Oh, you did what? I can’t believe you did that! Call me next time. Accountants and attorneys could have saved you money. You, too, can annoy and laugh at others at family and social gatherings and parties.
In this episode of Tax Tuesday, Toby Mathis and Jeff Webb of Anderson Advisors discuss how to write off rental property expenses, as well as answer additional tax-related questions. Submit your tax question to taxtuesday@andersonadvisors.
Highlights/Topics:
- Can losses from real estate syndications be taken against active income if you or your spouse are real estate professionals, or is there more criteria? Real estate syndications are treated pretty much the same way that any other type of real estate property would be that’s for rent. If you do a cost segregation, you have accelerated depreciation. You can deduct stuff as a real estate professional that you may not be able to deduct as just somebody investing in real estate.
- Can I owner finance or lease purchase a property that currently has a mortgage on my personal name and the deed is titled on my LLC? Yes, you could do this as a Subject 2. They’re not taking over the mortgage, they’re buying it subject to the existing mortgage.
- Trying to buy a short-term rental. If I sign for the loan personally and title the property in an LLC, would that be considered co-mingling personal assets with LLC to break the corporate veil? No, that doesn’t really break the corporate veil, but you should keep the transactions as separate as possible. If you’re just buying the property and then transferring it to the LLC, that’s not a big deal.
- Can I start filing taxes for LLCs I created for two of my rental homes, even though the real property deeds have not yet been transferred/filed/recorded to said LLCs? It depends on how the LLC is being taxed. If they’re disregarded to you personally, report them on your 1040. If it’s going through an entity, they’re not titled to that entity, that’s more problematic. You still have to file the taxes.
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Resources:
The Build Back Better Framework
Uniform Gifts to Minors Act (UGMA)
Full Episode Transcript:
Toby: Welcome to Tax Tuesday, guys. As the room fills up, my name is Toby Mathis.
Jeff: I’m Jeff Webb.
Toby: You are listening and watching Tax Tuesday where we bring tax knowledge to the masses. Let’s get a little list of where everybody is from since it takes a little while for everybody to get into the room because there’s a lot of you out there. Give me a city and state.
Tacoma Washington, we have an office right there. Indiana, Newton Missouri, Tucson, Arizona, Georgetown Texas, that’s right outside of Austin. There’s California, […], Maryland, Houston, Oklahoma City, Las Vegas, Riverton, Wyoming. Hey, Victor, welcome. Eagle Mountain, that sounds so pretty. El Paso, Texas, Allentown […]. The Woodlands just to the north of Houston. I know that area.
Kailua, Hawaii, nice. Treasure Island, Florida. Mooresville, North Carolina. We got Charleston, South Carolina, beautiful. Randallstown, Maryland, Baton Rouge, Louisiana, Larkspur, Colorado. We got a lot of folks on.
We’re just going to dive right on, and from all over the country is what we like to see. Central Texas, here. There’s Jerry. Hey, Jerry. Nice to see your name. Your name keeps popping up. You’re doing awesome. We got Tampa in the house, Conway, Arkansas. We got Florida. That’s a big state. We got more from Houston. […], is that right? Alaska. I’ve never heard of […]. Do you know […]?
Jeff: I do not.
Toby: That’s Houston, so […] Houston. San Jose, California. We’ve been drinking a lot of coffee. Let’s dive in. We got a lot to go over because somebody picked a lot of questions to go over today.
Jeff: Sorry.
Toby: You didn’t pick any.
Jeff: I know, I didn’t.
Toby: You’re so lucky. There are hundreds of these questions coming in every week and our guys are just doing a great job getting at them. There’s Manasota Key, Florida. I love the Keys. Anything that says Keys down there, you can go on either side of the state too. It’s gorgeous.
Ask live questions via the Q&A feature, there’s a question and answer. By the way, let’s see who do we got. We got Ander, I know we have Patti, we have Matthew that is doing all the tech stuff and making sure you guys get your questions answered. We also have Attorney Eliot Thomas. I know that we have a bunch of accountants including Dana Cummings, Christos Zattas. Dutch is on. There’s Troy, Piao. You guys have some high horsepower on. A bunch of CPAs, accountants, and attorneys are here to answer your questions when you put the questions in the question and answer.
If you have a long question that is pertaining to your situation, put it in the question and answer. If you have a comment, put it in the chat. A comment could be Jeff looks good today. You do look good today. You got a nice shirt on. It’s like the calm before the storm. This is Jeff before tax season. After tax season, after April 15th—the first tax season because tax season for us is all year round—we’re going to have another picture of you.
Jeff: We should do a hair count and see who comes closest in the right number of hair left.
Toby: See, Shelly thinks you look good today. That’s how you use the chat. If you have any questions, email them via taxtuesday@adersonadvisors. Somebody says you do look good. We are going to have to count. I’m starting to lose my hair. I got to get away from the tax folks. It’s contagious here.
If you need a detailed response, if it’s something serious about a specific tax situation to you, at some point you may have to become a client because we don’t want to answer and get liability for nothing. We’ll make sure that we get back to you no matter what. This is supposed to be fun. Taxes can be fun, they’re annoying as heck, but it’s a treasure trove if you start to enjoy it and look at it. This is fast, fun, and educational. We’ve been doing this for years. We’ve been teaching classes for 25 years. Jeff, how long have you been a CPA again?
Jeff: 32 years.
Toby: For 32 years, Jeff has been annoying others at family gatherings about telling them, oh, you did what? Isn’t that your favorite thing to do?
Jeff: I could have saved you money.
Toby: I can’t believe you did that. Call me the next day. That’s half the fun is just giving somebody that look oh my God, what?
All right. These are all the questions today, guys. We’re just going to read through them and then we’re going to go through them one by one. “Can losses from real estate syndications,” for example, they said accelerated depreciation, which if you don’t know about that and you’re a real estate investor, you need to know about that we’ll talk about a little bit, “be taken against active income i.e. W-2 if you and your spouse are REPS?” Which stands for real estate professional status, “Or are there more criteria to pass?” We’ll go over that.
“Can I owner finance or lease purchase a property that currently has a mortgage on my personal name and the deed is titled in my LLC?” I don’t touch these questions up, guys. Every now and again, there’s a little grammar that makes me go, hmm, but basically, if it’s a mortgage in your name titled in an LLC, can you owner finance or lease purchase? We’ll get into that.
“I have a nonprofit that provides affordable housing,” thank you very much for doing that, it’s sorely needed. “Can the nonprofit invest in other avenues like private money lending, real estate funds, real estate notes? Can it also partner joint ventures with others in the acquisition of property? Can my nonprofit profit partner with my LLC?” Great questions. We’ll give you the answers. That’s actually going to open up a whole can of worms, which is fun to go into.
“Trying to buy a short-term rental. If I signed for the loan personally and title the property in an LLC, would that be considered as mingling personal assets with LLC to break the corporate veil?” Good question, we’ll answer it.
“I received PSU and PSU stock from the company I work for,” PSU stands for performance stock units, you’re getting paid with stock. “What are the advantages to net shares over funds at distribution? With net shares, I do not have cash taken from my account to cover the taxes. I only receive the number of shares after the equivalent shares have been sold to cover taxes. With funds at distribution, I receive all of my shares vested but have cash withdrawn to pay taxes due. All insights are welcome.” Good question. I don’t think we’ve ever had a question like that so it’s a good one.
“Drivers for Grubhub, DoorDash, et cetera. Can you document your starting and end your mileage from a central area as you’re required at the start of a shift to be in an assigned area? If this is not correct, how do you document or start your mileage at first food pickup to the last how you deliver to?” Really good question and I think a lot of you guys are probably doing that gig work because it’s printing money.
“Can I start filing taxes for LLCs I created for two of my rental homes, even though the real property deeds have not yet been transferred, recorded, filed to said LLCs?” Good question. Jeff loves these types of questions.
“I’m starting out in real estate, I saw you on Gogo’s weekly meeting,” Gogo’s is a client of mine, she’s really cool, really successful realtor, “and I’m wondering if in my first year with very little in sales, should I register as an LLC taxed as an S-Corp or file as I normally would?” That one’s for all you realtors out there, you’re going to want to keep your ears open because this affects you and there are some really good rules there.
“In the part of Texas where I live, there are mother and daughter houses. If I purchased one as a primary residence and rent the side apartment, what are my options for tax savings? Am I able to write off expenses for that portion of the house, mortgage, taxes, utilities, et cetera? Am I able to depreciate that portion of the house?”
“What is the best way to handle money that was gifted to children one and three years old? What to do with it so it doesn’t affect them now but they could access it at 16 or 18 without penalties or fees?” Good questions. We have a few more because somebody went nuts—that’s actually me. I couldn’t help it. There were a whole bunch of good questions. Let’s answer this one too. We can sneak some in, these are easy.
“Can I sell my apartment building on an installment plan to avoid the large amount of taxes owed when I sell? Can I do a double escrow to accomplish this because I have a small loan on the property?” Good question.
“Should my personal bank accounts and life insurance policy be owned by the same trust?” Good question. A lot of you guys need to be poking your ears up for this.
Then last but not least, “Are charitable contributions made from our partnership considered tax-deductible?” Really good questions today. A lot of different variations, so we have to dive in.
Before we dive in, if you want to see replays of the Tax Tuesdays, we break them down and put them on our YouTube channel. If you want to see a gazillion questions that have been answered, I don’t even know what Tax Tuesday we’re on. We passed a hundred a long time ago, so I have no idea where we’re at. It’s a lot.
If you like looking at old Tax Tuesdays and look for questions, also you can go back in time and see how we did. Let’s see because we’ve made predictions in the past. We’re actually pretty good. You can go to our YouTube channel, by all means, subscribe, please. I like the subscriptions because then we know. All we do is we put the little bell link and it’ll let you know when something’s up, when something’s put on YouTube.
The best part is that whenever there’s a tax law change or whenever there’s something pending, we always throw stuff up there. Make sure you’re not doing anything crazy. Last year, with the Build Back Better, a whole bunch of people did a lot of crazy stuff because some adviser somewhere talked him into it because the laws were going to change. It’s kind of like falling for that a few times. Don’t do that. You sit on your hands. The best thing you can do as an investor is to take your hands and stick them underneath your butt cheeks. You just wait for things to happen. Try not to overthink it.
All right, let’s jump in. To under thinkers right here, we do not overthink anything. We underthink it all.
Jeff: Do you ever get a 10-page question and the answer is, eh, maybe.
Toby: It depends. That’s what a legal education is. We spend all that money just so you could figure it out that we could monetize it depends. “Can losses from real estate syndications, i.e. accelerated depreciation, be taken against active income?” It’s actually active ordinary income, “If you and your spouse are real estate professionals or are there more criteria to pass?” Jeffrey, what do you think?
Jeff: Real estate syndications are treated pretty much the same way that any other type of real estate property would be for rent. The nice thing about real estate professionals is I can own the property and my wife can be the real estate professional, but if we’re filing jointly, our tax returns, we’re both real estate professionals as far as—.
Toby: Why does anybody care about real estate professionals?
Jeff: Real Estate Professional is that oddity that we no longer deal with passive income, it’s all nonpassive income. In this case, they did the cost segregation, you have accelerated depreciation. That stuff you can go ahead and deduct as a real estate professional that you may not be able to deduct as just somebody investing in real estate.
Toby: Let’s say that I work for an employer, myself and my spouse, and we make $150,000 a year. Then I have a real estate investment and let’s say that I put in $25,000 into a syndication. A real estate syndication is a fancy way of saying a group of investors buying and taking down an apartment complex. A lot of times, we can accelerate the depreciation. A lot of people think, oh, I have to write off residential units for 27.5 years, nonresidential units for 39 years, and they’re stuck in that mindset. Actually, that’s not an appropriate methodology to use. It’s an allowable methodology and it’s the default.
Realistically, when you buy real estate, what you should be doing is having an engineer go through there and say here’s the portion that is 5-year property, here’s the portion that 7-year property, here’s the portion that’s 15-year property, and here’s the structural property that’s 27 or 39 years. You end up writing it off much faster.
Under the Tax Cuts and Jobs Act, they made that even tastier. That portion, which is usually about 30% of the improvement value, you could write off in one year if you want, or you could just pick and choose which one of those items. I want to write off the five-year property in one year. Do I want to write off the seven-year property in one year? How about the 15-year property in one year? I could do all that and I can accelerate the depreciation.
What Jeff said is absolutely the case. Your passive losses cannot be used against your ordinary active income or your capital gains for that matter. They’re only used against passive income. If you have passive losses, you carry them forward. Sometimes, you’ll look at your tax return and we get this all the time. You’ll have a taxpayer that says, I have these carry forward losses. I never lost money and you’re like, well, it’s the losses that kicked down off your real estate, the excess depreciation. There is a way to write it off.
There are actually two ways to ride off that excess depreciation. One is if you’re an active participant in real estate and you make less than $150,000 a year, you can get up to $25,000 a year as a deduction. It phases out between $100,000 and 150,000. Let’s say you make $100,000, you have real estate loss, and it’s $20,000, great. I’m going to take a $20,000 loss against my return. Yay, I’m saving taxes. Even though I didn’t really lose $20,000, I’m depreciating.
Now there is recapture of that, that you have to always be cognizant of. In a syndication, it’ll give you a big loss, but you may be recognizing that as recapture, and recaptures are capped at $25,000. If it’s ordinary, it’s on the 27.5- or the 39-year property, or it could be the fair market value of that property as ordinary income if you’re accelerating it or its leftover useful life, they’re going to look at that.
In this particular case, like Jeff said, I’m sorry to be long-winded because it’s a complicated subject, but it’s worth it to know this stuff. Jeff said, one spouse is the real estate professional. The whole return qualifies. I’m not going to dive into real estate professionals, but one spouse has to hit the hour requirement and the percentage of time that they spend on personal service requirements. Both spouses have to beat this thing called material participation.
Here we have this syndication that’s passing things down, and it really boils down to whether that syndication, whether you’re a general partner in it, whether you’re a manager in it, whether it’s an LLC, whether it’s a limited partnership. All of those things have slightly different rules. It all comes down to, are you materially participating in that activity?
We can group all of your real estate activities as one activity. That means that when that loss gets passed down off of one property, I can apply it against all of the others and then my other income if I qualify as a real estate professional. Otherwise, I would have to meet the material participation on each property, and with a syndication, I’d have to be a manager. Otherwise, I’d never do it.
Jeff: Yeah, as a limited partner, you’re never going to qualify unless you’re a real estate professional.
Toby: Exactly. And if you are a limited partner, you can’t meet the requirement unless you are a manager or unless you are exceeding 500 hours—spouse’s combined—of material participation on all your real estate activities. I was just goofing around on BiggerPockets, a really good site. They goofed this up so badly.
Every time somebody asks a question, you have five or six accountants and a bunch of laymen going into there and they always ask things like, can I write this off? The answer is always going to be it depends on your facts and circumstances, and they’re all over the place. It’s enough to make you lose your mind.
It really boils down to if you’re a limited partner, you better have 500 hours of material participation when adding up both spouses and you group all your real estate activities, which has consequences. If you group your real estate activities, you got to make sure you don’t have a whole bunch of loss carryforward, so you’re going to be a little bit ticked off that you’re waiting to be able to take them until you dispose of all your properties or substantially all your properties. Long-winded answer.
Can it be taken? Yes. It’s easier if you’re an LLC. It’s easier if you’re a manager. If you’re not and it’s a limited partner and you’re not a manager, you’re looking at 500 hours on all your other real estate activities to be safe.
Jeff: Is it fair to say that if I just wanted to invest in five syndications as a limited partner, it would be very difficult to qualify as a real estate professional?
Toby: If that’s all you did, it would be almost impossible. You’d have to qualify on your other properties and group them all. If they group them all, then it’s possible. I think you’re asking for it, and by the way, the portion that I’m telling you is not in the code, it’s in the regs, which is still the law. If you’re a limited partner, you are passive period with a couple of little exceptions.
There are two exceptions. You’re manager, or you’re doing 500 hours and I believe that there’s a 10% gross rental income that is also a limitation. If it exceeds more than 10% of all your gross rents from all of your real estate, then you’re also going to have an exclusion. You just got to be prepared for that. It’s an annoying, long answer to what looks like a very simple question. The real answer is you should talk to an accountant and let’s get your facts so we can give you the accurate answer.
Jeff: It’s 4:00 PM, good meeting you.
Toby: Sorry about that. One question, never know whether it’s going to take all day. “Can I owner finance or lease purchase a property that currently has a mortgage on it in my personal name and the deed is titled in my LLC?” Jeff, what say you?
Jeff: You could do this as a Subject 2, that is they take over the mortgage.
Toby: They’re not even taking over the mortgage on a Sub 2. They’re buying it subject to the existing market.
Jeff: Exactly. I often say those wrong.
Toby: They used to have assumable mortgages, they don’t anymore. Back in the day when Jeff was…
Jeff: There’s a little risk with that, that you have to be prepared to jump in and pay the mortgage if your buyer stops making those payments because it’s still in your name. What do you do with the title in these cases?
Toby: Doesn’t matter. You have a mortgage that’s secured. The property is secured by this deed. Usually, it’s the deed of trust or the mortgage, that’s what the lender cares about. They don’t care who’s paying for it, but if I loan Jeff money on a property, he puts it in an LLC, it doesn’t matter to me at all. Sometimes a lender, if you tell them, you say, hey, this is what I’m going to do, they’ll squawk. If you just do it, they always say, as long as nobody’s paying for it.
I purchased properties this way, by the way. When Vegas was losing its mind in 2008 and everybody’s running for cover, there were some really good loans that were issued out of that time that were 2%. I was buying properties, anything that had these really low mortgages on it, or somebody did a modification.
They would do these ridiculously low modifications and I’ll be like, yeah, I’ll take it subject to that loan. We had a servicing company that you’d pay the servicing company, they’d make sure that it was allocated to the mortgage so that you weren’t giving it to the previous owner. You made sure it was going to cover that mortgage. Everybody’s happy. The answer is, yes, you can.
“I have a nonprofit that provides affordable housing. Can a nonprofit invest in other avenues like private money lending, real estate funds, real estate notes, et cetera? Can it also partner in joint ventures with others and acquisitions of property? Can my nonprofit partner with my LLC?”
Jeff: One thing I see with this is a lot of these investments are going to be subject to unrelated business income tax.
Toby: Potentially.
Jeff: Potentially.
Toby: If you’re doing private money lending, do you think loaning to one loan…?
Jeff: I don’t think one loan would be. I think it’s if you try to put the nonprofit into the business of lending.
Toby: You want to make sure the nonprofit’s doing its activities, and that the monies and the profits are going towards its charitable activity. In this case, providing affordable housing, and there are bright-line rules, by the way. If more than 70% of the rents are from low- to moderate-income housing like Section 8 qualifies, that’s a 501(c)(3), that’s a public charity.
If that’s the case, then you could be doing a lot of other activities as long as they’re not activities in which you materially participate. Private money lending, you can probably get away loaning some money out there with you. If you open up a division, hey, we’re moneylenders and we’re doing hard money lending, expect it to be UBIT just taxed at 21%. How about the real estate fund? Let’s say they go into a real estate fund. Are you worried about that?
Jeff: I’m not as familiar with the real estate funds.
Toby: Private placement, syndication?
Jeff: No, I think that’s okay. I’m sure that’s okay.
Toby: Real estate notes, I start buying a note so I’m going to get interest.
Jeff: Yeah, that’s all investment income.
Toby: As long as it’s investment income and you’re using it for your charitable purpose, who cares? You’re good.
Jeff: What about the Nonprofit JV with your own LLC?
Toby: Here’s the deal. If you joint venture in property, then we still have to look at the 70% rule and what you’re generating your income from. If it’s low- to moderate-income housing property, you can JV to your heart’s content. If you’re flipping, you’re going to start running up against UBIT again.
If we’re just acquiring properties and let’s say we’re JV-ing to buy an apartment complex and most of that income that it’s generating is low- to moderate-income housing, you’re good. You just look at the HUD levels, by the way, for that area to say whether or not it’s underneath that threshold. It could be $107,000 for a family in San Francisco, but it could be $60,000 in another city in middle America.
“Can my nonprofit partner with my LLC?” I’ll say this, it depends. If you’re a public charity, you do a conflict waiver, and it’s reasonable, it can partner with your LLC. If it’s a private foundation, no period, full stop. I know somebody always says, it always depends. It does, Sherry. It just depends on what kind of nonprofit it is.
Nonprofit, there are 29 flavors. It could be a business association. That would be different than if it’s a 501(c)(3) that’s a charitable organization, which is different than if it’s the Jeff Webb Memorial Foundation. Memorial, if it’s a private foundation, you cannot do business with it. You can’t sell a million-dollar building for a dollar. That’s the IRS’s example. You can do zero business with it. You can get compensated, but you can’t do outside business. Anything else on that one?
Jeff: Nope.
Toby: See now we’re going fast. “Trying to buy a short term rental,” which by the way, is huge right now. In Vegas, it is ridiculous. They’re so limited in the amount of Airbnb, it’s something like $9000 a month on average or some ridiculous number. Somebody says, “Jeff, be nice.” See, they’re being mean to me again. They’re saying I’m going down rabbit holes again. I do like rabbit holes.
“Trying to buy short term rental. If I sign for the loan personally and title the property in an LLC, would that be considered as mingling,” it’s actually commingling, “personal assets with an LLC to break the corporate veil?”
Jeff: No, that doesn’t really break the corporate veil. You should keep the transactions as separate as possible, but if you’re just buying the property and then transferring it to the LLC, that’s not a big deal. It’s when you start collecting rents and stuff like that, you want to come into the real estate’s bank account, not your own personal bank account.
It’s really tough to screw up the corporate veil in some states. You have to just show disregard for it. The old adage, I clerked for Judge Hall at the King County. Great judge, by the way, and she used to say, I’ll give you the same respect as you show something. Expect the court to give you the same amount of respect that you show—something that stuck with me a long time.
I use the phrase that we’ll give your business the same amount of respect that you do. If you have a loan in your name, that doesn’t mean you disrespect the entity, it’s pretty commonplace. In fact, you’re probably required, especially if it’s just a single family home. You put it in the LLC, great. As long as that LLC you’re treating with respect, the court will.
How do you disrespect an LLC? You go in there and you buy your groceries out of the LLC bank account. Not having a bank account does not kill it, by the way, it’s just a factor. Let’s just say that you just take all the money personally and there’s no separation, you’re not keeping books on it, the courts are likely to say that you’re pretty disrespectful to that entity. We’re going to treat it with disrespect.
Not all states do that. In Nevada, you have to pretty much commit fraud with it and do illegal activities with it to really get pierced. It’s going to be very seldom and you have, quite often, sometimes a year, a year and a half to fix it. You can always go back in and create the paper trail if you didn’t. Fix it and make it look nice. Don’t worry about it.
It is very common in real estate for you to buy a property then transfer it in the LLC after. In fact, it’s probably more than norm than people buying it in the LLC. You cannot get an LLC loan on just private, you just can’t. They’re going to underwrite it to you. They’re going to close in your name, and then sometimes that closing, the title company will transfer it into an LLC, but that loan’s almost always you.
When you do portfolio loans, it’s vice versa. They will not let you close in your name. They want it going straight into an LLC. Nine times out of 10, that LLC is going to be owned by another LLC that they’re using as the security, not even the properties. They want to be able to take your business away from you that owns all the properties, that owns the business. Own the other LLC that owns all the properties, if you can follow.
Hey, we’re mentioning Sub 2 today. I didn’t even think about that. We have a Sub 2 event coming up on Saturday. Two of the parties that we work with over on the Infinity side who do a ton of Sub 2. In fact, that’s where they’re most successful right now. They’re in Texas. All you Texans, you probably want to come in and listen.
We are going to be having an event on Saturday that is basically how to Sub 2 and how you can buy properties without coming out of pocket. If you like that type of information, by all means, it’s free Saturday, February 19th, 2022. It’s coming up next week. Actually, what is today, the 15th?
Jeff: Fifteenth.
Toby: It’s coming up in four days. Come join us. Really great folks working with the Alpine Group, and it’s going to be fun. It’ll be Kendra and I believe Jamie, and we’re going to go over this. Patti, correct me if I’m wrong. This is what they do, guys. This is how they make their living. We ask people when they do something a lot and they’re good at it if they want to come explain it to others. Otherwise, Sub 2 is one of those really unique areas. There are a few other clients that we have that do really, really well in that space and it’s going to be fun.
Somebody says, “Is the schedule 9:00 AM Pacific Standard Time?” Somebody sent out the wrong notice this morning. It’s 9:00 AM Pacific Standard Time. You can’t drag me up that early.
“I received PSU and PSU stock from a company I worked for. What are the advantages to net shares over net funds at distribution? With net shares, I do not have cash taken from my account to cover the taxes. I only receive the number of shares after the equivalent shares have been sold to cover taxes. With funds at distribution, I receive all of my shares vested but have cash withdrawn to pay taxes due. All insights are welcome.” What say you?
Jeff: Anytime you have PSUs, restricted stock units (RSUs), any types of options from your company, they usually involve paying for the withholding on these things. There are three ways to do it. The first one is you pay cash. That’s easy. Like I said, you get all your shares.
Toby: Let’s time out for a second. It’s just stock that you’re getting because you’re working. If somebody doesn’t know a PSU, it just means they’re paying you a stock, so you’ve done a really good job. It’s performance stock units or something like that.
Jeff: Yeah. I’m the Disney CEO. They can only pay me so much in cash, but they can give me all these stocks.
Toby: Stocks. Right. And it’s taxable to you. You’re being paid in stock. So let’s say that stock is worth $100 and I paid Jeff with stock, there are tax withholdings. So go back, sorry.
Jeff: That’s all right. There are a number of ways. There are three ways to pay for those stocks, the withholding on it. The first is paying in cash, then you get to keep all the units that they issue you. The second way is you can sell some of those units, some of those stocks, which is a taxable transaction, but not really because there’s probably no gain or loss on it. That pay is the tax. And the third way is net shares. It’s basically they’re withholding the stock. Not everybody does this, only certain companies do this.
Toby: I think that was actually what you were just going on. If I have 100 shares at $100 apiece, the company is going to give you 70 shares and withhold if it was 30%—
Jeff: That’s the net shares or you could actually sell the stock, get all the shares outright, and sell them through Fidelity, Charles Schwab, or whoever.
Toby: It really depends, but most companies want the shares. As a company, you could just pay the cash with the withholding and you could keep the shares. Let’s say Jeff’s getting 72 of the 100 shares and the rest was withholding. I could sell the 28 shares and come up with the cash that way, or I could just pay it as the company and keep the 28 shares. I could give the whole 100 shares to Jeff and then Jeff’s going to have to come up with cash. The company’s going to have to do withholding, it’s going to have to come up with cash.
Jeff: The real advantage between these net shares and funds at distribution is if I pay cash for that withholding and all, I’m not selling the stock, I’m not having the stock withheld is I get more stock, possibly at a discounted value. I also don’t have a taxable transaction just from trying to pay for my taxes. Isn’t that crazy, you pay taxes on taxes?
Toby: You’d pay tax, or if you sold it, your basis would be when invested.
Jeff: Right. I’m thinking more along the lines of where the grant price is actually much lower than the fair market value.
Toby: Wouldn’t that be taxable when you invest at the option price though?
Jeff: I think that’s true if you do the 83(b). That’s a special election, sorry.
Toby: You’re talking about making the election to tax it to me as opposed to […]. No, I could actually choose at the lower figure and then I’m paying too. We’d have to play with it. There are so many different options when you’re in these employee situations where somebody is paying you with the stock. At the end of the day, just know that when you receive something from an employer, chances are it’s taxable too. The big question for you then is do I want to come out of pocket and pay something? The answer, so let us talk about insight. If you think your company is going up, pay it with cash, pay the taxes with cash.
Jeff: Exactly what I was thinking.
Toby: If you think the company is going to be in kind of a doldrums, then use the money on something else. That’s a better option. Then I would say, hey, just give me the net shares and I’ll keep my cash. That’s the way I would look at it. Right now, inflation is melting everybody’s ice cube of cash. Somebody told me that once. They said, hey, just think of it as though your cash is frozen and it’s melting.
Right now, inflation is melting at about somewhere around 10% a year. They could say 7.8 or 7.5 all they want. We know a tire because we can actually see our bank accounts. It’s really expensive to put gas in your car. It’s really expensive to put food on your table. It’s probably double digits right now for inflation. Realistically, we don’t have a lot of cash. We invest it in something else—in stock and equity.
Equity is usually bolstered by inflation and growth, same thing with real estate. If you’re a growth stock and you don’t have a good underlying stock, then you’ll get beat down. Financial companies usually do well when the interest rates go up because they get to make more money.
All right. “Drivers for Grubhub, DoorDash, et cetera.” This is a good one. “Can you document your starting and end mileage from a central area as you’re required…” you’re supposed to be in a particular area when you work for, let’s say, a Grubhub, you’re going to your area, “as you’re required to start a shift to be in your assigned area?” Not at your house, not where maybe your home office is, so you have to be somewhere else. “If this is not correct, how do you document? You start your mileage at the first food pickup or the last house you deliver to?” What say you, Jeff?
Jeff: You may disagree with this, but I was more leaning towards you starting your day at your home.
Toby: That’s where I would go.
Jeff: I would have the Mileage IQ or whatever you’re using.
Toby: Get an app. It’s called Mile IQ and it’ll GPS you. You can swipe left or right if it’s personal or business.
Jeff: Not so much at Grubhub, but just the Ubers and all. I know those people are driving while they’re waiting on a pickup and all that mileage should be included, not just your miles while you’re driving.
Toby: What we know for sure is that during COVID, all the states and the Feds took the position that your car was not your place of business so that it couldn’t be shut down. Your home, wherever your office is, wherever you’re doing your administrative tasks, generally speaking, that’s at a home office, that’s where your day begins.
Jeff: Assuming that you’re working your entire time, I turn it on when I leave the house and turn it off when I get back home.
Toby: One hundred percent. Get those mileage, and what is it, 58¢ a mile right now?
Jeff: I believe so.
Toby: You get 58¢ a mile. Resist the temptation to buy cars in a business unless it’s being used, ridiculously more than 50% for business. You drop below it, then there could be some bad currencies, plus we don’t care. Most of the drivers I know—unless they’re driving a town car or something, they’re doing the higher end stuff, or they’re being a limo driver—are driving economical cars where your mileage is actually going to start putting money in your pocket. The cars, buy it for $7000–$10,000 or something, a decent older vehicle. You can get a lot of miles out of that. Your 58¢ a mile is better than trying to write that vehicle off.
All right. “Can I start filing taxes for the LLCs I created for two of my rental homes, even though the real property deeds have not yet been transferred, filed, recorded to said LLCs?”
Jeff: This is going to be one of those that depends questions. It really depends on how the LLC is being taxed. If they’re disregarded to you personally, yeah, go ahead and report them on your 1040. The LLC is there more for liability protection than anything. If it’s going through an entity, especially an S Corporation or a corporation and they’re not titled to that entity, I think that’s more problematic.
Toby: You still have to file the taxes. You set up an LLC as taxed as a partnership, you’d still have expenses. You have the startup expenses, you have the organizational expenses, you have the state fees—do you have anything? You still have to file a tax return for it, even though it might be a small loss. You don’t get to report the income or loss from those real estate properties until they’re in that LLC, but that doesn’t mean the LLC isn’t doing something else.
If it’s an escort, same situation. They’re looking at the earlier data that it had members or shareholders and/or conducted business. If it’s just sitting there waiting for the properties, which don’t put real estate in an escort 99.9% of the time, there are few cases where you might, but for the most part, we’re probably talking about a partnership or a disregarded entity. In either case, you still could still file taxes.
Jeff: A good example of this is I bought a property in January and created the LLC in July. We can’t put income and expenses to that LLC when it didn’t even exist.
Toby: Absolutely. All right guys, hey, if you like this type of information, again, there’s YouTube. We have our podcasts. You can go to Google Podcasts and Apple Podcasts and listen. You can put us on (what is it) 1.5 times, that’s what a lot of folks do so they’re able to get through this much faster.
Jeff: Especially that first question.
Toby: The first question was a doozy. Everybody loves real estate professional status. That’s 469(c)(7) if the code. It’s actually pretty straightforward. It just has some moving pieces.
“I am just starting out in real estate. I saw you on Gogo’s weekly meeting and I’m wondering if in my first year with very little sales, should I register as an LLC taxed as an S Corp or file as I normally would?”
Jeff: So I’m assuming this is a real estate agent.
Toby: I would imagine this as a real estate agent because that’s Gogo Bethke. She’s a really good agent out there, I think. I won’t say where. I don’t want you guys to go hit her up, but she has a really good team. A lot of people follow her, and it’s all real estate agents, so I assume that’s good.
Jeff: If you didn’t do a whole lot in 2021, I would not worry about it. If you think you’re going to do a lot more sales in 2022, I might look into making an S election.
Toby: Let me be annoying here because I’m good at it and I’m an attorney. So I just had a case—we’re actually dealing with it—where a real estate agent represented a property. They disclosed a known condition on the property. The buyer actually had a person come out and inspect said property and close the deal. Then it turned out that the issue was more prevalent than they thought. In this case, it was termites. Disclosed it, did everything they’re supposed to, now being sued. The lightning sued out of them.
Normally, I would say, hey, you know what, if it’s not a risk activity, who cares. But I would say at a minimum, put an LLC around you so that if anything blows back on you, they have to sue somebody for misrepresentation, the market crashes—we don’t know when that’s going to happen. But agents were getting blown up left and right in 2008, 2009, 2010, 2011 because again, people lose money. They get angry, they get lawyers, and they go after everybody.
You want to make sure that something that you do now isn’t a liability occurrence that comes down the road five years from now. In chain of title issues, it could even be longer. I’ve seen them occur more than a decade after closing. By the way, for things like fraud where somebody’s saying lack of disclosure, your statute of limitations even when they discover it or should have discovered it. So it can be a long time from now. At a minimum, I would put an LLC around it, just to isolate the liability.
If I am a real estate agent, I don’t have to worry about somebody coming after me trying to take my other assets away, my home, my vehicles, my personal checking, and eat my investments. I don’t want someone messing with me. So I’m going to put an LLC around it and I could start it out as a disregarded LLC, meaning that it does not file a tax return. I’m filing as a sole proprietor. Up until about $25,000 of net profit, it’s really kind of eh. At about $15,000–$30,000, it’s really right around $25,000. It’s $1500 that you’re going to save per year by being an S Corp.
You can make the S election on an LLC that’s disregarded with one piece of paper, a 2553. If you don’t make the election during the year, there are also ways to make a late election underneath a revenue procedure. What would I say to somebody who’s just starting out? I would say set up an LLC, make it a disregarded entity, and let’s see where the chips fall. Worst case scenario, if at the end of the year you’re doing way better than you thought, we make a late S election next year, then it relates back to now.
Jeff: Good call.
Toby: That’s just me. But I like to keep the options, so sorry.
Jeff: No, I agree with that 100%. I was expecting more annoyance in that.
Toby: That goes with any business. Somebody says, “How do you make an LLC as a disregarded?” When you get your tax identification number, it’s called an SS-4. The IRS does not know what an LLC is. So when you do an LLC SS-4 and you get a tax ID for it, the IRS says, what are you filing? If it is an LLC, is it going to file a tax return? Disregarded means, no, it’s not going to file a tax return. All the income, all of the profits, and all of the losses are going to flow under the owner’s tax return as though the owner made the money, so it’s disregarded for tax purposes. The LLC is ignored. The IRS doesn’t know what an LLC is.
If you say I’m filing as an LLC, Jeff will make fun of you because there’s no such thing as filing as an LLC. You’ll literally start going, oh, I missed that forum in my million years of being a CPA. At cocktail parties, you’ll probably spit vodka out of his nose or something like that. Did you really just say file it as an LLC? We really will make fun of you if you say things like that. I’m just kidding. It’s ignored for tax purposes when it’s disregarded. It would be funny to see you snort vodka. We don’t even drink. I’ve never seen you drink.
Jeff: I do it so seldomly.
Toby: I’m not good at it. It makes me break out in spots under bridges, county jail. Just kidding. “In part of New York where I live, there are mother and daughter houses. If I purchased one as a primary residence,” I’m just kidding. No underbridge, stop it. All right. “In the part of New York where I live, there’s a mother and daughter houses. If I purchase one as a primary residence and rent the side apartment, what are my options for tax savings? Am I able to write off expenses for that portion of the house, mortgage, taxes, utilities, et cetera? Am I able to depreciate that portion of the house?”
Jeff: We’re seeing these more and more in new builds, mother-daughter, next-gen, and multi-gen where a part of the house is actually segregated from the rest of the house for somebody’s living space. Going back to your question, you absolutely can write off some of these expenses. It’ll be a portion of expenses based on square footage, number of rooms, or any number of ways to apportion those deductions.
Toby: Your personal house, you can’t write anything off except the mortgage, and that’s only if you itemize your real estate taxes and your mortgage. But if you have a portion of it that’s being used as investment property, then you take that percentage and you’re going to write that off against your investment income. Again, it’s going to create a passive loss, or it’s going to offset that and create a passive income stream from the rents. But the tax […], you’re going to get to write off a portion of all of those things—mortgage taxes, utilities. Plus, if you have any debt, you’re going to be able to write off—that’s obviously the mortgage, but what else would we have on there?
Jeff: HOA fees, repairs to the house in general.
Toby: Property management if you have it.
Jeff: Property management, yes. And then things you can write off directly are expenses for that part.
Toby: You’re going to need landlord insurance, so that portion of the insurance that covers plus any additional coverage to cover if you have a third party there. You’re going to want to make sure that you have that rider. I would recommend that you get an umbrella policy. Everybody should have an umbrella policy, they’re so cheap. They’re really just lawsuit protection because they’ll cover the lawyers in most cases, even if it’s disputed as to whether the claim is valid.
Jeff: I’m not particularly a fan of renting out a room, I like this idea. We actually consider doing this ourselves.
Toby: Here’s the other deal. If you are renting out a room in your house, you don’t have depreciation recapture. If it’s another unit, a separate structure, so it’s not in the four walls of the home is what they say. Even though your house nowadays, I’ve seen these crazy houses that have 10 walls. They just call it not in the main house but it’s a separate unit, then it’s going to be depreciation recapture if you sell.
You’d have the capital gain exclusion on the main premises and you’d have some recapture and capital gain not from the sale of a primary residence, but just normally, which means you can 1031 that portion if you really want to. It’s almost like a whole other separate rental property. Not a bad idea, though, especially in New York. Again, we need places for people to live. We are underbuilt for folks that are making less than $75,000 a year. I think that we’re going to see relaxed zoning in a lot of different states where they have issues, especially for lower-income folks.
All that stuff starts coming into play. You start looking at that, you start saying, can I add on to it? Can I add an ADU? Can I add something else? An auxiliary dwelling unit or whatever. Can I add something there for housing?
All right. “What is the best way to handle money that was gifted to children’s ages one and three years old? What do I do with it so it doesn’t affect them now, but they could access it at 16 or 18 without penalties or fees?”
Jeff: My best answer would be a 529 plan.
Toby: 529 plan that was gifted to them. I suppose you could put it in a 529 if you’re going to have them go to college.
Jeff: I would gift it because there’s that five-year gift you can do for 529 plans. I could put $80,000 into a 529 plan for a child this year, but I could not make any more gifts for the next four years to that child.
Toby: Here’s the thing. If you have an UGMA (Uniform Gifts to Minors Act) like you’re putting it into an account. I imagine that grandma, grandpa, or some third party gifted money to them, and now you are controlling said monies. If it is passive income, there’s something called the kiddie tax. That just means that you as the parent would be paying tax on that income until they’re 24—18 to 24, depending on whether you’re still supporting them and they’re going to college or whatnot.
They would have access to that money in theory at 18. I don’t think it’s 16. I think it’s actually 18 because they’d have to have the ability to contract. Generally speaking, that’s what ends up happening. You pay the tax and the taxable events on your return as their parent. If it’s active income, which I can’t imagine that an investment would generate active income, and I guess it’s possible if you did a master partnership or whatnot. But even then it’d be passive. I’m trying to think of a situation where it would be taxable to the child.
Jeff: I think if you throw it into some of these publicly traded partnerships or some that might be generating.
Toby: Possibly. There’s a de minimis amount that wouldn’t be taxable at all. I think it’s like less than $2000. And then if you have active income, they don’t pay tax on the first $12,000. It’s not bad, as they get older, if they have some active income, I just don’t know how they would generate it. For the most part, it should be taxable to you, as long as it’s over a certain amount. Depending on how much they are gifted, it may have zero impact on you, it may have a small impact on you, but it won’t hurt the children if it was gifted to the kids.
Jeff: Yeah, it’s about the first $1100 or $1200 is tax-free. The next $1200 is taxed to the child. Then above that, so you’re at $2300–2400 gets taxed at the parents.
Toby: It was some small amount I just can’t remember the rules.
Jeff: Standard deduction wouldn’t kick in because standard deductions could be the lower earned income.
Toby: I’m saying that if they had a bunch of earned income.
Jeff: Oh, certainly.
Toby: So if somehow they ended up doing something where they had earned income, which again, they would have to be a little bit older.
Jeff: Especially a teenager.
Toby: Yeah, maybe if they were teenagers and they were doing something where they use the money to invest in an active business. I know of one situation where somebody did that. They opened up a restaurant and the kids were part owners in the restaurant and they worked in the restaurant, then that isn’t kiddie tax what they’re earning there.
Anyway, it’s why you have an accountant. It’s probably going to go, like what Jeff said, 529 plan is a good place if they’re going to make gifts. That may be where they want to start putting it so that it’s tax-free, or if you put it into a Uniform Gift to Minors Act account and the children would get it when they’re of age. In the meantime, it wouldn’t hurt them.
Here’s a good one. “Can I sell my apartment building on an installment plan to avoid the large amount of taxes owed when I sell? Can I do a double escrow to accomplish this because I still have a small loan on the property?”
Jeff: Yeah, you can certainly do an installment sale. It’s a rental property, it can be subject to installment sale, so you can only get taxed a piece at a time based on how much you’ve received.
Toby: Installment sales is taking it out over multiple years, so it’s not getting payment all in one year. You could have a 5-year installment sale, a 10-year installment sale, or a 30-year installment sale, and it’s spreading out the taxes over that period.
Jeff: But what about this double escrow? Does that really do anything for him?
Toby: It’s not. You don’t double escrow on this one. In the case that you have a loan, you’re still going to have your basis subtracted out of this thing, you’re going to have depreciation recapture, and you’re going to have capital gains. The return of your basis is never going to be taxable. The recapture is going to be taxable max at 25% and your capital gains can be maxed out at 20%. If you have net investment income tax it could be 23% plus your state taxes, but you’re spreading out over the period that you’re receiving it.
If you have a small loan on the property, then they could be buying it subject to that loan. If you’re not going to pay off the loan, in which case, again, it’s subject to that loan, it’s treated as though it’s their loan now. You don’t have a taxable event. It’s spreading it out over the life of the return of the monies. That loan really has nothing to do with your tax hit. It has to do with your return at basis 0, recapture 0 to 25. Long Term Capital Gain 0 to 20 is how that breaks out. What do you usually put in a spreadsheet or something on an installment sale?
Jeff: Yeah, because like you said, we’re going to have those factors. Interest that they owe. If you have a Subject 2 like you’re saying where they’re just paying off your loan, that actually counts as proceeds for the year and that’s what your installment is.
Toby: It wouldn’t have anything to do with your tax. It would have to do with the buyer’s taxes because the interest is being credited towards them, but you didn’t pay any interest in theory when you have somebody else pay your loan. It won’t affect you. You don’t have to double escrow.
“Should my personal bank accounts or life insurance policies be owned by the same trust?”
Jeff: It’s okay to do that. I’m not a huge fan because I’m not sure what it does for you. I know for larger policies that we talked about the life insurance trust, but those are typically irrevocable trusts.
Toby: Your personal bank account would not be in the same trust. If a trust was designed to hold and own a policy and you wanted it outside of your estate, that’s called an irrevocable life insurance trust. You would not put your bank account into it. By this question, I assume you mean a living trust. In which case, there’s no liability in either one, we don’t care. Your personal bank account and your life insurance policies could still be in there.
The reason that you do that is you would usually have named beneficiaries, here’s a bunch of cash. Let’s say that I have children and I want the proceeds to go to those kids but I don’t want to just give it to them. You could have the beneficiary in that case be the trust that has restrictions on the payout, so it could go to your living trust and then it’s the beneficiary.
Jeff: Let’s say I have a cash value policy, and I pick substantial loans against it, does any of that change what you do with it?
Toby: Not really. Whenever we’re looking at an asset you look at—let’s say this horrible coffee cup here, this is my beautiful art of me drawing a bowl. Let’s say that this hot coffee is a liability. The bank accounts and insurance policies are not hot. There’s nothing that I’m worried about causing burns inside of this cup. Neither one of those is hot. But if I mix hot with cold, I’m contaminating the cold water now with this hot water that could cause issues. We wouldn’t put something hot.
A hot asset would be like real estate, it’s risky. It’s going to bring along liabilities. I wouldn’t put that in there in the same cup with something that has no risk like a brokerage account or my personal bank statements. That’s all we’re doing. If we have a trust, handy dandy trust, and I have two cold assets, things that don’t create liability, I’m putting in that. I don’t really care. I’m not too worried about this.
“The sailor on this sailboat should have life insurance for him and his passengers as they do not have life preservers. Oh, just saying. I say when I should have his life insurance and […].” I’m not sure if I follow that, but that’s interesting. I have to process that one. David, you got me.
“Thoughts on primary house on an LLC managed by a C Corp show the taxes HOA fees?” No, you wouldn’t do that. That’s still personal assets, even if you put it into an LLC.
All right. “Are charitable contributions made from our partnership considered tax-deductible?”
Jeff: Yes. Charitable contributions made by partnerships and S corps are considered charitable contributions made by the partners and the shareholders.
Toby: It just passes through. If it would be deductible to you as an individual, it’s deductible as it flows through to you from a partnership. If Jeff and I are two individuals, we’ve maxed out our charitable contributions for the year, and we make excess charitable contributions out of the partnership, it just comes to us. If I’ve maxed out mine and Jeff hasn’t maxed out his, he would get to write it off. I would carry it forward into future years. Make sure that works.
The last one, hey, there’s me. There’s Toby. That’s YouTube. So if you like stuff, there’s what we do. They make me do goofy poses now, like your assets are invisible. That’s a good one. I’m flipping you off in the second one, or no, I’m saying number one. Anyway, join us, sign up and subscribe. We always will give you more of it. You can see right there Tax Tuesday Q&A, your tax questions live. We are streaming this on YouTube so you can always come in and watch Tax Tuesday on YouTube and watch recordings and all that good stuff after, we have a lot of fun.
If you have questions, by all means, send them to taxtuesday@andersonadvisors.com. We will make sure that we get you an answer. It doesn’t cost you a nickel. Visit us at Anderson Advisors. We’re always there, pretty easygoing when it comes to giving out information. We don’t play hide the ball. We’d rather you be educated and we have a lot of fun. “Thanks, Jeff, for standing by and bailing Toby out when needed.”
Jeff: They’re so mean to you.
Toby: I deserve it sometimes. No, but we have a good time. Hope you do too. Got to say thank you to Eliot, Christos, Dutch, Troy, Piao, Matthew, Dana was on, Patti was on. We have a big team of probably 10 people just there answering questions. They answered 154 written questions. We don’t charge anything for this. We get way more than we deserve. We always figured smart to give, give, give, give, give. That’s kind of our motto. The rest of it, the universe takes care of us.
I’m going to bow out with Jeff, but we’re going to leave this still going so you guys can get your questions answered. Iya says, “You all have a great team.” Absolutely, we do. We’re very lucky that we have really smart people who are tireless workers who are willing to help. We are lucky. I’m lucky. Are you lucky?
Jeff: I’m lucky.
Toby: Luckier than we deserve. We’ve heard that before. All right, guys. We’ll see you at the next Tax Tuesday in two weeks. In the meantime, send us your questions. Thanks, guys.
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