In today’s Tax Tuesday episode, tax experts Toby Mathis, Esq., and returning guest Jeff Webb, CPA, CFO of Anderson Business Advisors, discuss the usual mix of complex and simple tax questions including questions around paying minor children through your LLC, gifting vs. inheriting property, structuring your stock trading business, and how and when to use cost segregation to get the biggest tax benefits. Submit your tax question to taxtuesday@andersonadvisors.
- “When dissolving a C-Corporation with a single shareholder and having a net operating loss, does the loss go on the shareholder’s personal return and can the loss be offset against personal income?” No, because that C-Corporation is its own entity. However, you probably finance some of those losses. Anything that you invest in the company that you don’t get back will be a capital loss to you.
- “I jointly own an inherited property that is currently on the market. Can the expenses that I have (utilities, staging, maintenance, repair, taxes) be added to the cost value?” It depends on how the property is being used once you inherit it.
- “Can I deduct expenses for working at home and what forms can I use?” That depends. If you’re an employee, then no deduction anymore for employee work expenses.
- “My wife’s father wants to sign his house over to us and her brother. What tax advantage is that to her dad? And what tax issues does it raise for us? Should we start an LLC or some other structure?” No tax advantages for Dad. When Dad transfers the property over, it’s a gift. And when you give an appreciated asset you receive the basis of the gifter. If it is an investment, it is best to start an LLC.
- “When you have a C-Corp (no income at this point, a Wyoming LLC that owns two LLCs with rentals), which entity pays for general expenses like memberships, cell phones, internet, education, etc?” When you have an LLC with rental (C-Corp), then you pay the C-Corp and management fee. The C-Corp then covers all the expenses.
- “How does paying for your child (under 18) help with taxes, if any?” If under 18 through LLCs, there is no employment tax.
- “Can you benefit from cost segregation at any time?” The longer you wait, there’s nothing left to depreciate. A tiny benefit, if any.
- “Need to move from sole proprietorship to some form of business entity. […] C-corp? Something else?” Jeff is not a fan – there are a lot of landmines out there. If you’re doing well, you want the capital gains. Put your cash in an LLC with an 80/20 split. Watch how to structure a trading business!
- “I currently own a home in one state (Oregon) and I am looking to purchase an investment property in another state and plan to do so using an LLC or an S-Corp. […] What would be the easiest way to go about this?” Do not own an S-Corp! Buy the AZ property in a land trust and LLC. Have someone guide you through this process
- “If I invested $30,000 in a marketing class to start a marketing company, do I have to amortize it over 15 years to see any of it back? Can it be a business investment and get it all back?” The only ones that can do this are C-Corps.
- “Is 1245 property subject to depreciation recapture if the rental property is sold with capital gain?” Gain is subject to recapture. You’re going to pay ordinary income tax.
- Send us your questions, and check out the event schedule listed in the resources section.
Full Episode Transcript:
Toby: All right. Hey guys, if you are looking for Tax Tuesday, you’re in the right spot. My name is Toby Mathis. I’m joined by…... Read Full Transcript
Jeff: Jeff Webb.
Toby: If you’re looking for some answers to tax questions, you’re in the right spot. We’re hoping to find some answers too. Hopefully you guys can help us, because we have a really good community out there in the chat land.
We’ll just go over some ground rules here. Tax Tuesday has probably 200-plus episodes at this point. We’ve been doing this for a number of years. It’s one of those weird things you don’t get paid for, but you like doing it so you just keep doing it. Everybody says, why do you keep doing it? You say, because it’s fun and because we like doing it.
Now we have a whole team. behind us. You got Dutch, Eliot, Jared, Tanya, Troy, Amanda, Patty, and Matt in the background. I’m probably missing people. Alicia, I think, is going to be on, one of our tax professionals. We have a whole bunch of people to answer your questions. Those are a lot of tax professionals. We have a bunch of CPAs and tax attorneys in that bunch.
Feel free to ask your questions. But here’s the deal. Ask your question in the Q&A, because that way it doesn’t go […] when you have 100 people responding to a question. Like this question, where are you sitting right now, today? What city and state? If you say I’m in Seattle and I’m drunk, that’s not what I’m asking for. Seattle, Washington.
There’s Cary, North Carolina. Put it in the chat. Olympia, Washington. All right, we’ve got some Washington. There’s Princeton, New Jersey, Connecticut, Phoenix, Arizona, Lexington, Kentucky, California, Santa Monica, Sacramento, San Jose, Castle Rock, Washington, Auburn, Washington. I know that well, next to Puyallup. Alexandria, rolling hills of the states, Austin, Northern California.
Okay, they’re going too fast now. I tried to keep up, but that’s when you […]. Bellevue, Washington. I know that area very well too. San Antonio, Texas. I was just in Kirrville. I know that area. There’s Hallandale Beach. Two weeks ago, I was in Miami, so I know that area well.
I went to the Yellow Green Farmers Market in Hollywood. You’ve got to do it. Then go to Puro Tinto Coffee. It’s some friends of ours from Colombia. It’s the best coffee in the world right there. There’s Sherry. Hey, Sherry. Nice to see you again. Paulsbo. Oh, my gosh, the Vikings over there in Paulsbo, Washington.
Anyway, we have people from all over the place. Sherry says she’s been gone. Hopefully it’s good travel. If you don’t realize this, I read the chat right in front of me here. If you see my eyes go off, it’s because I’m reading chat and questions.
A lot of you folks, I’ve known for years and then become friends. We go out to dinner when they show up. Some people are like, hey, maybe I’m in town, it’s so much fun. Yeah, we have a good time. We like the people that we’re able to serve in some capacity, so this is fun. Whether you’re a client or not, it doesn’t matter. You can ask questions.
If you have questions that come up in between sessions, because we do this every two weeks, by all means send it at firstname.lastname@example.org. You could send in a question. If you start asking questions about all your stuff—we got the North Shore of Oahu over there. Turtle Bay, right? We have people all over the place. They’re still putting in there. We’re really stretching the map this time. I’m jealous, though. She’s over in Oahu right now.
Anyway, if you have a question that’s really specific to you, we may ask that you become a client at some point and say, hey, we can’t just answer specific things about filling out your tax return and things like that. But if it’s general questions, we’re absolutely willing to help you. If you’re a platinum client, you already get to ask all the questions you want. We’re going to answer them even if they’re specific to you. Hopefully you guys can honor that. All right, let’s jump in. We got a bunch of questions that we’re going to go over.
“When dissolving a C-corporation with a single shareholder and having a net operating loss, does the loss go on the shareholder’s personal return, and can the loss be offset against personal income?” Great question, and we will answer it.
“I jointly owned an inherited property that is currently on the market. Can the expenses that I have, utility staging, maintenance repairs, taxes, be added to the cost value?” Probably the basis, right? We will answer that.
“My wife’s father wants to sign his house over to us and her brother. What tax advantage is that to her dad, and what tax issues does it raise for us? Should we start an LLC or some other structure?” Great question. The best time to ask that question is before dad does something that he can undo.
“When you have a C-corp, no income at this point, a Wyoming LLC that owns two LLCs with rentals, which entity pays for general expenses like memberships, cell phone, internet education, et cetera?” Again, really great questions all the way across the board so far. Eliot picked these out. Eliot, good job, buddy.
“How does paying your child under 18 help with tax, if any?” Again, really good questions. We’ll be able to help a lot of folks today, I’m sure.
“Can you benefit from cost segregation at any time, for example, after 25 years on a 27 1⁄2-year property as an extreme? What is the downside of doing it sooner than later given bonus depreciation, which is reducing annually at this point and will go away entirely?” Is it going to go away entirely? What is it going to be at?
Jeff: It’s going to be all the way up to that 27 1⁄2 years. Bonus depreciation went away. It’s 80% in 2023 and 60% next year.
Toby: Maybe it goes away in 2026, right? They use small fonts. They’re taunting me.
“I need to move from sole proprietorship to some form of business entity. I’m an active trader doing well. I want to protect my account, as well as provide the best solution for retirement contributions and charitable contributions. C-corp? Something else? Fully happy breaking even or even leaving money in the corp for future purposes.” Good question.
“I currently own a home in one state, Oregon. I am looking to purchase an investment property in another state and plan to do so using an LLC or S-corp. I eventually would like to make my investment property, Arizona, my primary residence, my current residence, and investment property. What would be the easiest way to go about this?” We’ll answer that.
These are good questions, Jeff. Again, we owe you a beer, Eliot, if you drink beer, or wine, or soda pop. I think Jeff will give you a diet Mountain Dew. They should be a sponsor.
“If I invested $30,000 in a marketing class to start a marketing company, do I have to amortize it over 15 years to see any of it back? Can it be a business investment and get it all back?” Interesting way to put it, but we will answer that.
“Is 1245 property subject to depreciation recapture if the rental property is sold with capital gain?” Really good questions all the way around.
Jeff: I noticed there were no questions that took up the entire page.
Toby: You know what, I like that. All right, let’s dive in the deep. Before we do, just know that some of these answers you may find sitting on my YouTube channel, which some of you guys may be streaming on the YouTube channel, in which case you have Troy moderating for you. Way to go, Troy, in our office. He oversees all of our bookkeepers. You can absolutely go in and subscribe. It’s free, and all of the Tax Tuesdays get recorded and put onto my YouTube channel so you can listen to them later in case you have insomnia.
All right. Tax and Asset Protection workshop, my partner and I, Clint Coons. Gosh, we’ve been doing these since 1999. We are doing a bunch of virtual ones. On December 7th through the 10th, we have a four-day live version, where our first day is infinity day if you like investing, and then three days—I was 12 when I started. That’s about right, Sherry. It’s more accurate than you realize.
It’s a four-day event. You come out to Vegas. We’re going to be at the Virgin Hotel Casino, which is the old Hard Rock. They revamped it and put a new wrapper on it. It’s a lot of fun. It’s four days. You get to hang out with a lot of cool people who are all investors, and I think that’s probably my favorite part. Plus you get to hang out with us, because guess what, we like to wander around and talk to everybody, because it’s like a big old family.
People always show up. We’re always looking for nuggets. I love the nugget hunters that have been to a dozen of these things. They love to show up, they share, and it’s just a really good community way, way, way cool. If you like being around nice people who want you to succeed. You’re not going to get hit with a million different offers from a million different vendors. We just teach it
There are two sides to Anderson. We have the Infinity side, which we teach people how to make money. And we have the Tax and Asset Protection side, where we teach you how to keep it, preserve it, and then pass it on in a loving and caring way to your family or to your organizations you care about. You can absolutely do that. There’s the YouTube link. We’ll send that link out to you too. You just type in Toby Mathis on YouTube, and you’ll find it. All right, let’s get to these questions.
“When dissolving a C-corporation with a single shareholder, and you have a net operating loss, so you lost money, never made money. Does the loss go on the shareholder’s personal return, and can the loss be offset against personal income?”
Jeff: The answer is no, but however, no, because that C-corporation is its own entity, it has no attachment to you. The loss is generated in that C-corps day in that C-corp even when you dissolve it. Now the however portion is, as you probably find that some of those losses.
Toby: I’ll get a 1244.
Jeff: You have shareholder loans that we can convert to common stock. Anything you invest in the company that you don’t get back is first off going to be a capital loss to you. However, like you mentioned, that 1244 allows you to deduct up to $50,000 if you’re single or $100,000 if you’re married filing jointly of those losses from that corporation. I believe all our corporations are set up with 1244 provision.
Toby: Yeah, we make them on every single case. What Jeff is talking about is there’s a statute that says for C-corporations, I mean it’s CNS. I don’t think you’ve heard about it.
Jeff: It is CNS, but I’ve never seen it actually apply to S.
Toby: It has to be a corporation, because you already taken the loss. If you’re materially participating, you put the money in your basis. If you didn’t have basis, then maybe it would unlock it, but that’s getting ticky-tacky. All the accountants out there all of a sudden just go, what are you talking about, basis with S-corp?
Here’s the easiest way to look at it. If you lose money in a corporation you had to put money in, you’re going to get that loss somehow, some way, if it’s a C-corporation. If it is an LLC taxed as a C-corp, then it stays capital loss, which you still get to write off, but capital losses offset capital gains with the exclusion of you can write off up to $3,000 a year of excess capital loss against your ordinary income.
Jeff: Yes. A quick example is me and my wife invested half a million dollars into this corporation, and it’s just not working, so we shut it down. Because we have that 1244 provision that you talked about, when we file a return jointly, we’re going to be able to write off $100,000 ordinary losses, no limitations or anything.
Toby: The rest of it, though. If you lost a half million, you get to take $100,000 against your ordinary income, so your W-2 income. Just think of that. If you make a good salary, it offsets that, then you have $400,000 of additional capital loss.
Jeff: Which can be a bad thing if you don’t have any other investments to write off. It could be a good thing if you do have. Heck, if I have a rental property that’s appreciated significantly, I may just dump that puppy.
Toby: Right. I think the moral of the story is it pays to have an accountant that understands this type of principle, but you just have to know how to match it with the type of income, and then are there exceptions? Passive losses offset passive income, and there are two exceptions, real estate professional and active participation.
With capital loss, capital loss is limited to $3000, and then there’s a few little exceptions. The big one is the 1244 stock loss, and then 1202 is the untaxed gains. You have 1244 stock loss, but it has to be a C-corp, not an LLC taxed as a C-corp. It has to be an S-corp, or it can’t be an LLC taxed as an S-corp, and you have to make the election to be treated under 1244.
We do that as a matter of course here not because we don’t trust you guys that you would do it, but it’s because we don’t trust you guys that you would do it. I’m just teasing. We just throw it in on everyone, because we figure in case you have loss—let’s not add injury to insult. Let’s offset your other income.
Jeff: One thing I wanted to mention that you brought up earlier was, if you’re making any kind of decision like shutting down your corporation or selling this or that, it’s not a bad idea to go in a platinum question say, hey, I’m thinking about doing this, what are the possible red flags or tax consequences?
Toby: That’s what platinum is for. If you’re a platinum member with Anderson, just go in there and ask, and that way they can look at it. Now you’re shifting the liability on to us. Hopefully our guys answered correctly. If not, at least you have somebody you can hold to account. And we are happy to play that role for you.
“I jointly own an inherited property that is currently on the market.” It sounds like somebody passed away, went through probate or went through a trust, and you inherited a piece of property. “Can the expenses that I have, utilities, staging, maintenance, repairs, taxes, be added to the cost value?”
Jeff: This was the one we talked about. The answer is really, it depends on how the property was being used once you inherit it. You could have been using it personally, you could have been renting it out, or it could just be sitting there.
Toby: Let’s say that I inherited a property, and I jointly did this. Maybe mom and dad passed away, and they left it to Jeff and I, and we’re brothers. We have these expenses. Maybe the estate’s paying the expense, or maybe I’m having to pay for it. Maybe there’s nothing else in there.
Mom and dad just left us a property. We have to sell it. You get a step up and basis, so you’re not going to have any gain. The next couple of months, I’ve got to fix it up and get it ready for sale. It had to go through the probate process. In some states like California, that’s a six-month holding period where you got to sit on this thing.
You have utilities, I’ve got to keep the electricity on, I’ve got to keep the water, I’ve got to keep gas going. Now I have to bring in someone to stage it to make it look pretty, ’ve got to maintain the place, I got to fix what’s busted, and I have to pay the property taxes. The property taxes, I would assume I could write that off even if it’s personal. Even if I lived in it, I could write that off.
Jeff: Yes, you could, and then we get back into the whole limitation on taxes argument.
Toby: The utility, staging, maintenance, and repairs, utilities sounds like I’m done. I can’t do anything, unless I made this into a rental property and had utilities. Is there any way I could write off utilities?
Jeff: I think if it was just an investment property, any expenses incurred to maintain this, and its value, you’d be able to add on the basis. I’ve seen this done. However, if you are using it personally, you or the brother in this case…
Toby: Let’s say that so and so passed away, and we’re living there.
Jeff: I don’t think in this case, it matters if it’s you or him. It’s going to have the same result either way. You’re not going to be able to deduct these utilities, repairs, and stuff like that.
Toby: The question is, is it personal use, or is this for an investment? If it’s for an investment, it sounds like I may get a deduction. It wasn’t actually made available for rent. I guess I possibly could create a little bit of a loss out of it.
Jeff: Yeah, whether it’s an active investment or an idle investment.
Toby: It sounds like with facts and circumstances, you may be able to add these things. Even if you had it as a loss and you weren’t able to take the deduction, because you didn’t have any other passive income, let’s say this was an investment property, then you could still take that loss, and it offsets any gain, adds to basis. But we just had a step up and basis anyway. I’m wondering whether it would even matter. I guess the more and more I’m looking at this, the more I’m leaning that unless it’s appreciated significantly since the deceased passed away, chances are these are just going to be […].
Jeff: I’m of the opinion that you can probably include staging as a closing cost. However, when you add in some of the other closing costs like broker fees and stuff like that…
Toby: But you don’t have any gains. So when are you going to write it off?
Jeff: That’s what I’m saying. When you sell this property, you’re probably going to have a loss.
Toby: But it’s a personal loss then, so you wouldn’t be able to write it off?
Jeff: Again, it depends on what type of property it is.
Toby: The best thing for these folks is probably to get it on the market and rent it out for a little bit, see if they can at least turn it into a rental property. Otherwise, you’re probably going to be eating those expenses. But maybe the estate pays it. Hopefully, there are other assets.
It’s not straightforward, and that’s why you would sit down with somebody and map it out. I’m wondering if anybody in chat has had to deal with it. We always have CPAs on, guys, that watch these. Does anybody dealt with that out there, in CPA world or accounting world that has dealt with this issue that has anything to add? I’ll watch the chat while we go to the next one.
Jeff: Sometimes it’s better to just not close the estate, not distribute the property, and have the estate sell it, because they’re still going to get the step up, and then you have the cash to distribute as you please.
Toby: They’re making it sound like the expenses that I have, realistically the estate should be paying, but they’re being forced to pay it. Not uncommon. Hey, here’s your inheritance, here’s your property. Then you’re like, great, now what the hell am I supposed to do with it? I got to maintain it, I got to fix it, I got to do all these things. Yup, those are out of your pocket. One of the better things you could do is turn it into an investment property, so at least those losses could potentially be taken.
Jeff: I guess another factor in this is, who actually owns this property? The brothers or does the estate still technically own it?
Toby: It says, I jointly own an inherited property, so the estate distributed it. Somebody says, I’m not a CPA, but the right thing to do is get reimbursed from the estate. That would seem to be what I would say. Usually, I think what Jeff just said is that the estate might sell it, but it sounds like they distributed it to these folks. And now they have it.
That’s one of those things that sometimes the attorneys are just doing what attorneys do, and the accountants are left out in the cold. If the accountant came in there and talk to him, they might say, hey, estate, just sell it and then distribute the proceeds. How about that? You still get the step up, but they didn’t. Probably it’s going to be personal, and you’re going to eat those. But you inherited a house. At least it says property. Maybe it’s, you inherited a piece of land or whatever it is.
Jeff: Swamp in North Georgia.
Toby: That’s it. True story, my dad inherited two lots in Alabama, and the cost of probating him was more than the value of the lots. It was always this thing. Her grandma’s always like, I got this land, I’m going to leave it to you guys, and all that stuff. Then she passed away and left it. He never even got it. He was like, the Lord’s like, gosh, it’s going to be more expensive to open this thing and get this done.
Jeff: Just sign this quit claim
Toby: [inaudible 00:20:15] you take it.
All right. “Can I deduct expenses for working at home, and what forms can I use?” I don’t remember that question.
Jeff: I don’t remember that question either. We’ll start off with that depends. If you’re an employee, no. There’s no place to deduct.
Toby: That was from last time. All right, we’re going to have a chat with the slide creator. That was a repeat from the last session. See? All right, who did the slides? Raise your hand. We should still answer it since it’s in front of us, though. Patty? At least she’s accountable. Give her the stink eye. Jeff, can you give her the stink eye?
Jeff: If you’re an employee, no, there’s no deduction anymore for employee work expenses.
Toby: That is right. We lost miscellaneous itemized deductions in the 2017 Tax Cut and Jobs Act. You need to have a business to write those things off. If you have a business, a C-corp, an S-corp, an LLC taxed as a C-corp, an LLC taxed as an S-corp or a nonprofit, they could reimburse you for the administrative use of your home. Otherwise, you’re eating it. If your employer doesn’t pay it, you’re […].
All right, now let’s go on. Hey, this looks like the right slide. The capital gain and loss wasn’t used personally, so you can treat those carrying expenses, selling expenses, or basis. Tanya is coming to the rescue. Thank you. All right. We got rock stars out there. Yes, Patty, this is great. This is a perfect slide.
“My wife’s father wants to sign his house over to us and to her brother.” What could go wrong?
Jeff: I had to read that person’s two or three times.
Toby: Here, I’m going to leave the house to the family. He says us, but I have a feeling that dad’s going to leave it to his daughter. There’s no us, and dad’s like, yeah, let me just leave it to my…
Jeff: I’m familiar with this word here.
Toby: Yes. We would not do that, just so you know. There would be no us, it would be to his daughter and his descendants. “What tax advantage is that for dad?” Let’s just answer that one.
Jeff: There’s really no tax advantage other than he doesn’t have to pay real estate taxes anymore.
Toby: Yup, and he’s using up his lifetime exclusion of $12,950,000.
Jeff: I do know some people would just like to get out from under properties.
Toby: Yeah, he’s trying to saddle her. You take this dog? No, I’m just teasing.
Jeff: And really treat each of you evenly badly.
Toby: This is your great grandfather. Nobody’s been living in there. What tax advantage? There isn’t, but there is a tax disadvantage. That is that when dad transfers that property over, it’s a gift. When you gift an appreciated asset, you inherit, or you receive the basis of the gift door. If dad gives you this property, you just lost out on the step up and basis that occurs if dad passed and gave it to you.
We’ve seen this a number of times where it’s ugly head. When somebody is in a situation where they’re getting older, they fear that the end is near, and they transfer property of their children. They pass away, and they end up missing out on millions of dollars of step up and basis.
Actually, it was a case in Ohio that I still remember that was four siblings. Dad owned a building in downtown. It was a city building, millions of dollars, and the tax impact was millions of dollars. It was many, many, many, many, many millions of dollars. Because he gifted it before he passed, the children’s basis was dad’s basis, which was next to nothing. You’d owned it for 50 years, so they ended up with a huge tax hit when they sold it.
As opposed to If dad just leaves it to you, your basis would step up. The basis of the property would step up to the fair market value when dad passes. In English, let’s say dad paid $100,000 for a property, and now it’s worth $500,000. If he gifts it to you guys, your basis is $100,000. If you sold it, you’d have $400,000 of gain. If dad passes away and you inherit that property, your basis is $500,000, you sell it, and you pay zero gain.
I would be one to say, I would caution you against outright gifts. That said, if there’s a reason to do it, some states’ tax, the states, Washington, Oregon, some of these places might have a really hefty estate tax. Dad wants to get rid of a property out of that estate, there might be a compelling reason to do that. Maybe there’s not a lot of gain, maybe he’s only owned it for a little period of time.
Maybe that would justify it, or sometimes people will do something like they’ll sell it. They do an asset freeze, where they say, hey, you buy it at fair market value on an installment sale. Maybe dad lived in it as his primary residence, so there’s not a tax hit on the capital gain. And now your basis has stepped up, but you do have to pay for it.
He could always give you money every year to pay for it, but you do have to report it as though you’re paying the principal and interest every year. He’s going to have imputed interest, even if you don’t pay it. There are some issues. Anything else you want to throw in there?
Jeff: Transfer tax can sometimes ugly head. Some states have hefty transfer taxes, some states don’t.
Toby: Pennsylvania, like 3%.
Jeff: One thing I sometimes hear is, well, my dad’s in poor health, he’s afraid he’s going to have to go into a nursing home, and he doesn’t want somebody taking his house to pay for it. I know Medicaid has a five-year lookback pay. I’m not sure what the lookback is for Medicare.
Toby: They’re about the same, I think. I know that it’s a five-year look back period, and then bankruptcy can be 10 years.
Jeff: If my father transfers his house to me and then goes into a nursing home four years later, they’re going to look at what assets he had before that.
Toby: And there can be penalties, by the way. If you do transfer an asset that you’re in and then owing to somebody else so that you qualify, there are some pretty hefty penalties. You do this, again, I hate to sound like a broken record, but you’re going to have somebody who’s actually going to research it and make sure that you’re doing this the appropriate way.
As for how you would hold it, it depends on what you’re going to use it for. If you guys are moving in it, maybe you already live there and you’re just changing ownership, but the living arrangements are staying the same, you may not have to do much of anything. I would say at a minimum, do it as a trust.
If it’s an investment property between you and your brother, or your wife’s brother, your brother-in-law, then I’d probably be looking at doing some sort of LLC and having some mechanism in the event there are disputes so that a tie doesn’t go to the runner. You guys actually have a mechanism for handling things, should they not agree on where the property is being held.
Jeff: I was going to bring that up that sometimes, even with close family, you all don’t always agree on everything.
Toby: Really? Yes.
Jeff: You’re my brother, you know.
Toby: Yes. All right, brother from another mother. “When you have a C-corp, no income at this point, a Wyoming LLC that owns two LLC is with rentals, which entity pays general expenses like membership, cell phone, education, internet, et cetera?”
Jeff: I wasn’t exactly sure what we meant by membership. I’m guessing some kind of subscription.
Toby: Maybe platinum?
Jeff: Yeah, that’s a good one.
Toby: Something like that.
Jeff: Actually, for the ones listed here, I think I’d pay them all through the corporation.
Toby: I would too, yeah. Here’s how it works. When you have the LLCs with rentals, and you have a C-corp at that point, it looks like you have a Wyoming LLC that owns two LLCs. You have the Wyoming LLC managed by the C-corp, and you pay the C-corp a management fee. It’s that simple.
C-corp then covers all the expenses. The C-corp is going to write off the cell phone, the administrative office for the home. Don’t leave that one out. Don’t leave out 280A, a bunch of tax free money. Memberships, you can pay anything that’s reasonable for the management company, which expands your ability to write things off because it’s not just real estate, it’s the operating of an entity, and those entities own real estate.
A family corporation just like a family office, there are expenses that might be something like this. Let’s just say, hey, this cell phone, as an individual, I can’t write this puppy off. Even as a sole proprietor, I can only write off the portion that I use for business. But if I’m an employee of an organization, that means it has to be taxed as a corporation, so S-corp, C-corp, LLC taxed as an S-corp, LLC taxed as a C-corp or a nonprofit organization, then it can reimburse me 100%.
Even if I’m already incurring the expense, if it’s coming out of my pocket, I can get reimbursed. That starts moving money that would have been taxable into the realm of no longer being taxable, and it doesn’t show up on your return anyway. That’s what I’d be doing.
Jeff: Yeah. There’s a bit of a balancing act that goes on with a management fee, because ideally you want your management fee to cover all these expenses. However, you also have to look at, is the management fee reasonable for the revenue they’re collecting from your LLCs? If you’re only collecting $10,000 in revenue, you of course can’t write off $5000-$10,000 of management fees.
Toby: You could because that can be guaranteed. How many times have we had that come up in an audit? We’ve been doing this a long time, and I’m trying to think. I’ve never had it questioned. Have you ever seen it where they’re actually like, oh, it seems like too much.
Jeff: They don’t seem to audit rental properties.
Toby: Almost never. It was 0.05% last year for partnerships. For S-corps, it was 0.05% audit rate last year too. Compare that to the regular people, it’s 0.2%. If you’re under $25,000, it’s 0.8%. If you’re a sole proprietor, it’s 1.6% if you’re making over $100,000, 1.4% if you’re over $200,000. There’s really high audit risk. Or if you’re over $10 million, you’re in a really high audit rate.
Jeff: They like the low hanging fruit. With a rental entity, almost every expense is going to be easily documented.
Toby: Yeah, and this is simple. What are they going to say? Their only argument is that it’s not reasonable, in which case, they got to go out and show that there are no property managers out there charging. This isn’t even a property manager. This is, how much could I pay someone to manage my portfolio of LLC? To manage my company, I go get an employee. You’re going to have to tell me that $10,000 is too much to hire a manager to manage a business? No.
Jeff: We sometimes see that with clients who have a third-party property manager and still have a corporation. The corporation is not managing the day to day property, they’re managing that underlying entity, that LLC, the holding company, or whatever it may be. That’s where that management fee is coming from.
Toby: Yup. Good question. Yeah, I would run it through the corp. You don’t have to run it through the corp, technically. You don’t get the same benefits. If I have a C-corp, I can write off 100% of my medical, dental, vision expenses. I can just reimburse myself. Anything that comes out of pocket, even if I have an employer sponsored plan, if I have copays or deductibles, I get to write those off. Or if I have something that insurance won’t cover, I get to write that off. I’ll take that action all day long.
All right. “How does paying your child under 18 help with tax, if any?”
Jeff: This is what we call basically income shifting, or shifting in from you who is likely, hopefully in a higher tax bracket than your enraged child. You can do that. They can invest in an IRA or a Roth IRA. Pretty much so, they’re not paying any tax on this income.
Toby: If they’re under 18, and it’s out of your partnership entity. Let’s go back to this one. Let’s say that the kids are working through LLCs. They’re doing advertising, they’re posting pictures, they’re taking photos, they’re doing the tech stuff. If you pay them, you don’t have to do employment taxes.
Jeff: We’re talking about workers’ comps, state and federal unemployment.
Toby: Old age, disability, and survivors in Medicare.
Jeff: Yeah, which is the big one.
Toby: Yup. All of those, you don’t have to do any of that. You don’t have to do withholding on them, because there’s no tax owed. If they’re less than $13,850, zero. They go above that, there’s going to be some tax, but again, it’s going to be minuscule. It depends on how much you’re paying them if they’re under 18. Don’t be giving them $100,000 a year. But if you’re giving them $15,000 a year to cover the cost of their tuition, clothes, or other expenses, it might be tax free.
Jeff: I pay my minor child, say, $12,000 in a partnership. I deduct that whole $12,000. I don’t have to pay any payroll taxes on it. To them, their standard deduction more than covers that $12,000.
Toby: They don’t even have to do a tax return.
Jeff: I mentioned IRAs, but in this case, I think you would probably go with a Roth IRA.
Toby: I would go with a Roth IRA under those circumstances, because then they’ll never pay tax on the portion of the money. Then you’re going to be like, hey, I don’t care, I’ll pay for this stuff, because they just put $6000, $6500, or whatever it is this year into a Roth IRA. And they will never ever pay tax on that money or the growth ever again.
Here’s the deal. Let’s just say that they put $5000 a year into a Roth. They do that for four years, then they go to college, and they need money. That money’s not locked away. They can take the contribution out at any time tax free. Let’s say that you did this for four years, and you had $20,000 in a Roth, and they had an expense, oh, my gosh, I need to pay for my last semester of tuition, and it’s $10,000. I could take $10,000, knock that thing out, and it doesn’t hurt me at all.
The growth, the appreciation that’s occurred in that, let’s say I put $20,000 in there, now it’s worth $30,000, the $10,000 of appreciation, I can’t touch, or I’ll have penalties. Unless you have a reason like first time homebuyers, medical, emergencies, things like that, there are some ways to even get that money out without penalty. Long and short of it is Roth IRA under those circumstances works like magic. It’s fantastic.
Jeff: There’s a new provision that doesn’t really have anything to do with this, but you may think about it as the 529 plan. You contribute to your child’s 529 plan for 17-18 years, they never go to school. There was a new provision under SECURE 2.0 that will allow you to convert that 529 plan into a Roth IRA. Crazy, but I’m pretty sure. If anybody in the tax world knows that I’m wrong, please let me know.
Toby: Where does the 529 plan go into? Because you didn’t pay tax on the way, you didn’t get a deduction, so it seems like it would be a Roth. You could put that into a Roth, I’d be like, […], because you could put it in a limited amount in 529. You’re not capped, are you?
Toby: Most people don’t exceed the annual gift.
Jeff: I know the ABLE accounts are capped.
Toby: Somebody says they think the limit is $32,000.
Toby: It’s something to look at. Maybe next time we’ll do a little research on it. We’ll write our own question. No, let’s make sure. We’ll figure this out. I’ll see if any other accountants respond. We’re not omnipotent. We are a community. We just try to make the best decisions we can with our limited noggins.
Jeff: I am all knowing. I know all the stuff that I don’t know.
Toby: I don’t know anything that I don’t know. Apparently that’s my problem. All right. “Can you benefit from cost segregation at any time, for example, after 25 years on a 27 1⁄2-year property as an extreme? What is the downside to doing it sooner than later given bonus depreciation is reducing annually at this point and will go away entirely?”
Jeff: If you convert this 27½ property, any part of it to 1245 property, we’re basically saying 15 years or less. I know it’s supposed to be 20 years or less.
Toby: Hold on for a second. Aaron says, I’m a college admissions expert about $500,000, 529 plan contribution limits. What can we roll over into a Roth? Starting 2024, 529 account holders will be able to transfer up to a lifetime limit of $35,000 to a Roth IRA for a beneficiary. Okay, there we go. See, we have smart people out there. Thank you, guys. That’s Douglas and Aaron. Thank you, guys, for responding.
Jeff: Remember, you can also move any excess funds to a different beneficiary.
Toby: Yeah, you could put it to somebody else or…
Jeff: Somebody more deserving.
Toby: I think you could just use it too. You can take it out, but I think you have a tax you have to use.
Jeff: Then it becomes taxable.
Toby: Yeah. If you don’t want to pay tax, then you can just make sure that it’s rolling over to somebody else.
Jeff: It becomes taxable, not on what you contribute to it, but the gain on it.
Toby: Because you never paid tax on it.
Toby: So you always can take that back out. Yay. Somebody’s coming out with a big long one. 529 plan has to be open for at least 15 years, the beneficiary of the account should not change, but you can name yourself as a beneficiary. The maximum allowed to be rolled to a Roth IRA is $35,000.
Jeff: I would not roll it to me or make myself beneficiary, because I don’t want to go back to school.
Toby: Somebody else, we could punish them. They have gone back to some of these wackadoodle colleges. I don’t know what they’re learning there anymore. All right, let’s go.
My dad sat me down. True story. He said, Toby, college isn’t for everybody. You’re pretty good at painting houses. You should stick to that. I’m like, what? And I never applied to college. Luckily, I was good at soccer and somebody said, hey, you should come play here. I was like, really? Okay. That was it. Otherwise, I’d probably be painting houses to this day. Who knows? Life is atrange.
“Can you benefit from cost segregation at any time?” All right, we asked that question. You were about to answer it. What’s the downside to doing it?
Jeff: The longer you wait, and then this extreme case of 25 years, there’s nothing really left to depreciate, Harley. Your 1245 property has probably already been fully depreciated under this scenario. I guess you made the point that you might be able to take that little bit and divide it up between the different properties.
Toby: I’m looking at it. Cost segregation is a fancy way of saying, doing it right. If you buy a house, and I’m sorry I’m going to probably offend a few people. But if you buy a house, and you treat it all as 27½-year property, not the land, we know the land you can’t depreciate, but the box that’s on the land, and you treat it all as 27½-year property, you’re not supposed to do that.
They let you do that, because it benefits the treasury, because a dollar today is worth more than a dollar in five years. A dollar today is worth more than a dollar in 10 years. A dollar today is definitely worth more than a dollar in 27½ years, but they’ll let you do that if you want to. They’ll say, okay, spread out the whole thing. Don’t break it out into its components.
There’s personal property in there. There are appliances, countertops, removable flooring, land improvements, that fence you put up, and all the shrubs you put it in there. Yeah, 27½ years seems fine by us. They let you do that, but it’s not the methodology you really should be using.
A cost seg is breaking it and saying, here’s my five-year property, here’s my seven-year property, here’s my 15-year property, and here’s my 27 1⁄2-year property. The ratio between those is usually about 30%-40% between five, seven and 15-year and about 60% that’s sitting over there in the 27 1⁄2-year property.
Let’s go to this question. They’re saying, hey, what if you wait 25 years? You’ve written everything off 25 of the 27½. You have two and a half years left on everything. If you did a cost seg, I can write off whatever that extra 2 1⁄2 years right now. My seven-year property, same thing, my 15-year property, same thing. Really tiny benefit, if any, and the cost of the cost seg is going to exceed it. They’re not free. Unless this is a $100 million property, it’s probably not going to be worth it.
I don’t really look at cost segs and think of the downside, because what you’re doing is you’re doing what you’re supposed to do, and you’re getting the dollar today instead of waiting decades. If I can get that dollar today, I always want the dollar today. I don’t want it in five years, I don’t want it in seven years, I don’t want it in 15 years, and I definitely don’t want it waiting for 27 1⁄2 years. When you do a cost seg, that’s step number one.
Step number two is, do I bonus depreciate that, because anything less than 20 years, I can write off up to 100% of it? Depending on what year you put the property in service, it’ll dictate what the amount is. Right now, if you bought a property in 2023, and you did a cost segregation, you broke it down, let’s say I bought a half a million dollar house, let’s say $100,000 of that was land, throw that away, so I have $400,000 of depreciable basis. Let’s say $120,000 of that is five, seven, 15-year property, I could write off 80% of that $120,000 right now. And that would be $96,000 off the top of my head.
I would get a $96,000 deduction right now. What is that worth to me? Depends on your circumstances. If you have other rental, or if you have other passive income, all these things, I can wipe out with this big fat deduction. I’m a real estate professional, I can write off the thing against my W-2. I’m an active participant in real estate, then I could write off up to $25,000.
All of a sudden, I’m accelerating my deduction and it gets me my money back quicker. It means I’m not paying taxes this year, and I can put those dollars that I save. Again, a dollar today is worth more than a dollar in five years. It gives me those dollars today so I can continue to grow.
Jeff: I know one of the companies we work with, Cost Seg Authority, you go to them, you give them the exact scenario, and they’re going to tell you before they charge a dime if this makes sense or not.
Toby: Yeah, that’s if you work through us. We’ll give you a link. They do it. Can the depreciation deduction be carried forward? Your passive loss can be carried forward until you get rid of the property or until you have other passive income. When you get rid of the property, this is where it gets weird.
Let’s say you sell a property and I have these passive losses floating around. You know that when you sell a passive activity, the capital gains are actually considered passive so you can wipe those out with your passive loss carry forward from your other real estate. There are so many ways. I just look at it saying, I want to write it off now. Unless there’s a good reason not to, you’re going to have to convince me not to. I just want to see how much of it benefits me.
We’ve had plenty of clients where the benefit was six figures, the benefit was strong, five figures, and it didn’t cost them any. It cost them $3000 and they saved $50,000. They’re like, yeah, give me that. I have $47,000 in my hand that I otherwise wouldn’t have, that now I can go out and do other things with. Fun stuff. Sorry, I just go off on that one. And I know I’m being slow today.
Tax and Asset Protection workshop, we already talked about this a little bit. If you want to learn about land trusts, LLCs, corporations, trader tax sometimes, actually dealer tax, wholesaler tags, how depreciation works, and I’ll give you some cost seg examples, then come to the one day virtual events.
We also had the four-day live event. You mentioned Cost Seg Authority. Erik Oliver always comes out and gives a presentation on cost segregations. Again, if you’re an Anderson person, they’ll do your analysis for free. They’ll tell you what the deduction is going to be before you even pay them a dime. That way you can decide whether or not it makes sense.
By the way, you can make these deductions. You can make this election up until you file your tax return plus extensions. If it’s you individually, you have page one, Schedule E property on there, you could be making that cost seg election all the way up until October 15th. We were doing it on a few people that saved their bacon.
Number of people wrote in this first year. I know one client in particular with zero tax. They’re like, I cannot believe it, because they’re real estate professionals. They went from paying a lot of tax to paying a little in tax, simply because they retired and utilized the benefit of the tax code to make them some extra money. Yay, we like that.
Okay, Jeff. “We need to move from a sole proprietor to some form of business entity. I’m an active trader, doing well, I want to protect my account, as well as provide the best solution for retirement contributions and charitable contributions. C-corp? Something else? Fully happy breaking even or leaving money in the corp for future purposes.” What do you think?
Jeff: I’m not a fan of the whole professional trader insecurities.
Toby: They have a 5% success rate.
Jeff: And a lot of landmines out there.
Toby: You may be part of that 5%. But as the guys that do the taxes, even some of the great groups that are out there, thousands of people, and everybody’s blah, blah, blah, we’re all killing it, 80% lose money.
Jeff: Disregarding his last couple of questions because they are important, if I’m doing really well, as a trader, I don’t think I want to be a trader. I think I want to have those as capital gains.
Toby: Right. Here are the rules. There is no such thing as a trader under the code. There’s a publication on it. I have to have regular frequent and extensive trading, catching the daily movements in the market. Here are the rules. Are you ready? Golden rules.
Golden rule number one is, it’s really tough to do this if you have a W-2 job. You got to hold for less than 30 days, period, full stop. If your average hold period is more than 30 days, you’re not a trader. At least 750 trades a year, I would say, is a good number. You need to be trading about 75% of the trading days, otherwise you’re not frequent enough.
There’s a lot of court cases, they’re all over the place on it, but they come down very consistently. That 30-day average hold is a bright line test, boom, you’re out. You take too many vacations, boom, you’re out. It’s not how you make your living, it’s not substantial. Again, if you’re less than a $25,000 account, don’t even think about it.
Here’s the deal. I don’t like traders. I don’t want to be a trader. They like to audit everybody, because it’s facts and circumstances. They apply the facts and circumstances which it’s the old adage. What do you call an attorney with an IQ over 70? Your Honor. You have to go in front of a judge, and you don’t want to be paying the freight to go get that opinion.
The reason people do it is because an investor, let’s say that Jeff is not a trader, and he has a bunch of expenses, he can’t write them off because he’s an investor. He doesn’t get to write those off. He goes to some seminars, he goes to some workshops. He pays to be a part of a bunch of groups, he subscribes to a bunch of stuff. It doesn’t get business deductions, he’s toast. How about his home office? No, he can’t.
Me as a trader, I say, I’m a trader, now I get to write those off. I write them off of my Schedule C, but my income all goes on to my Schedule D, which is where my capital gains are.
You guys look at me like, oh, I don’t even know what that means. Schedule C is where you have an active business, but there’s no income. Schedule D is where capital gains go, but you don’t have expenses. You’re writing your expenses off over here and putting the income over here. You may as well just say, please audit me. Please ask me what the hell I’m doing. That’s number one.
Number two, if you want to write off the losses from your trading, which a lot of people do because trading is inherently risky, and more often than not people lose money at it, especially the newbies, you’ve got to be very careful. ‘ve got to learn. There’s a learning curve in this. You don’t just go throw $300,000 at it and hope something good happens. That’s called gambling.
We live in Las Vegas. We know what happens when people gamble. They keep building billion dollar buildings. The Fontainebleau is $3.2 billion. How do you think they’re paying for that? It’s not because the shrimp cocktails are so good, it’s because people are gambling. They’re doing all this stuff, and they’re losing money. They’re passing it on.
The reason people do trader status is because then they do something else. They make a mark to market election so they can write off their losses, which is even more asinine. You treat everything like you sold it on December 31st, even if you didn’t. I’ve seen people blow themselves up this way too, because stocks go up at the end of the year, they go down, tax time, you sell the stock, and you can’t even cover the tax on it.
Jeff: And you have to let your broker know that you have made a mark to market election.
Toby: And you have to do it the year prior. Anyway, there’s all this nonsense. Here’s the way to do it with no nonsense. Are you ready? Let me see if I could actually write this up. I’ll make it really simple. You’re going to put your cash in this guy right here. Matt, we’re going to have to restart this computer at some point, because it won’t show me what I’m drawing.
Jeff: I don’t think it’s been restarted since 2022.
Toby: Yeah. Okay, we put money into an entity. This is going to be an LLC. We have you be an 80% owner and the corporation be a 20% owner. The reason we’re doing that is because if it makes money, 20% of those profits flows into the corp. And now it can do things like pay you a salary into a retirement plan. You could defer the whole thing into a 401(k).
Hey, I made $50,000, $10,000 of it flows into the corp. You could pay yourself out $10,000. You have the employment taxes, so probably closer to eight into a 401(k) if you wanted to. Or you just use all that money to write off your expenses.
You do the 280A, the administrative office for the home, cell phone, computer, get your kids involved, get everybody involved, and start just wiping out that extra 20% so that you just lowered your tax bill. That is perfectly fine, and now we’re not sitting here dealing with this trader status. What is the corporation doing? It’s not trading, it is managing an LLC, which nobody has ever argued that a corporation can’t manage an LLC.
Jeff: You shifted 20% of the income over the corp. Is there any way to shift more money over to the corp?
Toby: It’s a good thing you asked that. We do a guaranteed payment to our partner, and we pick an amount that has nothing to do with the profit. Let’s say that you knew that you needed to get an extra $25,000 over to that corp. You would just say, all right, I will manage this, I would probably add some real estate entities into it, other types of investments, or possibly another line of business into the corp. It could be a side gig, it could be something, but I’d had the corp doing more activities, and then you could pay that as well.
It comes off the top. In other words, you’re not deducting it as an individual. What it’s doing is reducing the amount of tax that you owe by reducing the amount of income that’s actually going on your return. Your return doesn’t say, I made $100,000, and then here are my expenses. Let’s say there’s $150,000 of it that went to the corp, it shows that you made $50,000. And it is still capital gains. It doesn’t mess it up. You don’t get weird surprise taxes, you don’t have mark to market elections, and all that fun stuff.
This is the strategy that I prefer. I have this on the YouTube channel. It’s How To Structure A Trading Business. I think it is still floating around out there. There are only 700 videos on that site. If you type in a trader, I’m sure you’ll see how to structure a trading business. It’s one of the more popular videos that we put out. You can just sort by the most popular videos, and it’s going to be in the top 10 somewhere. That’ll explain it too. I know, we’re already late.
Jeff: I was going to ask a question, but let’s move on.
Toby: “I currently own a home in Oregon. I’m looking to purchase an investment property in another state and plan on using an LLC or S-corp.” Do not use the S-corp, let’s just make that clear. Do not own a piece of property that you’re going to live in or that you’re going to use as an investment property in S-corp. You take it out to refi it, you’re going to get hit with a tax event for all that appreciation as wages. It sucks. “I eventually would like to make my investment property, my primary residence, and my current residence, Oregon, an investment property. What would be the easiest way to go about this?”
Jeff: For me, the easiest way to go about this is not to buy the Arizona property and make it an investment property. I’d buy the Arizona property and make them my primary. I would skip the delay, the extra steps, if possible. Buy the Arizona property, make that my primary residence, and then make my Oregon property the rental property.
Toby: Yeah, I hear what you’re saying. Let’s say they’re buying an investment property. Eventually, they say they like to make it their investment property. They maybe three or four years down the road. You just buy that Arizona property. I would use a land trust and an LLC. if there’s going to be debt.
If there’s not going to be debt, then I might just use the LLC and make it part of a structure so that you don’t own an Arizona LLC, but you own a Wyoming entity that owns the Arizona LLC. Don’t worry, this isn’t going to hurt you in the future, because you can always just distribute that Arizona LLC out to yourself if you’re going to own it as a primary residence. And then you use it as an investment property and wait.
The Oregon property, I’m probably going to own that in a personal property trust, we call it a personal residence trust just to keep your name off of it. We don’t need to do anything else until you make it into an investment property. Once you make it into an investment property and you move out, then I would still use an LLC.
The thing to know is that when you’re in Oregon or any state, and you leave a personal residence that you’ve lived in as your principal home, if you’ve lived in it two of the last five years, you could exclude up to $500,000 of capital gain if you’re married. If you are looking at this situation, I don’t want to lose that.
I might leave the Oregon property. If I’m going to keep that puppy, I am going to be really tempted to sell it, and this is going to sound odd to an S-corp, at some point in the next three years to step up my basis. I would do it on an installment sale. I would elect out of the installment sale, I’d have zero tax, and now I have a step up and basis on that property so I can depreciate it even higher.
Jeff: I didn’t really think about that, because it starts the clock on 121.
Toby: If I move out and I make it into an investment property, I have three years to sell it and still get my 121 exclusion. You could sell that. Let’s say that your two years in your Oregon property is nice and tasty, it’s appreciated nicely, and you’re thinking, I really don’t like going up to Oregon anymore. I’d like to stay in Arizona, you could sell that Oregon property, get your 121 exclusion, and reinvest it in an Arizona property by doing a 1031 exchange. You could 1031 out of Oregon and Arizona, and literally step up your basis and pay no tax on the sale of that property.
If you want to keep it, let’s set up an S-corp and sell it to the S-corp. You’re going to want us guiding you through that transaction or somebody guiding you through that transaction, because it’s potent. But with all great tax strategies, there’s some give and get. You’ve got to make sure you don’t step on a landmine. You want to make sure that you are good.
All right. “If I invested $30,000 in a marketing class to start a marketing company, do I have to amortize it over 15 years to see any of it back? Can it be a business investment and get it all back?”
Jeff: The only entity or person who can use this deduction is your C-corporation, because here you’re saying it’s a new line of business for you, you’re learning to be marketing. Sole proprietors out, partnerships out, S-corp is out, but it can be a working condition fringe benefit on the C-corporation, which means they can reimburse you or have a shareholder loan in this case as a startup expense.
Toby: Yeah. I’m assuming that they already did the marketing class and then they set up the company. If that’s the case, I did the marketing, I learned how to do it, and I set up the company after, I’m toast. I get to write off $5000 in startup expense, and then I’m going to amortize $25,000 over 15 years. You don’t lose it, but you’re writing it off over 15 years. $25,000 over 15 years, boo. You still get to write it off, though. If you close the company, then you accelerate that and write it all off.
This is where it gets fun. Let’s say that you bought a marketing class, you have six months to go through this marketing class, and you set up a company somewhere in between. Now we’re looking at the value of what you’ve already completed that’s going to be part of the startup expense. Up to $5000 is write off immediately, the rest is over 15 years.
Everything beyond this point, the value of that class, it could just reimburse you for, because now you’ve transferred the benefit to the corporation or to the business. The business is saying, hey, this is helping you out in this marketing realm. I need you to learn these skills, I need you to do more. There are ways to do it. Jeff is absolutely right, I’d probably be using a C-corp under these circumstances to make sure the IRS doesn’t have an avenue to come back at me.
Jeff: And I probably would document this somewhere saying, we need you to take this course in your situation where it happens after business formation.
Toby: Yeah. You’d say, hey, this is what the company’s doing, this is our line of business, you are helping our business by going and getting this. This is how it works. When I was at CLU as an undergrad, I was sitting there and I was in a business class, where there were all these MBAs from Boeing. Boeing was paying for their engineers to get MBAs.
Me sitting in the same class, paying the same dollars, I can’t write it off. Boeing can, because it’s making them better at their position. Me is preparing me to do something new in life to get a degree that is worthless until I do something with it. I wasn’t getting my MBA. Business degree, yay, so you can go to law school, or I could go back into accounting. This is the last question.
Jeff: We’re not too bad.
Toby: Yes, only a little bit late. “Is 1245 property subject to depreciation recapture if the rental property is sold with capital gain?”
Jeff: Here’s what happens.
Toby: What is 1245 property?
Jeff: 1245 is your personal property, anything below 20 years or below.
Toby: 1250 is your structure, right?
Jeff: Yes, your real estate itself.
Toby: The box. 1245 is the stuff in the box, land improvements, your driveway, your shrubs, your appliances, your countertops, specialty electric, removable like your blinds, your carpet, and your linoleum.
Jeff: 1245 recapture works basically like this. I buy a tractor from my farm, I fully depreciate it, and three years after I buy it, I sell it to somebody else. Since it’s fully depreciated, I have no basis, but I have a gain of $10,000 on my tractor. That is subject to recapture up to the amount of gain.
Toby: Up to the amount that I paid too. If I paid $5000 for that tractor, three years later, I sell it for $10,000 because Covid is going on. I have gain on that, and I have recapture on that.
Jeff: Yeah, you can’t recapture any more than you’ve depreciated to start with.
Toby: Let’s say I depreciated $5000, am I going to have to pay $5000 of recaptured ordinary tax?
Jeff: In the case of I sold it for $10,000, you’re going to have to pay recapture on that.
Toby: Yes. The easiest way to think about this, guys, is that when you have 1245, which is tangible property, you’re going to pay ordinary income tax. Let’s say I bought a piece of equipment, I got a deduction at my ordinary rate, and I can actually write it off against my ordinary income. Then if I sell it and I have gain, I have to pay recapture up to the amount that I depreciated because it’s like, hey, it’s not fair.
You wrote it off, and you’re not going to have long term capital gains because that’s lower tax. We make you recapture if you could or did depreciate it. The 1250 property is the structure. In that one, they limit your recapture to 25%. Capital gains is up to 20%, recapture is up to 25%. Congress wrote these weird rules so that you can’t completely hose them.
Jeff: Here’s what we do with rental properties. You’ve done cost segregation, you have all this 1245 property, kitchen cabinets, flooring, and on and on and on. When you sell your rental property, you’re selling the box.
Toby: You’re selling the box, or you’re selling any of that stuff that you just depreciate.
Jeff: But you’re going to say, I got all these brand new kitchen cabinets I just put in five years ago. Well, you’re abandoning those.
Toby: Bye. Yeah, there’s no gain on it.
Jeff: There’s no sales price, there’s no gain on that property. Your sales price is on the box.
Toby: Do not put it in your purchase and say, oh, I’m buying all the land improvements, this, that, and the other. What you’re really looking at is, I don’t have a tax as long as it’s useful life is over, or it’s going to be abandoned. If I sell a property and I have some carpet in it, and they’re already like, we’re tossing all that, then I’m not putting the carpet on the sale.
Was that item sold? No. If I wrote it all off, do I have recapture? No, there’s no gain on it. I only have to do recapture if there’s gain on that item. You want to make sure that it’s specifically excluded. Don’t screw that up.
Tax Tuesdays, recordings, you can always go to my website. How many videos are we up to? 669 videos. I put one out about every few days, so you can come out. Yeah, we’ve been doing this just for a minute. You can always come out there and get lost. You could look at those fun ones. There’s how to make your assets invisible, living trust 101, and endless passive income. That’s the most surprising that you’ve ever done.
Jeff: I have to watch that one.
Toby: Actually, I’ve watched it and I was like, it’s pretty interesting. A year ago, I was like, what did I say? It was the 70/30 rule, 30-30-30-10, and lever. I was like, yeah, it’s concise. It’s easy to follow, so it’s got some pretty good views.
How to pay zero capital gains. Yes, it’s illegal. I always start off by saying don’t sell it. This way, I’m not paying tax on your capital assets. Reduce taxes at the tax and asset, that’s not really a video. That’s something everybody watches if they’re going to come to the Tax and Asset Protection event.
All right, there’s that Tax and Asset Protection workshop. By all means, pop on and sign up there for free. You can learn all about great entities. If you have questions in between these events, by all means, send them in to taxtuesday@andersonadvisors. Eliot looks at them and grabs questions that Jeff and I have to answer. Sometimes Eliot is sitting in this chair quite often too, sometimes it’s Troy, sometimes other people. Everybody does a really good job. We’ve been doing these for a long time. I forget what episode we are at, guys.
Jeff: I think we’re at 209 or something like that.
Toby: We’re over 200, right?
Toby: We’ve done over 200. We’ll just keep doing them until somebody makes us stop. If you ever have questions, come on in and ask. We have a great team. I wanted to say thank you to Amanda, Dutch, Troy, Tanya. Jared. Anybody I’m missing, I apologize. There’s Eliot, of course, Patty, Matthew, the whole staff that comes in and answers the questions. There are folks answering on the YouTube channel as well. Thank you guys for joining us via YouTube, if that’s where you’re at. We really appreciate your coming around.
If you know anybody that would benefit, by all means invite them to the Tax Tuesday. We like to answer questions. We like to spread tax knowledge to the masses. It makes us feel good that we can clear up some of the confusion that’s out there and hopefully help some people.
Jeff: We like making you smarter, because it sometimes makes us a little smarter.
Toby: Always. We learned something new tonight. Thank you to the folks that participated by answering questions. You guys rock. Good luck to you. There’s a couple of questions that are unanswered. Actually, there’s 14, so we’ll answer those.
What I’ll do is I’ll mute Jeff and I, make us go away. If you’re waiting on a question, don’t leave. Stick around, we’ll answer it and make sure that we get you a prompt response. We will see you in two weeks. Thanks, guys.