make any adjustment to the regular scheduled depreciation amount?” We’ll dive into all this?
“Can I be a real estate professional by running short-term rentals?” Great question. We’ll dive into that.
“Why is it better for the wholesale trust/land trust to be a C Corp instead of an S Corp? If I am buying land and subdividing on paper only but doing engineering studies, am I looked at as a dealer? Again, this is only land.” Great questions. I think we went over one of those. I remember in the last two months or so. It’s a good one.
“I plan to donate my timeshare and does that relieve me of my maintenance fee yearly? Due to COVID, I have not used my week and I called the company and refused to give me credit for the time and I paid the yearly fee as well. How can I legally make them accountable for this?” I assume when you’re saying them you’re talking about the charity. We’ll get into that.
When I see MF, I’m assuming that they’re meaning multifamily. “If a previous multifamily owner took appreciated depreciation on 15-year items, how would I know and would that impact the purchase price?” We could jump into that.
“How does the IRS track capital gains on sales under 2 years from acquisition if 5 million homes sell per year in America?” That’s probably your favorite question.
Jeff: That’s my favorite.
Toby: Why is that your favorite, Jeff?
Jeff: I think it’s because somebody saying how the heck could the IRS possibly track all this?
Toby: I always say this, it goes up there with, they don’t know whether I sold my Bitcoin. I’m like, oh my goodness. Cash business. They’re running a carwash. They don’t know if I got paid anything, do they? Do they? We’ll explain this one. We’ll explain what an orange jumpsuit is and how to keep fashion while incarcerated.
“Are there any restrictions on being a REP during retirement? My father is retired from the Postal Service and spends more than enough time materially participating in repair, maintenance, and general work on rentals.” What say you, Jeff?
Jeff: I’m assuming the father owns the property rental real estate. This is actually the perfect way to do it. You’re retired. You’re not working anywhere else. You have all the time in the world to spend on your rental properties, and you’re the ideal real estate professional. In this case, it sounds like you’re spending a substantial amount of time on rentals.
Toby: When does it actually matter?
Jeff: It matters for the two tests and material participation test.
Toby: Let’s even step it back farther. Dad has rentals, dad makes $20,000 a year on rental, do we care whether he’s a real estate professional?
Jeff: No.
Toby: Because we’re not worried about that. Now, dad has rentals, but dad has losses because of depreciation, and he’s able to offset some of his pension, some of his Social Security, or whatever else. Maybe he’s got $20,000 of losses. Now, does it matter?
Jeff: It does matter because you have passive losses versus non-passive losses. Those passive losses are likely to get suspended. Maybe, maybe not.
Toby: Yeah. The easiest way to think about this is passive losses only offset passive income. There are two times when this isn’t the case. Number one is when you are an active participant in real estate and you make less than $100,000 a year. Technically, it’s less than $150,000 because it phases out between $100,000 and $150,000. But if you want the full $25,000 deduction, you just need to be below $100,000.
If dad’s retired and he’s making less than $100,000, then he doesn’t even need to qualify as a real estate professional, unless his losses are more than $25,000. If the losses are greater than $25,000, then he would need to qualify as a real estate professional. Real estate professional, you just mentioned, has two tests. What are the tests?
Jeff: One is the material participation test. I don’t even know what to call the other test.
Toby: The other is it’s 469 is the code section, (c)(7) if you need a direct cite. You have a 750-hour plus more than 50%. It’s basically are you involved in real estate development, construction, sales, or brokering? It doesn’t matter whether it’s yours or somebody else’s. It’s, am I in those industries? You could be in construction, you could be a real estate agent. If you’re spending 750 hours and more than half your time, then you’d qualify.
Dad here who’s retired, he would need to make sure he’s hitting the 750 hours to be a real estate professional, then you hit the next one. It depends on whether he’s married as to whether he has to hit this, a spouse, or a combination of the two. That is they have to materially participate in their real estate activities. Do they have to do it for each house?
Jeff: No, they can actually aggregate the properties. It’s almost impossible to meet that test if you don’t aggregate and have multiple properties. You just can’t do it. You’ll qualify one.
Toby: That’s what the IRS will do if you’re using an accountant who doesn’t know what the aggregation election is, you’re going to end up having to qualify materially for each property. The 750 hours doesn’t matter about properties. Even though there’s a court case where they screwed that up, it’s been overruled multiple times, not just in courts, but also with the IRS Chief Counsel. It is 750-hour half your time, test number one, any real estate. Then they look at your real estate and it’s per property did you materially participate? There are seven tests.
You meet one of the seven tests. The easiest is if you’re managing them yourself so if he’s doing on his rentals you don’t have to worry about anything else. If it is somebody else’s managing, then you’re going to have to do more than 100 hours total between spouses. There’s a joint return.
Dad is probably going to be okay. Your dad is probably going to be pretty good. He may not even have to worry about it. He may be able to go underneath the active participation test. You know what, just throw the scenarios and just make sure he’s tracking his time. That’s the only thing I would say.
“Do I have access to my Roth 401(k) contributions in the way I do Roth IRA contributions before 59 ½? What if I separate from my employer and roll the Roth 401(k) into a Roth IRA? Do I have access to any of those funds before 59 ½?” Jeff.
Jeff: The first prohibition that you might run into with a Roth 401(k) is the employer not allowing in-service distributions. If they do, though, you could take it out. You could roll it into the Roth IRA before you’re 59 ½. If you do take money out of that Roth IRA that you rolled, you can take out all your contributions tax-free.
There’s a couple of rules. There’s a 5-year rule, which only affects earnings. There’s a 59 ½ -year rule, which again, only affects earnings. But if you’re pulling that money out that you’ve just contributed, there’s no penalty, there’s no tax.
Toby: Your contribution you can always take out. What Jeff’s really putting well is whether it’s a Roth IRA or 401(k), you can always take out what you put in it without any penalty at all. It’s just, you have to put it back in within 60 days or it’s gone. It’s in your pocket. It’s not tax, but you’re going to lose the ability to have tax-free growth on it. Then you look at the growth on your contributions. That you can take out if you’re 59 ½ and it’s been in there for 5 years without any penalty, anything whatsoever.
There are some ways to get money out earlier than that. For example, if you are buying your first house you can get up to $10,000. If you need higher education expenses or if you’re ill, there are a few exceptions to the general rule. Just remember, you can always take out your contribution. I tell young people especially, use it as a savings account. Put your money in there and hope you never need it. But if you did, you just take out whatever you put in there. The growth, you might want to let ride. If you take it out early, what’s the penalty?
Jeff: Ten percent.
Toby: Ten percent plus it’s taxable. If I put in $10,000 over a couple of years and it grows to 15%, I can always take my $10,000 out without a penalty. The $5000 of growth, I may have to pay a 10% penalty, so $500 plus it’s taxable.
Jeff: Talking about that 5-year rule, we’ll use your example that I put. I have $15,000 in my Roth 401(k). Originally, I’d only contributed $10,000, but I’ve rolled that to my Roth IRA. That 5-year clock doesn’t start ticking until it hits a Roth IRA. If you don’t have any other Roth IRAs, your clock hasn’t started ticking just because you have it in Roth form.
Toby: Yeah, any Roth, it would be on growth on that. Real quick, Patty, I’ll answer. I think I see Catherine who had a question on the material participation. I’ll get into that. Also, somebody is asking a question on this one, which is, “Can I borrow against my Roth?”
Jeff: No.
Toby: No. That’s only for traditional funds. You can never borrow against an IRA. It’s only a 401(k) defined benefit plan like a pension, never an IRA. There were some rules under the CARES Act that allow you to take early contributions and pay him back over a 3-year period. That’s gone now. If you’d taken money out last year, there’s a good chance that you have a period of time to a) recognize it, and b) pay it back and take the deduction.
Jeff: One other thing I wanted to mention with the 5-year rule (another weird thing) is that the clock starts from the first time you contribute to a Roth IRA or put money in a Roth IRA. If you later open other accounts and put more money in, that clock has already started ticking with your first Roth IRA.
Toby: For the 5-year?
Jeff: Yeah, for the 5-year rule.
Toby: What if you’ll only put $1000 in and then put another five? You’re good?
Jeff: You’re good.
Toby: It’s 59 ½ and 5 years. All right.
Somebody asked a question, I think it’s worthwhile answering. When we’re talking about material participation on this one, this is dad. Let’s say dad and mom are both alive and married filing jointly, they can add up their time for material participation. Somebody says, “Can you clarify 100 hours for a married couple if they’re not managing their own properties?”
Material participation is a different test. Once I aggregate all my activities together, it’s whatever I’m using for material participation on that property. If I’m not managing my own properties, if I’m not managing them, I’m using another manager, I’m still going to add my material participation. That’s fairly common, especially if you have properties in another state. You’ll have somebody doing your Airbnb, but you’re going there and you’re doing repairs, you’re going there and fixing it up.
You might be going there working in other matters, doing the finances on that particular property with the property manager. You may be just coming to town and looking over your investment. The question is, can I do investor activities at the same time? The only way you can add in your investor activities to material participation is if you’re managing your properties, is my understanding.
If you’re looking for new properties and things like that, as long as you’re managing your own property and you’re doing those types of activities, it could potentially be material participation. But we don’t really see it. Usually, you’re blowing the material participation out of the water.
Think about it, you’re spending a weekend going in and doing work. That’s a lot of hours that you guys are getting, and usually, you’re doing it quarterly or at least twice, three times a year, you’re going to get over that 100-hour mark. It just has to be more than the property manager spent. Just make sure you’re keeping records of it.
All right. Asset Protection Workshop, we have another one coming up on August 28. There’s Mr. Coons talked about Real Estate Tax and Asset Protection Workshop. If you guys like this information and you want to learn more—free workshop. We do it all day on a Saturday. Usually, it says 9:00 AM to 5:00 PM, but usually we’re done at 4:00 PM. The reason being is because we don’t want to kill you. We’re going to do that. Here we go. Register for free Tax and Asset Protection Workshop, aba.link/ap.
All right. “I am 68 now and have an inherited spousal IRA (she was 5 years younger than me).” I’m so sorry, you lost your spouse, number one. “I know that I need to start required minimum distributions on my IRA when I hit 72.” That’s the new rule under the Tax Cuts and Jobs Act, and SECURE Act. “When do I have to start taking RMDs from the inherited spousal IRA? When I hit 72, or when she would have turned 72 (which would be when I hit 77)?
In settling her estate, I chose not to roll her IRA account into my IRA account so that I could delay taking RMD distributions from the value in her account as late as possible.” This is called a stretch. “This meant that I could delay taking RMDs on her value until she would have turned 70 ½,” really 72 now, “at which time I would have turned 75?” Really, it’d be close to 77. What do you say to this individual?
Jeff: I’ll be honest. I have not worked with stretch IRAs at all.
Toby: It’s complicated, I’ll just tell you that much.
Jeff: Because the old rules were if she had not started taking distributions of any kind, either what they call substantially equal payments or her own RMDs, then all the rule rules would apply only to you and not to your spouse’s age or anything.
Toby: Correct. You would have stretched it out, and it doesn’t change. They changed it for everybody else but you, so long as you don’t roll it into your account. If you rolled it into your account then it’s your funds, it’s applying to you. You don’t have to worry about something in the SECURE Act, which says that you have to take all the distributions out within 10 years. If it’s non-spouse and you inherit an IRA from somebody else, you have 10 years to take all the money out. That is not the case in a spousal IRA.
Really, you have a few different flavors. I’m just going to hit two of them. You rolled into yours, now it’s yours, it’s based off of your schedule. It’s when you hit 72, or you leave it in her name as you as the beneficiary. It’s still her IRA, it’s for your benefit, and you would use her numbers. Since she is younger than you, you would use her numbers. It sounds like that’s what you did.
The way it’s going to work is you would be required to take minimum distributions when she hits—it would be April of the year following her hitting 72. If you’re five years older, it would be the April following her hitting 72, which would be you’re 77, possibly 78, depending on when your birthday is. You’re going to get more time out of it.
I don’t want to dive into any more of the complexity because it’s so fact-driven. Just know that when it’s a spouse, it’s different rules. When it’s non-spouse, then it’s always like, hey, if it’s Roth, you can always just take the money out. If it’s traditional, you could take the money out, but it’s taxable to you, you don’t have the 10% penalty.
If it’s traditional and it’s spouse, then I could just be a beneficiary of it and use their age for the required minimum distributions, assuming that they haven’t already started, and that there weren’t equal distributions under 72(t) being taken. Or I just roll it into my account, mix it, and then I don’t have to worry about the 10 years. I just take it over my lifetime.
Jeff: One thing about the RMDs to be aware of is you can aggregate RMDs if they’re the same type of investment. You could aggregate all your IRAs and do one RMD from one of your accounts.
Toby: All your accounts together.
Jeff: All your accounts.
Toby: Yeah, even if you’re a beneficiary.
Jeff: 403(b) I think is the same way. 401(k)s you have to take an RMD from each account that you have. Inherited IRAs, you can also aggregate if you have multiple inherited IRAs.
Toby: And you can give them to charity if you want up to $100,000, and just directly. She says, “If my husband is older than me and starts taking distributions out of the IRA and I inherit, am I forced to take the distributions even though I’m not 72?” I believe so.
Jeff: Yes.
Toby: Or you just take it all. Again, if it’s a Roth, you don’t have anything to worry about. If it’s non-Roth, the reason you want it in there is so it continues to grow tax-deferred. You could always take the money out. Don’t just pay the tax and tear the band-aid off, but I like the tax benefits. I’d understand why other people do too.
Somebody asked, “Is it worth converting an IRA to a Roth after 59 ½?” What I’m going to say is it depends on the year of the conversion. If I have a whole bunch of losses, then I’m probably going to convert. If I don’t, then I’m probably not. If I’m in a high tax bracket, it makes no sense to convert because I may be paying a pretty good chunk of change, and I don’t have enough time to make it up.
The rule of a Roth is if your tax bracket is going to be higher when you retire, do the Roth. If it’s going to be lower when you retire, do traditional. That’s just math. I would have to spell it out for you. It takes about 30 years to break even on the conversion if your tax bracket’s going down. If you’re in a really low tax bracket, you have some events that, hey, I’m able to take some losses. For example, if we have losses that would ordinarily be something that we’d have to carry forward, convert some money, make some tax.
Jeff: You don’t have to convert it all, you can convert a little at a time.
Toby: Yeah. We look at this. This year, we can’t carry back business losses, ordinary losses anymore. Under the CARES Act, they gave us three years to carry back losses. If you have a business and you lose money, this might be the year where, hey, I had a really crappy year. COVID’s beating me over the head. I got a restaurant, I’m getting kicked in the shin. This is the year to convert because you’re not going to use up all that deduction because you don’t really want to carry it forward.
You just talk to us. We’ll map it out for you. We’ll make it clear for you guys. We’ll actually give you the numbers. I always tell people, there are three rules of anything financial—calculate, calculate, calculate.
“Why would someone invest in a publicly traded partnership?” Bad Taste is timeless? I’m sorry. “How are they taxed? I don’t hear you guys talking about them in a way either positive or negative. I wonder if a PTP is a good option to invest in for diversity.” Jeff.
Jeff: I think the reason we don’t talk about it is because we don’t talk about investments in general, as far as whether this is a good investment or a bad investment. Where I’m often […] publicly traded partnership shoes is in the energy sector, oil and gas. How are they taxed? There’s a carve-out for publicly traded partnerships. That’s a yes, the loss is kind of passive, but you can’t take those losses as long as you hold that entity.
As soon as you get rid of that partnership, that PTP, that’s when you get to recognize your losses. They can be good cash flows. You just have to be careful what you’re looking at. I’ve seen some hedge funds that are PTPs. They can be complex. As far as taxation, there’s really nothing in particular special about it. You have to look at it from an investment point of view, not the tax point of view.
Toby: Right. A publicly traded partnership, the reason people do them is if it’s going to be holding passive assets or investment assets, portfolio income, really. If I want to get technical, chances are it’s going to be things that are kicking down dividends, things that are kicking down interest, capital gains, maybe rents. The reason that they’re doing it is because there’s only one level of taxation, and that is with the partner.
The problem that you have is you’re going to have a tax nightmare and your accountant’s going to hate you because you have inside basis, outside basis. Like Jeff said, there are special rules, you get a K-1, and you’re going to get the tax documents that are done on year end. You’re going to be getting different documents throughout the year, and your accountant’s going to have to figure out what the heck is going on. Are they fun to prepare?
Jeff: They’re not bad. I don’t mind them. But like you said, if I paid $100,000 for my PTP interest, I’m going to hold it for 5 years, my cost is no longer $100,000 because of those K-1s. I’m recognizing income or possible losses.
Toby: Somebody says, and the tax documents don’t arrive until June each year. They’re coming all throughout the year. It’s like the joy of having partners that you can’t control. What you just said is actually spot on. Again, the people that do them are because they want to treat it like syndication but it’s publicly traded.
Jeff: The other downside of these things is they’re usually in lots of states that may want to come after you for state filings for very little money.
Toby: It makes money in a particular state than either it’s doing a—what is it, a consolidated return? What’s this? What’s the term? What’s the term of art for it, when they’re doing one tax and it pays the state taxes? Compound return? No, it’s not a compound either. Is it consolidated?
Jeff: No, it’s not consolidated. It’s not compound.
Toby: It begins with a C. Anyway, maybe one of the accountants. California charges $800 per year in fees. Composite, there we go.
Jeff: Composite, thank you. Who said that?
Toby: Shawn. He gets a star. We got some smart people out there. Thank you, Shawn. All right. You add a layer of complexity. If you’re just doing it as a, hey, I just want to put a little bit of money in one, then it’s usually a pain in the […].
If you’re doing it because it’s actually a specific investment you want, then the complexity is probably worth it if you’re being pretty targeted. I don’t really have a positive or negative opinion. They’re just a little bit different. What Jeff said, by the way, what he’s spot on about is if you’re taking distributions out of a partnership, that lowers your basis. So when you sell it, you have to recognize that as tax. Everybody’s like, ah, I bought it for 100 and I sold it for 200. Your basis is getting adjusted as those distributions are coming up.
Jeff: The last PTP I was in was before oil collapsed. I was getting really good dividends out of it and really good capital gain dividends. But like you said, they get adjusted. They do have their place in the world.
Toby: Yeah, I’m not negative on them, but you want to walk them with your eyes open.
Somebody asked, “Did Toby say that you can’t carry over losses anymore?” No, Toby did not say that. Toby said you can’t carry them back. Last year, if you had $100,000 of losses, if it was for 2020, we could carry it back to 2015. You take your taxes back that you paid in 2015, use it all up to carry it to 2016, use it up, carry it to 2017. It was great.
We’re getting back some of the taxes that we paid, that was the CARES Act. Now it’s gone again, and we just carry forward. But you have an indefinite period of time that you can carry it forward. It used to be that you could carry back 3 years, carry it forward 20. Now you can just carry it forward, but you’re limited to 80% of your business income in any particular year when you carry it forward. Clear as mud.
Jeff: We’ll never completely wipe out your business income anymore.
Toby: No, because that’s kind of stinky. I don’t like that.
Somebody says, “My question is if Anderson Advisors have made a video showing the process of selling your primary home to an S-corp, but still leasing it as a way you can use 121?” Yeah, Clint actually did one. I’ve done one, I believe. I’m teaching it actually on Thursday to a bunch of lawyers for continuing education on 121. It’s all about that. But what it is, is you can actually double up 121 and 1031.
A lot of times we’re talking about just houses that have run away in value and you don’t want to pay the tax on it. You’re up $ 1 million, you got a $250,000 exclusion or a $500,000 exclusion, we can do a 1031. But also, if you have part of your house that’s been a home office where you’re recapturing depreciation, or if you had a separate unit that was only for running an opposite office and you were doing it as a sole proprietor where that thing dinged you, there’s a way to double up on it.
I remember, 2005-14 is the revenue procedure that says you can do that. Your accountant, when they tell you that you’re full of doohickey, you can just point them straight to it. Why is that stuck in my head? Nobody knows. Some of those numbers just get wedged in there and that nothing else can get in. I can’t remember composite, but I can remember a silly rev proc that I read 15 years ago.
All right. “I have converted my primary home to a short-term rental this year. If I complete 100+ hours of service of active participation,” it’s actually material participation,” and more than anyone else, can I deduct the losses from my W-2 wages (active income)?” Jeff.
Jeff: Yes. If you’re materially participating in your short-term rental—as we talked before, it’s a rental, but it’s not. If it’s seven days or less, it’s considered non-passive income. Because of that, if you are materially participating—you’re going to contradict me.
Toby: I’m going to make so much fun of you.
Jeff: Okay.
Toby: I’m not going to contradict you. I’m just going to say that you’re making so many assumptions. They said short-term rental. How many people have you met that said, hey, I have short-term rentals and then actually were short-term rentals?
Jeff: True.
Toby: I’ve been doing a short-term rental. I’m renting it out for a month at a time. You can hit me now. There are three levels. There’s 7 days or less with services, there’s 30 days or less with substantial services, and 30 days or more with extraordinary services. Those are what qualify you for that potential to make it non-rental income. Then you go and you look at it and you say, oh shoot, am I materially participating? If it’s not rental income and it’s ordinary non-passive income or if it’s just ordinary income, am I materially participating?
The reason this is important is because Jeff and I—I always use the analogy that Jeff opens up the pizza shop and I’m a silent owner. I’m not materially participating, Jeff is. If there are losses, the losses that get handed down to me, I can’t write off unless there’s other passive income because I did not materially participate.
My income from being a silent partner is different from his, which if he had the pizza shop and he’s running it, he’s a material participant. When you look at your primary home, the question is, is it rental income? If not, did you actively and materially participate? Actually, I’m using active now. It’s material participation. Did you materially participate?
Under the facts that you’ve given, chances are you could use those losses including accelerated depreciation against your W-2. However, it’s no longer rental income. You cannot use those hours of material participation towards any other real estate activities you have, only on that particular activity. It’s not a rental activity. That could cause you to lose real estate professional status, for example.
If this is all you’re doing, you took a house, you made it into a short-term rental, and you’re able to accelerate the—if I’m able to accelerate the depreciation and take a big loss this year, it’d be great to offset my W-2 wages. Now, a caveat. If we get you too low, you’re not going to qualify for loans, it’s going to be really difficult for you to acquire more real estate. You’re going into lower tax brackets. I’m fine with big deductions at 37%, I’m not so fine at 12%.
Why are we wiping out 12% tax? I’d climb over glass for 12% tax, most investors would at some point. Don’t screw that up. I would just say, hey, you know what, I don’t need to take it all in 1 year. Maybe I’m spreading it out over a period of time. Maybe I don’t want to use it at all because I need my wages.
Jeff: This material participation test really is important here. If you meet that test, it’s better than the rental deductions. If you don’t meet that test, it’s actually worse than your rental losses.
Toby: It could be.
Jeff: Because you have passive losses that you can’t call real estate.
Toby: Correct, and you lose your real estate professional status when you’re grabbing them all together. Yeah, absolutely.
Somebody says, “Examples of materially participating.” Again, there are two categories that we always look at. There’s the real estate professional side where it says, am I involved in a real estate business with more than 50% of my time? That is, am I involved in the development, redevelopment, construction, sale, brokering, of real estate? In order for those hours to qualify, I don’t have to be working on my stuff. I just have to be more than a 5% owner of the business that’s doing it. I could be a real estate agent and knock that one out.
For the material participation, it’s a combination of spouses. If Jeff and I were married, it would be our time together. There are seven different tests. The easiest one is, I self-manage then I only have to keep track of my hours. Or if somebody else is managing your properties, meaning engaging in the activities with the tenants, screening them, collecting rents, all that stuff, then I would have to do more than 100 hours and more time than them. If I don’t want to have to worry about more time than them I need to hit 500 hours total. It’s per property unless I treat them all as one.
I know that some of you guys are like ah, what did he just say? That’s why you come to our classes and we’ll teach you, plus you just talk to our people. They’re good at it.
All right. “How should someone set up the business for Airbnb?” This is a great segue. These things are kissing cousin questions.
Jeff: My favorite still is, you have a property and I’m going to start us off by saying this is not your principal residence that you’re Airbnb-ing. But if you have a separate property, you rent that property to your corporation as a long-term rental, and then have that corporation do the Airbnb work.
Toby: What Jeff is really putting is for somebody who is aggregating their real estate activities with other rentals and you’re going to qualify as a real estate professional, the appropriate structure would be to make sure that Airbnb is considered a rental for your purposes by renting it to your corporation, having your corporation acts as the host. The host would be paying on a monthly basis. Everybody’s paying the host on a short-term basis so that it’s still rental income.
If you only have an Airbnb or all you do is Airbnb and you have substantial income—this is, for example, a medical professional—they’re bringing in $750,000 a year, and they own a duplex that they Airbnb. They should self-manage that at least in the year that they do the accelerated depreciation because they can unlock that as non-rental income, ordinary income, and convert it into ordinary loss with that depreciation, which will offset their W-2 income, their 1099 income, anything like that. That’s how that works, but there’s a flip side to it.
If you make money and you’re materially participating, you’re going to have Social Security tax on that. There are two sides that we look at. We’re talking about the loss, but if you’re making money at Airbnb, it might make sense to do the corporation as well to avoid getting hit with self-employment tax and all the income if you’re making a bunch of money.
We have clients that are clearing $300,000 a year, for example. I’d much rather that be rental income or a good chunk of it, mix it up, and avoid some of the pain of the self-employment tax on it. Anyway, now we’re back into Q&A. Somebody says, “Did you just say you and Jeff are married?” No, I’m saying hypothetically. Jeff and I are not married.
Jeff: He’s not my type.
Toby: All right. “If you take regular depreciation then replace windows, roof, and other large items such as A/C and want to take component depreciation for those items, do you have to make any adjustment to the regular scheduled depreciation amount?”
Jeff: It sounds like we’re talking about cost segregation here. Unfortunately, most of the items you named are not subject to the shorter life. They’re all subject to 27 ½ year life. If you’re replacing windows, replacing the roof—not repairing the roof, replacing the roof—other large items such as A/C, so you’re putting a new A/C unit outside the house.
Toby: HVAC.
Jeff: It’s only for commercial.
Toby: Oh, commercial HVAC. We’re assuming this is residential.
Jeff: Commercial HVAC, I think, has a 15-year life now, which 15-year life is subject to bonus depreciation.
Toby: Anything less than 20 years of depreciable life we can take in one year under 168(k) this year. When they say regular depreciation, they’re talking about either 27 ½ or 39 years, depending on whether it’s a residential property or non-residential property. You don’t have to keep that. You could elect out of that with a change of accounting election and get a cost segregation engineering study that says, here are all the pieces of the building. Some of it’s going to be a 5-year property. The best example I can give you is carpeting. Some of it’s going to be a 15-year property like sidewalks, fences, the shrubbery, all that stuff.
Jeff: Swimming pool.
Toby: Swimming pool. Jeff wants to write off the swimming pool. You would have a swimming pool in a rental?
Jeff: Do you think there is some liability there?
Toby: Just a tiny little bit, unless you have a lot of insurance. Maybe, if you’re going to get a bunch of money for it. All of those items could be accelerated and written off faster than the 27 ½ or the 39 years. There’s a tax reason to do it. Usually, it’s just playing with the numbers.
Jeff: To answer your question, do I make adjustments? You pretty much adjust everything when you do these cost segregations and do this component depreciation where you’re pulling items out of your cabinets, all the items Toby just talked about. And they’re going to adjust those numbers and reclassify them.
We use Cost Segregation Authority. They gave us a report that says what all the items are, how much depreciation they have, and how much past depreciation they should have. All it gets reconciled. When you do that, what’s called a change of accounting methods, Form 3115, to make that adjustment for this cost segregation.
Toby: If you want to learn more about that, we do discuss it quite often during the Tax and Asset Protection Workshop in brief set. But we go into great detail in a couple of the webinars. You can just look on our website. It’s the one I taught with Erik Oliver from Cost Seg Authority. We go through the examples and we break down a bunch of actual cost segs that we’ve done, and you can see them.
I do a lot of examples even during the Tax and Asset Protection Workshop, but it’s always great to actually see the numbers and see this is what they were going to have, this is what they got afterward, and this is the impact from a tax standpoint on their tax brackets.
When you see somebody putting an extra $40,000 in their pocket—in actual dollars, in tax dollars, not a deduction, but actual dollars—then it usually is like, whoa, yeah, it’s worth it for me. I’ll spend $2500 or whatever it is to do the study and get it done because I’m going to have a whole bunch of cash in my pocket. I can go out and buy more real estate.
“Can I be a real estate professional by running short-term rentals?” Jeff.
Jeff: No, you cannot. This goes back to…
Toby: I love these questions. I grabbed these questions just to torment Jeff.
Jeff: Okay, remember all the stuff Toby said about the earlier short-term rental? If these are true short-term rentals where they’re less than 7 days or less than 30 days of substantial services, they’re going to be carved out of your rental activities. They’re considered trades or businesses. It’s as if you’re running a hotel, residence inn, or something like that. Those are not rentals. They do not qualify you to be a real estate professional.
Toby: From a standpoint at the 750 hours, would that be true?
Jeff: I would think it would count with the 750 hours. You are managing a property.
Toby: Yeah, I guess you would. For a real estate professional, remember that there are 750 hours plus 50% of your time. There’s also the material participation.
Jeff: Now where I see this being a problem is if I have true rentals and short-term rentals, this could hurt my real estate professional.
Toby: There’s a couple of cases where it did just that. Somebody had six rentals, three of them were short-term, they aggregated all six together and the court said, short-term rentals are not rental. It was seven days or less with services. They were cleaning in between, they were providing linens, and they had some food in there, coffee, and all the stuff that you wouldn’t normally give a tenant. It was with services. It was no longer rental income. It was ordinary income.
The court said, well, that activity is no longer rental income. It’s no longer part of 469. When you do the next task, which is, all right, did you materially participate? You’d have to do each property, remember, but I could aggregate all my rental activities together as one economic unit. Now you have a problem because you can’t count those. There’s a couple of cases where they lost because they were playing the, I’m going to be the Airbnb King and screwed up the real estate professional status.
The way around this, Jeff mentioned earlier, is you rent. Let’s say you had three Airbnbs and three long-term rentals, you want six long-term rentals. What you would do is lease long to your corporation and let it do the hosting. You’d have a month-to-month. Now you’d have six properties that all are long-term rentals.
When you make that decision, it’s usually a wise idea to talk to your accountant and make sure you have a plan of attack so that you don’t screw something up that’s going to leave a mark. Also, you may say, hey, you know what, I don’t want days with services. How do I avoid it? All right. Let’s make sure that you’re always doing 2 weeks then as long as it’s not substantial services. You could do the cleaning, you could do potentially linens, but as long as you’re not doing concierge and feed them every day, you’re going to be fine.
Hey, if you like this stuff, follow us on social media. It’s aba.link/your favorite social media. Instagram, Twitter, LinkedIn, YouTube, Facebook, all of them. We have a lot of content out there, guys. We are truly education-based. We want to give as much information as possible so you can make really good decisions. We love our clients to be prosperous because really there are no tax problems that we can help solve if you’re not making money.
Somebody says, “Why is it better for the wholesale trust/land trust to be a C Corp instead of an S Corp? I’m buying land and subdividing on paper only, but doing engineering studies, et cetera. Am I looked at as a dealer? Again, this is only land.”
Jeff: I don’t have a good answer for this. I’m interested to see what you have to say.
Toby: If you are a dealer, you’re in the business of buying and selling real estate. You buy real estate to sell it. There’s a section in the code—I want to say 1236 or 1237, I forget—where if you subdivide land without adding substantial value to it, you’ve held that land for at least 5 years, and you’re not a dealer, then that doesn’t qualify towards your dealer activity. If you’re just buying land and holding it for a long period of time and subdividing it, it’s going to be treated as a capital asset until you cross over to six deals in a year. Then when you hit six deals, 5% of that becomes ordinary income.
This is one of those weird things that I don’t even care about the 5% because honestly, the transaction costs, we’ll use those expenses to offset the ordinary income first, so I really don’t care. What I do care about is, are you a dealer? Because if you’re a dealer, then there’s no exception for you. I see this all the time. People say, I flipped land, but I’m in this exception. I’m like, well, the exception has a bunch of rules. You violated this one, this one, and this one. I didn’t know there were rules? And they’re hard.
We put it in a corporation instead so you do not become a dealer. The reason we do that is because it’s an active ordinary income. We don’t want you to get hit with the self-employment tax, so we use the S Corp. You take a small salary, you can defer it all into a 401(k). The rest of it comes out to you as not subject to self-employment tax, Social Security, old age, disability, survivors, whatever you want to call it, FICA. It’s all the same thing. It’s that extra 15.3% tax.
“Why would you use a C Corp instead?” You might if I didn’t want the income to flow on to me. If I didn’t need the money and I was in a high enough tax bracket I might say, hey, I’ll just leave it in the C Corp. Let it pay tax at 21%.
Jeff: That’s what I wasn’t sure about because if the S Corp did have dealer status, that does not flow through to the shareholders, correct? If the S corporation is considered a dealer, that does not necessarily hit the shareholder.
Toby: It wouldn’t contaminate you as a dealer, but the income would still be ordinary income.
Jeff: The other question I had was the engineering studies, does that cause any issues here?
Toby: Subdividing without more is not, then they used a few examples. I believe you could even put in roads. 1237 is the section. Somebody was kind enough to pull it up. Thanks, Joseph. It basically gives you some things that you could do. If I put it up here, I could look. Let’s see. I’d have to go read it.
Subdividing without more is not going to raise the level of substantial improvement. If you put in sewer and things like that, yeah, you’re probably going to be ordinary income no matter what. But there’s always a workaround, guys. This is the thing. Even the flippers in the world—a lot of times, you’ll see somebody doing a big development and they want to lock in their gain for capital gains before they do the development.
Maybe they held some property for quite a few years and they want to do a big development on it. Sell it. Lock in your capital gains, do an installment sale, then do the improvement and lock it into a corporation. If you do the corporation and you say like, hey, now I’m regretting that I did this, I’d rather keep it long-term, you’d do the opposite. You develop it in the corporation and then sell it at fair market value over a long period of time to somebody else.
Technically, you can’t do an installment sale, you’re going to have to recognize all that income. But you’re recognizing it through the corporation to be able to give us some options to shelter some of that income from hitting you. It’s always going to be a waiting test, whether it’s going to be the S Corp or the C Corp. I think that for the most part, we’re saying don’t do any harm. Use the S because it’s going to flow down to you regardless, but sometimes I’m going to use the C. It all depends on your scenario. There’s no one-size-fits-all on that one.
It’s a conversation that you have with the accountant saying, hey, you need the money? If you don’t need the money, are you in a high tax bracket? Is that going to stay or is that going to go away? Hey, maybe we’ll let it be in a C Corp because we know we have a bunch of expenses. Maybe you’re doing a reimbursement for medical, dental, vision, whatever, and you say, hey, you know, we’re going to eat that away over the years. We have a one-time tax hit at the corporate level, but we know we’re going to offset that at some point. Look at that, it’s 4:00 PM.
“I plan to donate my paid timeshare, and does that relieve me of my maintenance fee yearly? Due to COVID I have not used my week and I called the company and refused to give me credit for the time, and I paid the yearly fee as well. How can I legally make them accountable for this?”
Jeff: Timeshares.
Toby: Jeff loves timeshares. He’s visualizing being on the beach, wherever it might be.
Jeff: There are two types of timeshares. There’s the right-to-use timeshare, and there’s the for-deed timeshare. When you donate a for-deed timeshare, meaning you actually have a title to that timeshare that has value (possibly). You’re actually contributing the title to your nonprofit. The problem with that is, yeah, you could have a charitable contribution. However, many of these timeshares are trying to be sold for $1, and they still can’t get rid of them.
Toby: It’s because they come with the liability.
Jeff: Exactly. Some of the right-to-use timeshares, in my opinion, you don’t own anything. The IRS shares its opinion, which is why you can’t deduct mortgage interest on a timeshare. You don’t own the property. Some nonprofits will take these. Some will take the others. They’re either going to use them personally, use them within the entity, or they’re going to try to sell them off to a third party.
Before you ever do the donation and it sounds like you already have—you need to make sure you know who is taking over who, now has responsibility for this.
Toby: There are charities that will take them. Whenever somebody gives an asset, what are the requirements? Let’s just say that it’s a timeshare that is worth $10,000. What are the requirements to take that deduction? Are there any adjusted gross income limits that we have to be worried about?
Jeff: The first test would be, what is the fair market value?
Toby: You have to get an appraisal of the timeshare. They’re going to look at the value of it minus any liabilities that come along with it. If there’s debt, for example, or if there’s a liability like these continued fees, it’s going to adjust the fair market value.
Jeff: For me, the biggest value behind donating a timeshare is to get out of that maintenance fee liability.
Toby: It’s going to become the liability of the organization that takes it over. Charities will take these. Charities will bid them out and use them. People will go to the silent auctions and get the one week and such and such. That’s how they’re going to use it. They’re going to use them to generate income.
They’re going to hope that there’s a big enough chunk of money that’s coming in. Let’s say Jeff goes in and there’s a week in Barbados. Jeff goes nuts because he wants to do good for all the little kids in the little league or whatever it is that’s the charity. Maybe it’s the American Red Cross, maybe it’s Haitian relief because we had these horrible earthquakes, whatever the case. Jeff says I’ll pay $2500 for that. That’s actually a pretty good price.
But let’s say that the fair market value for that week is $2000. Jeff isn’t going to get a deduction for $2500. He’s going to get a deduction for $2500 minus the actual fair market value of what he received. He got something in return. If Jeff bid $5000 and the value of that week was $2000, the charity would get $5000, Jeff would get a $5000 minus $2000 deduction against his adjusted gross income on a Schedule A.
If I give the charity a timeshare, it’s going to be the fair market value of that timeshare, calculating any of the liabilities that come along with it. Hopefully it’s a very good positive number, and then I’m going to deduct that against my adjusted gross income, depending on how long I owned it. Whether it went up and down in value is going to dictate whether it’s going to be an appreciated asset and subject to the 30% rule or whether it’s going to be the 60% rule.
Jeff: If you look into this, just do a Google search, there are lots of people scamming saying they’ll take your timeshare for donation, so you need to be really careful. In this case, it says, how can I legally make them accountable for this? Can you pull that donation back if they haven’t taken over it?
Toby: When you deed it over, they assume responsibility. Most charities, they’re going to do the paperwork. You’re going to basically run it through basically an escrow, or they’re going to sign off and say, it is now my property, which means they assume the liabilities that go along with that property.
You don’t just deed it and say, here you go. You actually have them and work with their donation department saying, hey, we have to execute this as a transfer. You go to a title company and you make sure it’s done the correct way. If it’s a non-titled timeshare, I think you’re going to have a lot of trouble getting any value out of it, honestly. That may not even be worth dinking around with. But again, most major charities will accept these. The question is, will they accept yours based on the facts?
They may say, there’s no way in heck I’m ever going to take this particular timeshare because it’s more trouble than it’s worth and it’s more expensive. In which case, they’ll just tell you, no, we don’t want it. I’ve done this. You go down to the local thrift store or whatnot and you show them TVs. I didn’t know they didn’t want TVs. We had a whole bunch of TVs. I go down with TVs and they’re like, we don’t take TVs. They’re really nice TVs, you don’t want a bunch of TVs? We don’t take TVs. Sometimes they do that, and you’re going to be annoyed. You go someplace where they do.
YouTube. Hey, guys. You can always check out a whole bunch of good content on YouTube. My partner, Clint, has a great real estate channel. We have a whole bunch of stuff on ours on aba.link/youtube. If you like this sort of thing, chances are, we did a video on it at some point.
This is so much fun. I’m watching some of the questions going back with Elliot, then I liked an A. She’s asking someone. I’m trying not to be obtuse. I love that. That’s one of my favorite words.
“If previous multifamily owner took accelerated depreciation on 15-year items,” so the owner of the property before you accelerated their depreciation. Instead of waiting 39 years or 27½ years, they wrote it all off in 1 year. “How would I know and would that impact purchase price?”
Jeff: The only way I know to say this is, you don’t care.
Toby: That’s a good one.
Jeff: What the previous owner did doesn’t impact you in any way, shape, or form. Once you purchase that property, everything starts over.
Toby: You know I’m looking at their balance sheet. If they owned it for 5 years and they have a huge chunk of depreciation, what happened here? Did you retire something, did your roof go bad? What’s going on here? We accelerated a bunch of the components. You don’t care.
Jeff: If they did a cost segregation last year, the year before they sold it, and wrote off a whole bunch of stuff, you could do the same thing in the year that you purchased it.
Toby: It doesn’t matter to you. It does impact them because if they sell it within the useful life, they’re going to have ordinary income. If I depreciated a 15-year item and I’ve only owned it for 5 years, I’m going to have to recognize 10 years of the 15 back as ordinary income. They’re going to have a little bit of a tax hit.
Jeff: The only way I see it really affecting them is they may want a higher price because they have taxes to pay.
Toby: Yeah. What you’re going to say is, do a 1031 exchange, knucklehead. You say it just like that.
All right. “How does the IRS track capital gains on sales under 2 years from acquisition if 5 million homes sell per year in America?”
Jeff: Have you seen those helicopters flying over your house?
Toby: We’re just seeing if you’ve sold it. Has he sold it yet? No, he hasn’t sold it.
Jeff: IRS is the data tracking entity of all time, maybe the KGB. There’s a couple of ways they track it. One way is—not always but often—when you sell a house, they issue a form 1099-S, which goes to the IRS.
Toby: Unless you said, hey, I’m exempt from paying any taxes on it because I’ve owned it for two years out of the last five and I qualify for a 121 exclusion. Otherwise, you’re required to report all of your income. That’s going on—what’s the form? What’s the capital gains form for the sale of real estate?
Jeff: Form 8949.
Toby: Form 8949, that’s exactly what I’m thinking. You’re going to have to report it. Otherwise, you’re saying, hey, it’s not taxable because it’s exempt.
Jeff: In California, you have a different problem because the FTB gets notice of every single real estate sale in the state.
Toby: And they’re going to look at your return.
Jeff: And they require withholding.
Toby: Not very nice. You’ll get it back if you’re exempt, but they’re going to take the money. There’s a reporting requirement on all real estate unless you meet one of the exclusions, one of the exemptions. For example, if they don’t know you’re a US citizen, then there’s going to be a 28% withholding.
A lot of people don’t realize this, when you’re signing all those documents, that’s a lot of times your title is doing. All right, Jeff, where do you live? US citizen? All right. You’re signing off here. On the proceeds, this was a primary residence and you’re claiming a 121. They’re getting themselves off the hook so they don’t have a reporting requirement. Otherwise, they’re going to report you.
If they report you, then you just recognize it then say, it’s a 121 exclusion on your return. It used to be really easy. You’d say, here’s the amount that I made, what portion is taxable? How do you use it now since they changed the return? I haven’t looked at it.
Jeff: Use it in the same way. You just put the exclusion on there.
Toby: That’s all you’re doing? You’re saying what’s the exclusion? The exclusion is gain only. Again, if you use it as a home office and you weren’t using our strategy of reimbursement, you’re going to have a little bit of an issue on the depreciation, and you’re going to have to do the residential use, non-residential use. You’re going to have to play which portion of that.
Todd, the exclusion is, if you’re a US citizen, it’s your home, and you lived in it two of the last five years, you did not do a 1031 exchange on that same property within 5 years, you have not done another 121 exclusion in the last 24 months. Then you have a $250,000 exclusion as a single person, or a $500,000 exclusion if you’re married. So long as you both meet the ownership and use tests. I wish I could make it easier than that. Most people just say, hey, you don’t have to pay tax on $500,000 if you’re married. It’s not quite that easy.
Jeff: We talk a lot about how hard the IRS is on us. A lot of it is tax filings based on an honor code.
Toby: It’s a self-reporting system.
Jeff: It’s a self-reporting system. There are some ways that they can track and see if you actually reported what other people claimed you earned.
Toby: No. People say, hey, do I have to report on my income? No, you just might go to jail if you don’t. You have a choice. They’re not putting a gun to your head. Technically, they’re just threatening you with jail time if you evade taxes. If you avoid taxes, you’re fine. If you just love orange jumpsuits, by all means, don’t report it.
Jeff: In a case like this, if they were to audit you, and it doesn’t happen that often, they will probably ask for your past 2 years’ returns before this return just to see if you took the 121 exclusion. Actually, they have those returns.
Toby: They look at them. “If the property is around all those, the two-year comes into play, or is that only for your personal property?” It depends. It can come into play, because the two out of five years is, did I own it and use it as my primary residence two of the last five years? Think about this. I could live in a house for two years, I could rent it for two years, and then sell it, and I’m still underneath that statute. I don’t have to pay any tax on the gain, so capital gain. That does not mean recapture.
Depreciation recapture is something else. I would have to pay the recapture on my depreciation that I could have taken or that I did take. They don’t even care whether you did it. Or you could just do a 1031 exchange because two years, renting it out for more than 14 days, you’re in a safe harbor. That is an investment property, you can 1031 exchange.
Jeff: I believe depreciation recapture goes away with a 1031.
Toby: 1031 exchange rolls it into a new one. If you accelerated the recapture, you just have to keep the same accounting methodology on the new one. What states besides PA do not recognize 1031? Just to be on the safe side I’m not aware of any others. I think that federally, PA doesn’t get to do anything on 1031. They still recognize 1031. They just don’t have a necessarily corresponding state statute.
We have accelerated depreciation, federally. California may say, no, I don’t accept that. You still get to take it on your federal return no matter what.
Anyway, that’s it. Come to our Tax and Asset Protection Workshop live coming up in a couple of weeks, August 28th. That is about 2 weeks, something like that. It’s Clint and myself. We always have a fun time on a Saturday. Come on in. It’s free. If you can’t make it, we still send you the recording, 9 times out of 10.
If you like the podcast, come on in and visit us. I miss you, Sherry. I can’t wait until you’re able to come back out to Vegas. Get on the bikes and ride. Every now and again, clients do come out here and we do ride around on motorcycles even though Vegas is the motorcycle-get-run-over capital of the world. I’m pretty convinced because we have some of the crappiest drivers out there. But we’ll go out to Lake Mead, we’ll go out to Valley of Fire, we’ll goof off.
Podcast, by all means, go and check us out. You can see a bunch of stuff. There’s going to be some really cool podcasts coming your way here pretty quick. I’m doing a really cool conversation with Tom Ferry tomorrow morning, if you know who that is. Not Tom, it’s his son. We’re going to be going over a whole bunch of fun stuff in that.
What else are we going to do? Replays. You can go into the Platinum. We’re going to have some fun there. You can always go into the Platinum Portal. If you’re a Platinum, you can see all of the Tax Tuesdays. If you have questions, go to taxtuesday@andersonadvisors.com. Just email us or just visit Anderson Advisors. Do you have anything else?
Jeff: I do not.
Toby: We’re 20 minutes over. I’m looking at it right now. It’s not horrible. Again, we’re going to have some fun. If you do want to, tomorrow morning, Tom Ferry, we’re going to do a Q&A. It’s always fun to get really, really smart people on. If you haven’t seen that, by all means, just reach out, go on to our website. It’s completely free (again).
If you don’t know who he is, he’s a real estate coach. He works with some of the best top realtors in the country. He’s just fun to talk to because he’s really, really, really, really bright. I got a bunch of questions to ask and that we’re going to go over. You can always join us tomorrow morning. Otherwise, by all means, come on and join us at the Tax and AP event, if you haven’t been.
For those of you who have been, you know what it’s all about. We love to go into LLCs, corporations, trusts, how to use 401(k), living trusts. We try to hit a lot and we go over some of the tax aspects, and how they work together. How to make yourself disappear on a public record so people can’t just go out there and target you. It’s a whole bunch of fun. We’ll see you when we see you.
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, a great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets.
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