Happy Holidays! In the last episode of the year, Toby Mathis of Anderson Advisors goes through a long list of tax questions from listeners to give quick answers, such as whether you can turn a 1031 exchange property into your primary residence. Submit your tax question to firstname.lastname@example.org
Discussed in the Episode
- When you gift more than $15,000 a year to one family member, do you have to pay tax on it? Any individual can give $15,000 to another individual without having to submit a gift tax return, but a gift tax return is required if the amount exceeds $15,000
- How do I pay taxes on rental properties that I own in Canada while I am in the United States? The United States accepts Canadian LLCs, but still charges you tax on all income generated from any properties anywhere in the world
- Can I turn a property that I acquired through a 1031 exchange into my primary residence? Yes, you can convert it under Section 121
- What is the difference between a family trust and a living trust? The same type of document, but a family trust is irrevocable and for the descendants; a living trust can be revocable and changed
For all questions/answers discussed, sign up to be a Platinum member to view the replay!
Go to iTunes to leave a review of the Tax Tuesday podcast.
- 1031 Exchange
- Real Estate Professional Requirements
- Entity Formation
- Capital Gains and Losses
- Toby Mathis
- Anderson Advisors
- Anderson Advisors Events
- Anderson Advisors on YouTube
- Anderson Advisors on Facebook
- Anderson Advisors Podcast
Full Episode Transcript:
Hey, guys. This is Toby Mathis, and you’re watching a very special Tax Tuesday. I am not in the continental United States, and Jeff has been out on a cruise ship. And it’s the holidays. What we’re doing is we’re going to record a bunch of questions and answers for you guys. I’m just going to go down a huge list today. I’m going to answer twice as many questions as normal, but I don’t have Jeff to bounce things off of, so I get to just give you my opinion on things, which could be very dangerous.... Read Full Transcript
Anyway, I hope you’re having a great holiday season. We still have our accountants, professionals, and support staff on to answer your questions, so you can still ask questions in the Q&A. You can even chat, although I would probably say go right to the Q&A if you have questions. I will not be able to see your chat, which I love to do. I love to go back and forth with people and communicate with you guys. It’s just so much more fun, but I won’t be able to do that today, so I’m just going to go through a huge list of questions.
We are going to do a speed round. Let me just kind of go over a bunch of the questions we’ll be going. I’m going to go through as much of this list as humanly possible. I’m not going to go for two hours or three hours, so I’m just going to start ripping through them. We’ll still target for an hour. You guys know me. Sometimes I hit it, sometimes I go a little over.
In our last Tax Tuesday, somebody was asking about staking. I said I’d actually dig into it. We will answer that. “How is staking crypto taxed? And how does that differ than mining?” I’ll go over that.
“When you gift over $15,000 a year to one family member, do you have to pay tax on it?” We’ll talk about that.
“What are the best ways for day traders to manage their taxes?” We will discuss that as well.
“What is the best structure, business entity, for a foreigner to own real estate rental properties in Florida?” A very good question, we’ll go over that.
Then somebody says, “Can you talk about the 3.8 NIT or net investment income tax? In particular, who/which types of entities are subject to it when you have it?”
It seems like some of the new regs coming out will make it; tax ethical to pass-through entities and to income that would otherwise not be taxed, for example. “Two individuals are doing all their trading through a partnership which is owned through by individuals and a C-corp. Can you cover the terminology of how pass-through entity applies here, and who and where the net investment income tax might hit?”
“When making an end-of-year purchase to write off against my taxes, does the purchase has to be made by December 31st or can I do it in January?” Sounds like if I want it for this year, so we’ll go over that.
“Hello. I live in Texas and invested in a syndication in 2020. I received the K-1 but never filed the state tax for Indiana. Do I need to file the state tax? Can I carry over the passive lost to next year even if I don’t file the state tax?” Thanks, so we’ll go over that.
“How do I pay tax on rental properties owed in Canada? I inherited properties in Canada for my Canadian parents, how do I pay taxes on those here in the United States?” We’ll go over that.
“I am a full-time wholesaler and currently have the business as a C-corp to avoid dealer status. Will I qualify as a real estate professional since I’m a full-time majority shareholder-employee materially participating in the real estate acquisition activities?” Great question. We’ll go over that.
“I’m going to sell my main residence and retire my vacation home. I live in Los Angeles. How do I avoid or reduce capital gains taxes? I’m counting on proceeds from the sale to help fund my retirement.” Good question and we’re going to answer that, too.
“I’m a high-income W-2 individual seeking advice on how to reduce taxes using CRT conservation easements and other non-traditional methodologies.” Kind of an open-ended question, but we’ll get into that. I literally just grab all these questions right out of what you guys send in. I like to just kind of rapidly shoot through them.
“Can I turn a property that I acquired through a 1031 exchange into a primary residence?” Great question, and I’ll answer that.
“I have a condo which was only rented out for nine months. It is on the market, but we’ve not found anyone yet. On my tax return, can I claim expenses for the entire year?” Good question, so I’ll absolutely answer that.
“If retired parents want to offload their rental portfolio to me, what is the recommended way to do so? Can they possibly defer their taxes? And what should I set up to be as tax-efficient as possible?” Great questions.
Living Trust. “My siblings and I inherited our parents’ home. We were advised to get a family trust for the property. What is the difference between family trust versus a living trust? Should we do both?” Again, great questions. These are really interesting.
“Well buying rental property to make my EFC increase that I pay for my kids in college.” If you’re not familiar, it’s the ability to do need-based government assistance. I think it’s grants and loans. “Also, if I buy a rental property in an LLC, will I pay fewer taxes than if I buy in my personal name?” Really good questions. You guys are going to notice we’re going to bust through a lot of them today.
“Can my S-corp reimburse me for moving expenses and repairs made to my home based on the business percent use?” Good question.
“My husband owns an S-corp. I’m a sole proprietor. If we travel to Hawaii and conduct my husband’s S-corp annual meeting, which portions of any of the travel costs can be tax-deductible?” These are just really good questions today. I don’t know what it is with you guys if you’ve been drinking your carrot juice or something because these are really intelligent, well-thought-out questions.
“If you’re going to receive a large sum of money, how do you keep from paying extra taxes or face penalties when spending it?” and, “Can an irrevocable trust protect my assets from taxes?” This is interesting.
“I’m referred to you by Mike G. I think the main premise here is regarding taxes on receiving a lump sum of money. My question is probably the same or similar to most in the group, which is the best way to reduce the amount of taxes we will have to pay on the lump sum of money if I have an LLC. What are some tax reductions? And if you live in a different state, would it be a good idea to set up a trust or LLC in Vegas, Delaware, Wyoming to reduce the amount of taxes? Is having an irrevocable trust the best asset protection for the lump sum of money?” And then the rest of these are going to be if we have time.
“In California, how do you change the title of a house to a trust or land deed without causing an increase in the property tax?” That was Prop 13. I think it’s Prop 19 now. I think it’s still 13, but they added some more, and I’ll go over that.
“How can large capital gain and recaptured depreciation be reduced?”
“I received bad advice about selling an asset and made too much money this year as a realtor.” It’s always a tough one, so those things go together.
“Buy and hold a property. How long do I have to hold to pay less tax when sold 1031 exchange?”
This is going to be a good one. I see the 60 days. Somebody says, “We withdrew money from an IRA to fund a real estate purchase with the intention of reselling the property within the 30-day window. The purchase took longer than expected and the property resale will now not close until after the 60-day window, and the initial funds need to be paid back. I have access to another form of company, 401(k), and I’m exploring options of either doing a direct or indirect rollover or even withdrawal to bridge payback of the initial IRA until the property closes. What tax pitfalls or complications are created by doing an indirect rollover from the 401(k)?”
Okay, so we’re going to just start busting through these. That’s a good question. A lot of these are a little complicated, so I’m going not to waste time on these things. I’m just going to start blowing through them.
“How is staking crypto taxed?” The IRS gave a notice. It’s called notice 2014-21 if I’m not mistaken, and it covers things like crypto mining, creating, and airdrops, and things like that. Here’s the best answer I can give you on staking. The IRS has not addressed it specifically. The AICPA has asked for guidance on this issue with the recommendation that they treat it like mining.
Knowing what staking is, which is really putting your computer out there in the system to verify transactions and getting paid for it, that would be ordinary income in my opinion. I believe that it’s going to fall similar to mining where you’re going out and doing an activity to generate the coins. It’s not much different than staking, so I think it’s going to be ordinary income.
The only other way that it can be treated is the creation of an asset. If you create an asset, then you wouldn’t be taxed on the creation of the asset. It’s possible, but I think I’ll get a 5% chance that they would treat staking as the creation of an asset without your activity because you are literally putting a machine out there and allowing it to be used to verify transactions, so you’re verifying a transaction and getting paid.
I believe staking is treated just the same as mining. It’s going to be ordinary income, and depending on whether you materially participated, will determine whether or not you have a self-employment tax on it or old age, disability, and survivors. If you do, then I would tend to be putting these things, perhaps, in another vehicle. But that’s a topic for a different day.
I would just say how a staking crypto taxed. I would say right now, unequivocally, it’s going to be ordinary income. Until the IRS gives us any more guidance, you’re really taking a risk if you decide to treat it as non-taxable. It doesn’t mean that you might not, but when the IRS does come out, you don’t want to be sitting there and get the three-year audit for having done it wrong for a few years.
I’d rather under this case say, look, they gave us notice. They’ve been very clear. If you’re creating an asset, if you’re creating the Bitcoin, or if you’re getting airdrops, if you do a hard fork, all these things are taxable transactions. The only issue is whether this is active and you’re doing something different than just owning something to get the airdrop.
You are doing an activity that’s going to be treated as ordinary income. That’s similar to some of the airdrops to your ordinary income as well. Then, did you materially participate will trigger whether or not there’s a self-employment tax on it.
If you’re a minor, there’s no way I could see not actively participating, unless a company that did the staking or did the mining, you’re a silent owner and somebody else managed it. That’s the only way you can get around it. But if it’s just you, I think it’s going to be ordinary income and I think you’re probably going to be looking at paying self-employment tax. I would treat it that way and take action to make sure you minimize those taxes.
“When you gift over $15,000 in one year to family members, do you pay any tax on it?” You’re talking about the gift rules. Any individual can give $15,000 to an individual, and it is not something that requires a gift tax return. We all have a huge gift tax exclusion. It’s over $11 million.
We can give away $11 million to people if it exceeds $15,000 in a year. We file a gift tax return saying I’m using part of that exclusion. You don’t have to file anything, you don’t have to pay any tax on giving somebody up to $15,000 a year. If you exceed it, like if I say, hey, Matthew, I’m going to give you $100,000 this year, I would file a gift tax return, Matthew never has to pay tax on it, it’s the giver that would have the gift tax. They don’t have to pay tax on it. You don’t have to pay tax on it, but you also don’t get a deduction.
If you really want to give family members money, I would have them work in your organization so you at least get a deduction for it, so you’re not paying tax on the $15,000. Chances are, if you’re giving somebody $15,000 a year, your tax rate is probably higher. You might be better off saying, hey, why don’t you do something with my business and I’ll pay you? In that way, they’re paying no tax on it and you’re getting a deduction.
“What are the best ways for day traders to manage their taxes?” The term day trader gets thrown around. A trader in securities is somebody who plays the daily movements of the market, and is a frequent and continuous user or worker in that market. I say worker very deliberately because that’s the way the court keeps going back as they keep saying it’s a trader business if you’re going to be a trader.
The reason that’s important is that if you are a trader, then you can deduct 162 deductions versus 212. Am I an investor or am I an active trader business? The best rule of thumb I can give you is you got to be doing at least 750 trades a year, you got to be trading on at least 75% of the market days. Anything below those, they’re going to blow you right out. We’ve seen $15 million active traders blown out because they traded four months out of the year, or inconsistently, or held longer than a couple of days. If you have long-term gain, you’re going to get toasted, too.
The way I look at it is I don’t want to be in that realm. You’re literally writing trader in securities or trader. You’re filing expenses on Schedule C and your income on Schedule D, so there’s no income. You’re running a loss every year, more than likely.
If you want to deduct that loss against your other income, they make these mark-to-market elections so that you could take the ordinary loss and use it to offset other income. Again, it gets complicated quickly and you are just putting a bull’s eye right on your forehead saying please audit the crap out of me, which could be way more painful than any benefits you’re getting out of this thing. What I tell people is, look, don’t fight with the IRS. Create two businesses, one that’s a partnership that owns the underlying assets, and another one to manage that and do other activities, which would manage the entity.
Let’s say I put together an LLC taxed as a partnership that has a brokerage account, there are two things that get triggered. Number one, I could have that corporation owning a percentage so that I’m not paying the corporation anything. It’s just making a portion of the revenue and it could use that to offset any of the expenses that it has. It’s basically managing the enterprise. It gets to write off ordinary and necessary business expenses.
Number two is, you could pay it a guaranteed payment. Like, hey, I’m a pretty good trader, maybe not the greatest, but what I want to do is know that I’m getting $20,000 a year into the corporation. Regardless of the profitability, you would say, hey, I’m going to enter into an agreement and I’m going to pay a reasonable amount of money based on the size of the account.
Basically, could I hire somebody to run my business and manage this LLC? Could I hire a third party? What could I pay them? A $1000 a month is nothing, but it could be significantly higher. Most people aren’t going to manage an entity for less than getting probably looking around $50,000 or something like that if you’re hiring somebody who’s going to full-time, so then it matters about the amount of the activity.
If I am going to do stock trading, I’m going to probably blend it in with the rest of my planning. I usually have a real estate holding company. I’ll have a securities company. I may even have an entity doing some loans or has assets that’s doing loans, even friendly loans to myself on liens and things like that. But I may have an entity, a corporation that’s managing them all.
That corporation owns a piece of the various entities on the trading activity. It needs to own probably a little bit greater peace, depending on how much money is being generated in that trading entity. That trading entity would need to be taxed as a partnership so that the management fees do not flow onto your 1040. If they did, they would go on your Schedule A as a miscellaneous itemized deduction.
If you’ve been watching this, you know that we did away with miscellaneous itemized deductions in 2017 under the Tax Cuts and Jobs Act, so you wouldn’t get zero deduction. You will not get a deduction if this is a disregarded LLC or if you’re doing this in your name, so the only way you’re going to write it off really is if you’re setting up an LLC taxed as a partnership with a corporation as its manager and as a member as well. Sometimes, you have to own as much as 20%.
If you need help on that, I’ll obviously reach out. It gets complicated quickly, but trust me, if you keep it simple, you don’t get molested by the IRS. If you do this crazy trader status stuff you absolutely do. That’s my experience, 23 years of doing this.
“What’s the best entity for a foreigner to own real estate rental properties in Florida?” Here’s the deal. In the United States, if you’re a resident, if you’re a citizen, you’re paying tax on all of your worldwide income no matter where it’s located. We always look at that, number one. If we have a foreigner that is not a resident of the United States, then they’re subject to their local rules.
You’re going to have two things. The activity in the United States and you have the activity as it relates to that particular country. There are only a couple of other countries that tax worldwide income, so your chances are, you’re not going to have to report that income in your local jurisdiction. Instead, you’d be doing a 1040-NR in the United States.
If it’s a partnership, you’d be doing the partnership in the United States or LLC taxed as a partnership. You’d be doing it where it flows through to your 1040-NR as rental income. You would pay a tax in the United States on that portion.
Probably, more than likely, you’re not having to report it on your local home tax return depending on where you live. But if you did have to report it, chances are, if it’s a major jurisdiction like you’re in Europe or something, we probably have a treaty, and there’d be a tax credit for the United States tax, and you would offset your local tax with that tax credit depending on the treaty.
These are real facts and circumstances tests. I can’t give you a straight-up answer because every jurisdiction is different. For example, Canada doesn’t recognize LLCs. They tax them as corporations. Most places don’t really care. They’re like, hey, United States, do whatever you want. Pay tax in the United States on that income and we don’t tax it, but we would still have to find out.
What’s the best entity? If you have rental properties, more than likely, it’s going to be, in Florida, for example, you could do a land trust and avoid having an LLC entirely because you have asset protection for the land trust. If it has a mortgage on it, the land trust avoids the doc stamps on the transfer so you could avoid a pretty hefty tax bill.
If it’s I-don’t-have-any-mortgage-and-I-sold-it-in-cash, you could do an LLC. Then a lot of this is determined by, do you have other rental properties in other jurisdictions, and does it fit in with an overall plan?
Generally speaking, whenever you have a rental property, you’re going to want it to flow through because it’s considered a passive activity. It doesn’t have to pay Social Security taxes. We don’t want to change that, nor do we want to create a double tax situation on a rental property, so chances are, it’s going to be a land trust and/or LLC. Capiche? All right.
“Can you talk about the 3.8% net investment income tax, in particular, who/what type of entities are subject to this?” They’re talking about pass-through entities now. And somebody said, “For example, two individuals are doing all their trading through a partnership, which is owned by individuals in a C-corp. Can you cover the terminology of how pass-through entity applies here, and who and where net investment income tax might hit?”
Here are two things. First off, the net investment income tax of 3.8 is on all capital gains, interest income, royalty income, investment income of any kind. You’re going to get dividends, your capital gains, all this is subject to the net investment income tax if your income is over a certain level. Of memory, I think it’s $200,000 for an individual, $250,000 for a married couple. It doesn’t matter really where it comes from as an entity. It’s going to keep its nature with a small exclusion of if it’s an S-corp, then they figure that it’s a trader business and you are not going to have to pay net investment income tax on the profits that come out of an S-corp.
What’s being proposed right now in the Build Back Better is that all types of income are actually subject to the net investment income tax, but they increase the threshold to 400,000 or thereabouts. I haven’t seen the final. Obviously, as I’m sitting here today, we only have it passed in the house. It may have passed by the time you watch this video.
That provision is what we’re looking at, so it’s a surcharge on top of everything, which is why you hear people say capital gains rate, the top rate being 20%. A lot of people say it’s actually 23.8% because if you are in the 20% capital gain category, you are necessarily already above the net investment income tax threshold, because the 20% is really when you’re over half a million dollars as a single person or close to $600,000 married filing jointly. It’s really as you get up there in wages, so you’re well beyond the threshold of that net investment income tax.
Everything that’s 20% is really 23.8%; that’s what they’re talking about. But the net investment income tax is not assessed on active profits, active income, your W-2 income, your things coming off of like a K-1 from an S-corp. Those are not subject to the NIT. They’re talking about expanding it and making it, and then just lifting that limit, so keep your eye on that one.
As of right now, regardless what you’re doing, if you’re trading, chances are it’s going to be assessed. The only exception that I’ve seen, I believe, there’s a possible exception if you are a trader in securities with the mark-to-market election. But again, you’re doing daily movement at the markets, more than 750 trades a year, more than 75% of the trade days, so if there are 220 trade days, you got to have like 170 some days where you had trading activity. It could be a pretty tough hurdle to clear, but it’s a possibility there. I know that there’s been a lot of activity.
I wish I could give you a much clearer answer, but there are some things up in the air. As of right now, I think you’d just be paying that 23.8% only if you exceed the threshold, so it’s not on every dollar, it’s only when you get over single again. I think it’s $200,000, or married $250,000.
“When making an end of year purchase to write off against my taxes, does the purchase need to be made by December 31st or can I do it in January?” Here’s the rule. I assume you’re talking about taking a 179 deduction or 168(k) where you’re doing bonus depreciation on something that you purchased and put into service during the tax year, so there’s your answer right there. You have to purchase it and you have to put it into service during 2021, if you want the deduction here.
That’s how it works. Cash basis taxpayers, that’s what we’re doing. I can’t see it being that different, even for accrual, but you’re buying it, putting it into place during the year to take advantage of either of those two provisions I talked to you about, 179 and 168(k). You actually have to take delivery of it and put it into service.
I think if you took it and it was in a warehouse, potentially you could do it but it’s much, much, much easier depending on what you’re buying. Like if you bought an airplane or something like that, you wanted to accelerate from seven years to take a big chunk, you got to put it into service during the year. It could be one day, but you still have to put it in service. Or if you do an Airbnb on a property, technically it’s not a rental if it’s seven or less average usage.
If you buy something in December, you close on a property, you Airbnb it one time or made it available for Airbnb, chances are, you’re going to get that deduction as long as you can prove that you put it into service and made it available for use. This comes up all the time, by the way, guys, people especially that are rehabbing properties and trying to put something into place before the end of the year.
I just talked to somebody who it’s not going to be ready. They’re not going to be at a close on that property till January because the construction went a month over. They would have been able to put it into place. They would have been able to get people in it, but the construction delays caused them to go into another tax year. There’s nothing you can do. It has to be in service.
“Hello. I live in Texas and invested in a syndication in 2020. I received a K-1, but I never filed the state tax for Indiana. Do I need to file the state tax? Can it carry over the passive losses to the next year if I don’t file the state tax?” You still get the passive losses on your federal no matter whether you file a state tax or not. The question is whether you’re filing the state tax or the syndication.
They could choose to do it. I forget the precise term. It’s like a consolidated return or something like that, where they’re filing on behalf of the syndication and they take care of that, or whether you’re required to. If they don’t, then you’re required to file a state tax. But if you don’t own anything, then there shouldn’t be any ramifications to it other than you file a late return. Just make sure you still do it. You don’t lose anything if you don’t, but you want to be able to document those losses and carry them forward, so I would just talk to your accountant about, perhaps, filing a late return in Indiana if you’re required to file that return in Indiana.
If you had income there, a lot of people are probably scratching their head going, you’re in Texas, why would you file in Indiana? Sounds like there’s Indiana property in Indiana income. Thus, you’re supposed to file an Indiana return. It’s just, does the partnership do it? If it’s a syndication like an LLC taxed as a partnership or a limited partnership syndication, then they sometimes do it. It’s up to the syndicator to decide whether they’re filing it or whether you’re doing it. Again, I can’t remember the precise term. I want to say consolidated return, but I think that’s wrong. I think it’s another term but it begins with a C.
“How do I pay taxes on rental property owed in Canada? I inherited properties in Canada from my Canadian parents. How do I pay taxes on those here in the United States?” It’s kind of weird. The US accepts Canadian LLC, so if you have a rental property, you may have a Canadian LLC, but the US still charges you tax on all income generated from any properties anywhere in the world.
Let’s say that you own a property in Canada, the Canadian revenue agency is going to assess a tax on your income in Canada. More than likely, the US is just going to give you a tax credit. I know we have a treaty with Canada and I believe that is giving you the tax credit. I haven’t pulled it out and looked at it.
Obviously, you’re going to want to have a Canadian accountant handling the taxes in Canada and the United States accountant handling the taxes the United States. If you want somebody that can do both, you’re probably looking at somebody who’s in a border state. I have a really good accountant in British Columbia named Hartmend that I could send you as well. Or you can look them up Hartmend. Kind of an unusual name in British Columbia, but he knows US taxation and Canadian. You can make sure that somebody who understands both is looking at it, but you want to make sure that if there are taxes owed in Canada, that you are getting a credit here in the United States.
Another one. “I am a full-time wholesaler and currently have the business as a C-corp to avoid dealer status. Will I qualify as a real estate professional since I’m a full-time majority shareholder employee materially participating in the real estate acquisition activities?” So you want to avoid dealer status and you want to be claimed as a real estate professional.
First off, if you’re a wholesaler, you’re not a dealer. A dealer is somebody who buys properties and sells them. Unless you’re buying these properties, closing them, and then selling them, you don’t have to worry about it. But you’re in a C-corp anyway, so it makes it a moot point. The question is whether that time will allow me to qualify under 469(c)(7) and make my real estate activities and all my rental activities change them from passive to being ordinary non-passive losses.
I take lots of depreciation, can I offset all my other income with it? That’s where you have to be a real estate professional or an active participant in real estate. But the active participant is $25,000 a year max and it phases out when you get over $100,000, so if you’re under $100,000 and your losses are below $25,000, you don’t even have to care about this. You automatically get it if you are managing the manager, like you’re the one who’s hiring the property managers or whoever it is on your rental activities.
“Can we include the time that I’m working for a C-corp in my computation of the 750 hours?” That’s the big question. The two prongs for real estate professional is prong one, I have to be engaged in a real estate activity for 750 hours a year and more than 50% of my personal service time. If you are in a C-corp and you’re doing the acquisition activities, does it qualify as a real estate activity?
That’s pretty broad. It’s construction, reconstruction, development, redevelopment, brokering, transactions, construction. All these different things go into the pay. Is it a real estate activity? What it really comes down to is, is it buying and selling, and are you involved? If the answer is yes, then you get to count the time as long as you’re 5% or greater owner of the company.
It doesn’t matter whether it’s your properties or somebody else’s. For example, if you’re a broker and you own 10% of your brokerage, and you’re spending 2000 hours a year helping other people on their properties, you still count that time under prong one.
Prong two is material participation on your real estate. We usually do an aggregation election to treat all your real estate activities as one. Are you material participant? There are seven different tests on material participation. The most easy one is if you self-manage. You don’t have to really care about hours as long as nobody else is doing substantial activities. But if you have a property manager, then you’re going to fall into one of the next two tests, which is you do more than 100 hours. If you’re married, it’s you and a spouse combining all your time on your real estate more than 100 hours, and 100 hours is more than anybody else spent on your properties.
If you have like a bunch of properties with the same property manager and you’re worried that they’re over 100 hours, then you would go to the next one, which is 500 hours, and we don’t care what anybody else does. And 500 hours is again, cumulative between you and a spouse, and it’s your management activities. It’s not just going out and trying to buy properties. It’s management activities.
If you’re managing your real estate, then you count all that time that you’re working on those properties, working with contractors, working on the management of those properties. Whatever you’re doing with those properties, you can add that even traveling to those properties depending on where they’re located. It gets into where you start adding these things up. The answer for you is yes, you get to count that. Can you count that time? Yes, as long as you’re a 5% or greater owner.
“I’m going to sell my main residence and retire at my vacation home.” Congratulations. “I live in Los Angeles, California. How do I avoid or reduce capital gains taxes? I’m counting on the proceeds from the sale to help fund my retirement or our retirement.” It sounds like it’s a married couple.
There are two things that we’re going to look at. Number one is, is this your primary residence and did you live in it two out of the last five years? Was your primary home ever a rental property before? Is there any disqualified use as a result? But let’s assume that you bought this, you lived in this house, it was always your house, and you’re selling it. You could actually rent it up to three years and sell it. As long as you lived in it two out of the last five years, you get a $500,000 exclusion. It’s Section 121.
Hey, I bought my house for $200,000 and now I’m going to sell it for $600,000. Let’s make it California. I bought it for half a million and now it’s worth a million, I would pay zero capital gains taxes. The 121 exclusion is only capital gains. That’s been a rental property, you make it into a rental property, the recapture is never included, so you still always pay your recapture. But you can use 121 and a 1031 on the same property.
I’ll give you a very real situation. Let’s say you bought it for half a million dollars and now it’s worth $2.5 million. You bought it 20 years ago, and it’s just exploded in value, and you have a $500,000 exclusion, which will mean that you’re going to pay tax on $1.5 million of gain, which in California, it means probably 13% plus 23.8%, so you’re going to be paying 35%–36% tax on that money, which sucks, so you’re going to have a huge tax bill. How do we avoid it? Half a million dollar tax bill.
Here’s how you avoid it. You move out, make it into a rental property, and then you 1031 it. Remember you’re going to use this money to live off of, so what I’d probably do is sell it, avoid all the tax, and then refi the replacement property to make sure it’s income-producing property.
If you wanted to buy your dream house, rent it for a little while and then move into it, you could do that too. Then you could sell the second house. As long as you lived in it for two years as your primary residence, you could avoid the gain on that one, too. Sometimes, people play a little hopscotch. But if you want to at least get the $500,000 exclusion as a married couple, you could do that pretty easily under this scenario, so you avoid all the capital gains. Assuming it’s never been a rental, then you could pretty much wipe it out depending on your scenario.
“I am a high-income W-2 individual seeking advice on how to reduce income taxes using a CRT, conservation easements, and other non-traditional methodologies.” First off, a lot of accountants see a high W-2 and they’re like, oh, there’s not much we can do. There absolutely is something you can do. You can always just give your money away to charity. You can even set up your own charity and give it away to it. We tend to go to the charitable realm or we create losses that become ordinary losses, generally, in real estate by having somebody qualified as a real estate professional or having their spouse qualify as a real estate professional.
Other things you could do is reduce your income. Again, it’s always going to be like a charitable giving issue. But instead of giving, what if you invested in a conservation easement, where you’re taking a piece of property and its best use might be worth $5 million but you’re buying it at its regular fair market value before you’re doing all the development, and then you’re going to give away that development right to a charity?
You may buy into it for $2 million, and you may get a $4 million deduction, and you’re sharing it amongst the folks that invested. In that type of scenario, I might invest $1 and get a $2 deduction. Is that worth it for me? No. If it’s a $4 deduction, now we’re talking about something.
Again, let’s say that I have a conservation easement that’s doing a four to one. If I put $1 in, I get a $4 deduction. Then just depending on what your tax bracket is, if you’re in the 35% tax bracket, multiply that by four. That would be, what is that, 120? I can’t even do it. I have to get my little calculator out, so four times three and four times 20. I got 20 and I got 120, so I’d have $1.40.
For every dollar I put in, I’m saving $1.40, so it costs me $1 to get 40 cents is what it really boils down to. The problem with conservation easements—I’ll just say right off the bat—I do like them and they do work when they’re done right. That four to one, you’re probably going to be in a safe realm, but it is a listed transaction right now. The IRS is mad at them and there’s been proposals to limit conservation easements. It’s not in any of the Build Back Better plan anymore, but it was. It was two-and-a-half times.
If you give $1, you’d get a $2.50 deduction. It’s basically breaking you even. That’s what they’re trying to do. As it is right now that does not exist, but just know that the IRS is mad that you can give $1 and get a $1.40 back from the government. But you could do that on a conservation easement, even with W-2 income. It is limited to, I believe, 50% of your adjusted gross income, so you can get that.
The other route is that CRT. What you’re doing is you’re giving up an asset to the charitable remainder trust with the remainder beneficiary being the charity, and it has to receive at least 10% of the value of that asset when you pass, so they do a little test and they figure out either it’s going to be a term of yours or it’s going to be your lifetime that the asset then goes to a charitable beneficiary.
The charitable beneficiary can be a private foundation. It can be a 501(c)(3). It could be your 501(c)(3). But let’s say I give it a million dollars and you’re talking about unit trust, but there’s also an annuity trust, the GRAT, where you take back an annuity.
Let’s say that you gave it a million dollars and you get an annuity at 8% for 20 years or whatnot. You’re going to get $80,000 a year, in theory, that you’re going to get as income, but your deduction might be 20%–30% of the amount that you put in, so you might get a $300,000 deduction for putting the million dollars in. If you’d give it cash, you would get a $300,000 deduction in year one to help reduce your W-2. But then in year 2 through 20 or whatever the length of that annuity is, you’re going to have an income hitting you.
A unitrust is just a fancy way of saying, hey, if we have an asset, we’re going to give it a unitrust amount, usually, it’s five to something percent, where it’s based off of the income and it’s based off the production of the asset. But again, the charity is going to get the asset at the end of the day. If the asset grows, there’s a good chance the charity is going to get more than the million dollars or $2 million.
I put assets worth a million dollars, I might get less of a deduction first off, if it’s the asset versus if it’s cash. I might get a 10% deduction, and then at the end of the timeline, the charity is going to get something that may be worth more than the million dollars I put in, so you have to be comfortable with that, but those work.
I tend to like people just doing a public charity and doing whatever charitable activity they enjoy doing that as a family, and then you could fund it. The only things we have to be aware of there is whether or not you’re a public charity or you revert to a private foundation. You actually have a five-year window or you get a grace period.
But I like those types of deals, especially if it’s a one-time funding where like, hey, I have a big income hit, I got big bonuses, and I want to make a deduction, a big deduction. I know I’m not going to use up the entire deduction in just one year. I’m going to be limited depending on how much I put in there, how much I could write off. Maybe I’m carrying it forward for a few years. We just do the math on those. But yes, as a W-2 high-income earner, you can absolutely use these tools. It’s just crunching the numbers and making sure that it meets your objectives.
Of course the CRT, you could have a traditional 501(c)(3) as the beneficiary. It could be your church, it could be your university, it could be an organization. As long as it’s a qualified 501(c)(3), then you can make it the remainder beneficiary. If you don’t know, it is possible to draft these things up and add the remainder beneficiary in later if you need the deduction for this year.
“Can I turn a property that I acquired through a 1031 exchange into my primary residence?” Here’s the scenario. You bought a property via a 1031 exchange. You moved the basis of the old property or properties into this property, and you love it so much that you want to move into it and live in it. Can you do that? The answer is yes, you can. In fact, the code specifically addresses this under Section 121. When it says if the property was a 1031 exchange property, you have to wait five years before you can use the 121 exclusion which is the $250,000 or $500,000 capital gain exclusion.
In English, I have an exchange property. I rolled a bunch of basis into it from an old property. I’ll give you guys a scenario. I bought a property. It was worth $100,000. It was now worth $500,000. I rolled via 1031 exchange that property to a new property. That was a great rental that I looked at and I said, you know what, I really like this property, I want to move into it, so I move into it.
Five years later, it’s worth a million dollars, and I say I’m going to sell it. The big question is, what tax do I owe? Do I get the 121 exclusion? Can I even do this? The answer is yes, I get to use the 121 exclusion. I have a period of disqualified use. The period before the property became my primary residence, there’s a period of disqualified use on your 121.
I’m going to have to do a ratio of how much time that I own the property, how much of the time was it used as a rental property versus how much of the time was it used as a primary residence. If you rent it before you sell it, you don’t have to count that time as losses as long as it’s less than three years. But we look at anything before it became a primary residence in that period of disqualified use. That could possibly affect how much of that gain is allowed to be used, how much of the exclusion I get to use against that gain.
It typically goes against the amount of the gain that I get to attribute to the personal residence and I get my full exclusion. Let’s say it was half and half. had a million dollars of gain, and I used it. Disqualified use half, lived in it half. At the end of the day, I still get my $500,000 exclusion because it’s half of whatever the amount is.
I had a million dollars of gain, half of it is $500,000. I get to use my $500,000 exclusion as full if I’m married. I know this stuff gets a little bit brain-twisted, but just play along here. You can convert it, just know that you’re going to have to do that calculation of nonqualified use. You still get to use your exclusion and it’s full as long as that amount of gain is attributed to it.
Just remember that if it is a 1031 exchange property, you’re using the basis of the properties that were the first properties you had that were sold that you exchanged. It could be multiple exchanges, by the way. You could go back, hey, I exchanged property A to property B, and then I sold property B and bought property C, then I sold property C and bought property D. I made that into my primary residence. Your basis is way back there in property A, to figure that out.
Then we’d also have some recapture. We just have to do the math. But yes, a property that you acquire through a 1031 exchange can be turned into a primary residence. You have to close, though, as an investment property and then you’d convert it at some point in the future.
“I have a condo which was rented for nine months. It’s on the market for rent, but we’ve not found anyone yet. On my tax return, can I claim expenses for the entire year?” Yeah, absolutely. As long as you didn’t personally use it more than 14 days or 10% of the time, then it’s a rental property in whole, 100%.
If you used it or your relatives used it during any of that time, then we might have a period exceeded 14 days or 10% of the time, so we had it 9 months. That’d be 270, so 27 days. I’m just doing 30 times 9, and then you would say, hey, 10% of that amount is what we would look at as our threshold for whether or not we have to worry about the personal use. But based off of your facts, I don’t think we have to consider that. You get to write off 100% of the expenses for the year because it was available.
The way the rules are, is it’s available for rent. That’s what we care about. If it’s not available for rent, you don’t lose the expenses, you just can’t create a loss, so if I get a property, and it’s vacant, and not available for rent, or even if it is available for rent, but it’s vacant for a period of time, I don’t get to create the loss necessarily out of that one. I do want to be looking at that. As long as it’s available, under these circumstances, you’re going to get it.
“If retired parents want to offload their rental property to me, what is the recommended way to do it? Can they possibly defer their taxes? They said significant capital gains, and what should I do set up?” Number one, rental properties. Technically, if they want to sell it to you, I believe you could still even 1031 exchange it, but then they would own it, so we probably wouldn’t want to do that.
If they want to just get out of it and just have an income stream, I would do an installment sale. One of the easiest things you could do is say, hey, mom, dad, let’s spread out the capital gain hit, and some interest, and return your basis over a, let’s say that they’re in their 70s and their life expectancy is 20 years or something along those lines, 15 years, I would just pay it out over that period of time.
Technically, I think you could go longer. The IRS may look at it saying, as long as there’s not a skin, which is a self-canceling installment where the note cancels, I think you’d be fine doing it over a longer period. But what you’re really doing is saying, mom and dad, elect installment method, I will pay you, as the income is coming in, you’re not having to come up with a whole bunch of cash. Your parents still pay capital gains, but they’re spreading out the long-term capital gains, the recapture on the depreciation over a longer period of time.
You do have to charge interest. You can use federal AFR rates, which are really low, which is the minimum amount between related parties. It might be 2%–2.5% or something along that. All of that gets baked into the pie. You run a spreadsheet or your account runs a spreadsheet saying, here’s what your tax implications are. Here’s how much income is returned of your basis, which is taxed at 0%. Here’s how much of your income is recapture, which is taxed 0%–25% depending on your bracket. Here’s what portion is long-term gain, which is 0%–20% depending on your bracket. Here’s what portion is interest, which is ordinary income.
You just have your parents included over a longer period of time. That might be the easiest route for them so they don’t get a significant tax hit in one year. It also makes sure that, again, rather than just giving it to their kids, this is a way that they can get financial reward for owning it, and then all the risk goes to you. They may say, hey, we want out. We just want to know this is what our income is. You can uncover those properties too with that note.
You have some other possibilities. We have some other tricks up our sleeve with regards to whether or not you want to do the installment. You could just say, hey, we want to pay the tax, but we want to have an income stream for the rest of our lives. Technically, they could even opt out in that situation, but they say, hey, but I want to get a revenue stream from their kids.
There is something called a deferred sales trust that they could possibly do, too, which is you put the properties into an LLC. The LLC, you sell to a deferred sales trust, which is an irrevocable trust for the benefit of their kids. Before you do that, you step up in basis the property. Or excuse me, you wouldn’t do this step up in basis on the installment note. They would just receive that income over time, the same thing we’re talking about, but then you could sell those properties.
You could step up the basis on those properties and sell them all if you wanted to get rid of them, and there’s no tax on it because of the step up in basis when you did it to the deferred sales trust. That one probably just blew a few of your guys’ minds, but the accountants out there are going, oh, yeah, you could do that. And they do do that, especially when you have big, huge companies or something where the taxes would just be massive, and really the family ultimately wants to liquidate that asset and make sure it still goes to the kids but they don’t want to bury the parents with massive tax liabilities. That’s how you do it.
Living trust. “My siblings and I inherited our parents’ home. We were advised to get a family trust for the property.” Chances are, you guys inherited it together and you want to keep it in the family, but you’re a little bit worried about each person giving up their portion. What we really get into when you hear these terms—family trust, living trust, land trust, dynasty trust—they’re all the same type of document. There’s a grantor, there’s a trustee, and there are beneficiaries.
When you do kind of an irrevocable family trust, you’re saying, hey, it’s going to be for the benefit of the descendants of mom and dad. Here’s what you do. It’s like, hey, we all get the right to use it. You’re putting it in a trust and saying, nobody gets to sell that, it doesn’t get eaten away in a divorce of one of the people. If somebody gets into a lawsuit, they can’t take it.
It’s just sitting there in trust, and you could set these trusts up for hundreds of years. You throw the property in it and it just says the trustee manages it for the benefit of the beneficiaries. It’s actually pretty easy. If it needs money, that’s the only hard part. How do you calculate that out? Are we going to rent it? Are there other assets that we’re going to throw in there to maintain that property? You probably going to want to consider that before you do this.
“Hey, do we throw some cash in there along with this so that we never ever have to worry about losing this property out of our family? What’s the difference between those same type of trust?” Living trust is revocable, meaning that I can make changes to it during my lifetime.
If I did a family trust, they’re probably talking about an irrevocable trust that holds the property for the benefit of some category of people. It could be all three siblings and their descendants or you could say it’s 1/3, 1/3, 1/3 if there are three kids, but it stays, what we kind of called per stirpes, which is it stays and each leg as 1/3, 1/3. But you don’t want to allow someone to sell so that you don’t have somebody selling off a portion of that property, or now all of a sudden, you’re sharing that property with somebody you don’t even know, or it gets eaten in a divorce.
You create these typically as an irrevocable trust, you make sure that that property is sitting in it managed by that trust. Again, usually, you’re going to start these things off over 365 years and it just sits in there for the benefit of your families.
I like that personally. We still put those provisions in living trusts, by the way. A lot of times I tell parents, especially if they have substantial assets, make individual gifts of things that have sentimental value, but hold the rest of the assets in trust for the benefit of your beneficiaries, so if they need it, it’s there, but they can’t just liquidate your estate and buy a bunch of Lamborghinis and go nutty or buy something stupid. It sits there and it’s for their health, education, maintenance, and support. That asset can still be used.
“When buying a rental property, will it make my EFC increase that I pay for my kids in college? The answer is, it’s included as an asset. It would be included as your income, but rental properties tend to offset their income with their depreciation, so there’s a good chance you’re not going to be paying any tax on it, but they will look at it as an asset.
As to the effect, I don’t know. If you buy a million dollar rental property, chances are, it’s going to have a pretty major effect unless there’s a liability against it. I would say, how the heck did you buy a million dollar rental property if you’re doing the EFC? Anyway, if you had that cash lying around, it’s considered an asset, but you’re having to move one asset to another, and it’s an asset minus liabilities still for that. If I bought it with financing, chances are, it’s going to have minimal impact.
“If I buy a rental property in an LLC, will I pay less taxes than if I buy a property in my personal name?” It depends on the type of LLC. Generally, no. Generally, it has no impact. LLCs can be disregarded for tax purposes to hold the real estate. Usually, you get a lot of benefits from holding real estate so we want it to flow onto your return.
We like it going on page two of your Schedule E via partnership return if possible because there are a few reasons for that. Number one, if you’re ever borrowing money, they use 100% of that income. Versus they use 75% if it’s on page one of Schedule E. That’s if you’re doing a conforming loan of Freddie Fannie. That’s just how their underwriting works as it is today. But as for the taxation now, it’s usually just follow through. It doesn’t save you anything.
Here’s where it does save you tax money. If you buy it through a charity. You can apply for a real estate tax exemption, but it wouldn’t be an LLC. If it’s a rental property, it would be an entity within the nonprofit, so if I had a 501(c)(3), technically that’s a corporation. It can be an LLC, but please don’t. 501(c)(3), those provisions actually say corporations and trust. The IRS finally came out saying, yeah, you could potentially do an LLC, but I’m just telling you, when they see it, they don’t know what to do with it, so it’s going to get a different look-see.
Just do what’s easy, do that corporation. If you put the real estate in it, you want to get your exemption, and then put it into an LLC. But as an individual, if you’re just putting rental property in an LLC, no difference. It could possibly cost you more. Where I’m sitting right now in Las Vegas, this is Clark County. If I put a property into an LLC, no tax. If I take it out of an LLC, there’s a tax, so that’s where it could hurt you versus your personal name. You want to kind of look at that.
The way we get around it here is we just use the land trust and then we assign the beneficial interest. The reason you do that is if you’re going to refinance the property, you don’t want to have to pay $300 or $400 to take a property out of an LLC. That kind of stinks.
The other way where it could hurt you is like in California. If you put a property into an LLC, you have doc stamps on the mortgage. You could be looking at a tax hit there, so you use a land trust to avoid that as well.
If you are putting a property in Pennsylvania into an LLC, you’re going to be paying a tax. Period. Pennsylvania is really, really strict about moving property out of your individual name. If you bought it directly in the LLC, you’re fine and you’re not getting any negative consequences. You get only the positive, which is the asset protection and the ability to have something separate from you.
“Can my S-corp reimburse me for moving expenses and repairs to my home based on the business percentage use?” First off, S-corp and you as an employee can qualify for an accountable plan where it’s reimbursing you as an employee for any of your expenses incurred as a business, so you’re the owner of the S-corp.
“Can it reimburse you a portion of your home based on business use?” The answer is yes if you’re using an administrative office. It’s either use either a room methodology or you use a total net usable square foot calculation, usually, it’s the best. One of those two is going to be probably closer to the 20% mark, and then, yeah, you can reimburse a portion of that percentage of your repairs. Even house cleaning, even all your utilities, all that stuff starts to be reimbursable.
A portion of it, just that portion. I use a spreadsheet to do those calculations, which I share out in my tax toolbox during Tax Wise workshops. During a lot of the Asset Protection events, I share that out. Come to those and you’ll see how it gets used. But moving expenses are no longer a deductible expense, so it can’t really reimburse you without having some taxable impacts.
If I am military, I know I can still write off moving expenses. If the business wants to pay a moving expense, there’s a good chance it’s not going to be able to deduct it because moving expenses are not deductible. But some accountants made it classified as an employee expense and write it off anyway. I’m just saying that right now, moving expenses technically aren’t a deductible expense to individuals, for sure.
To an S-corp, it might be added in as compensation, but again, it depends on the account. I wish I had Jeff here because he might tell me. Now we just reimburse it and forget about it. I don’t know. Technically, I know what the rule is, but it’s going to really be up to your taxpayer.
Yes, it could reimburse anything that’s business-related or done for the benefit of the business. If you’re moving as a result of the business, then it can always reimburse it. It’s just whether it’s going to be tax-free or not.
“My husband owns an S-corp. I am a sole proprietor. If we travel to Hawaii and conduct my husband’s S-corp annual meeting, which portions of any of the travel costs can be deductible?” This is where it gets really interesting. First off, if it’s just you and you’re traveling to Hawaii, there’s not a restriction on doing your meeting. It’s just if you ever get audited, they might look at and say, was it lavish or something?
People go to Hawaii all the time for their meeting, so I would try to lump something else in with it while you’re going to Hawaii. For example, we do an executive retreat every year pretty much, sometimes twice a year, where we’ll go to Hawaii. Pandemic has made it really difficult. We were doing it once a year, for sure, but we plan on doing it more often where we do these executive retreats.
You go there. When we do it. We set it up so that we have four business days, Thursday, Friday, Monday, Tuesday, where we meet a group for four hours and one minute each day to count it as a business day. Why is that important? Because if 50% or more of your business or more than 50% of your reason for going to Hawaii, which is counted by your days there is business, then you can write off 100% of your travel to and from Hawaii.
Here’s how it works. You get a travel day for that gets counted as business, and you have the business days, and you have book ended. At Friday, Monday, on a weekend, you get to count the weekend as business days as well, so if I have a Thursday, Friday, Monday, Tuesday, I get to add-in in addition, Saturday, Sunday, plus two travel days, so I’m now up to eight days that are business.
Can I stay in Hawaii another five days and not have to worry about losing my deduction for my airfare? Yes, I can absolutely do that. If I’m there and I’m doing business days and personal days, technically, I can write off the hotel and meals on the days that I’m there for business. Then on the days that I’m there for vacation, I would not write those off.
To answer your question more clearly, if you go there, what portions of the travel cost could be tax-deductible? Depending on how you’re setting this up, 100% of the travel costs, the air could be covered, and then a portion of your stay. If you are going there, and let’s say you’re only having one meeting day, and you’re there for a week, then you would not be able to write off the airfare. But you would be able to write off the one day that you’re doing the meeting and deduct at least the meeting room or at least if you’re doing it at a hotel, the hotel room.
Obviously, it’s better for you if you’re able to get more business days. That’s going to be really tough to do just to say I’m having a meeting. People have done all sorts of analysis on this. There are all sorts of little things like, hey, I’m going to set up a meeting, I’m going to go over financials on day one.
On day two, we’re going to do forward projections. On day three, we’re going to go over mission vision values. On day four, we’re going to do this. Just know that you have to spend four hours for it to be a business day, so what I would say is find other people that do what you do, and meet with them while you’re over there, and get as many business days as you can.
If you’re into real estate, talk to real estate investors there, look at real estate and document it, so that if you’re ever questioned on it, you can say, I did have a profit motive on these days. Again, you go over 50% of the time, counting a business day again four hours, one minute. If I can show that more than 50% is business, then I get to write off all my flight and everything.
Frankly, nobody’s getting audited right now. It doesn’t mean they won’t get audited in the future, but in the last few years we’ve seen just almost none. I think we did 10,000 tax returns or they’re bit pretty close. It had less than a dozen audits last year. It’s just really, really, really low.
Your husband’s S-corp, by the way, its audit rate is a fraction, 0.02%. It’s just really low, really, really low. You’re a sole proprietor is a little higher. We have to be careful about you. But the S-corp is probably not a problem. That’s where we write it off.
“If you’re going to receive a large sum of money, how do you keep from paying extra taxes or face penalties when spending it?” It depends on the source of the large sum of money. For example, I receive an insurance payout from the death of a parent or somebody named me as a beneficiary. I don’t pay any tax on that. If I get a lump sum that is a loan, I borrowed from a piece of property, no tax on that.
If I sold off a bunch of crypto, then I would have capital gains tax on that. If I got a big lump sum, like a bonus from my work or I got a distribution out of one of my businesses, I’m probably looking at ordinary income possibly subject to self-employment tax. All of those things have to be factored in, so I don’t know enough, but how do you keep from facing penalties is you calculate the tax and make sure that you’re paying it when owed.
We have a pay-as-you-go system. We pay on a quarterly basis. There are lots of exceptions or safe harbors. But generally speaking, when you earn something, you should talk to your accountant to make sure that you’re treating it appropriately at that time, so you don’t get massive penalties.
It’s really hard to get hit on penalties if you file your taxes on time. When I say on time, it means pay your taxes when owed, and file extensions, and file your tax returns by the end of the extension deadline. That’s when it’s actually due, so individuals filing your taxes by October 15th, make sure that you file your extension and pay any taxes due by that April 15th or if you earn it during a quarter by that quarter.
If you file a tax return, your penalties are pretty insignificant. We just did this. I saw a penalty on $10,000. It was about $100 for not paying something on a quarterly basis on time. It’s not huge. It’s usually 1%–2%, and then the penalty for not paying the interest that you’re earning is really maximum. I think you’re looking at about 1%.
If you don’t file, then you could get this 5% penalty and it starts to add up quickly. It can equal a pretty big chunk. I think it’s capped at 25%, but it’s still a pretty big chunk of that tax. As long as you’re filing your taxes on time, even if you didn’t pay it, it’s not brutal, so just make sure that you’re reporting it appropriately and you’re going to be okay.
“Can an irrevocable trust protect my assets from taxes?” Yeah, there are things called DINGs and NINGs, and all this fun stuff. I won’t dive into too much of it, but the answer to your question is, it can avoid a lot of state income taxes on federal income taxes. If you have capital gains, it could avoid the tax because it could be reinvested into that trust. But otherwise, no, it’s going to be flowing down to a beneficiary or the trustee is going to pay tax on it. You’re always looking to see who could pay the tax. Is it the trust or is it the beneficiaries? Or is it defective for tax purposes?
An intentionally defective grantor trust, for example, is when you set up an irrevocable asset protection trust, but it’s still taxed to the grantor. It’s called an IDGT. The individual who sets it up still pays all the tax on any of that income, so you use it.
For example, if I have a big chunk of asset that I want to make sure nobody can ever take, I’m in a high risk profession. I named my spouse as a beneficiary and my kids. It’s a fancy way of, I’m moving it out, it’s still part of my estate, I still pay tax on it, but they’re technically the beneficiary, so if I get sued, somebody can’t take it away from me.
We still got some questions here and I’ll keep busting through them. Somebody says, “I think the main premise here is taxes on receiving a lump sum of money. What is the best way to reduce the taxes? We have to pay on the lump sum? I have an LLC. If you live in a different state, would it be a good idea to set up a trust through LLC in Vegas, Delaware, Wyoming to reduce the amount of taxes? Is having an irrevocable trust the best asset protection on the lump sum of money and other assets?” Let’s go through that.
We already talked about lump sum of money in a previous question. We have to figure out where it came from. Where would I put it? Again, if I want to remove it from my personal realm so that if I get into a car accident or if somebody sues me in my business, I want to make sure that they can’t come take this asset, I’d probably set up an LLC in a place like Wyoming where my name is not listed on it.
It’s maybe ignored for tax purposes or it’s going to flow through to me as a partnership depending on how I set it up, but it keeps it out of view. I found that 99% of the asset protection really comes down to people not knowing what you have and being able to keep your affairs private, so you’re not just sticking it out there.
Can it avoid taxes? It could avoid state taxes if you have a trustee managing those assets in another state and it’s an irrevocable trust. You can do that. I wouldn’t be using an LLC at that point. I’d be using a domestic asset protection trust, like a Nevada Asset Protection Trust. I would have the monies managed here in Nevada by somebody. I’m not a trustee, but there are groups that do it. You could avoid the state income tax on those.
If it pays it out to a beneficiary, though, they’re paying tax on it, regardless, in their state. It doesn’t do as much as what you might think, but if you have $50 million, $100 million dollars sitting there, it makes sense. If you have $100,000, probably it doesn’t.
“Is having an irrevocable trust the best asset protection for the lump sum of money?” If it doesn’t make you insolvent, a domestic asset protection trust is extremely effective against outside parties, so long as they were not a creditor at the time that you set it up, as long as it doesn’t make you insolvent because we have a 10-year claw back on bankruptcies.
If you just have a bunch of money coming in, I want to make sure nobody could ever take it from me, and I’m not worried about doing something for federal estate tax purposes, I could set up a defective grantor trust to have another trustee in another state and have them manage it. I could potentially avoid state taxes on those gains if it’s not paying it out to me or on that income, if it’s not paying it out to me. If it pays it out to me, it doesn’t matter.
If I just put it in there, and let’s say I’m just going to invest it in securities, and I just want to make sure that it’s protected in the event that somebody ever comes after me, or let’s say I have a bunch of teenagers and I’m worried, like what if one of them has a car accident, or hurt somebody, or does something and I’m liable, this makes it next to impossible for them to reach that asset. Although, 99% of the time, the LLC is going to be just fine. They can’t take that away from you, either, then get a lien against it. That’s it.
“In California, do you change the title of the house to a trust or land trust without causing an increase in property taxes? The answer to a real simple question is yes. They’re going to want to see that you’re still the beneficiary of it. Where California nails you is on the change of a beneficial interest holder, the person who gets to occupy it. If I have a property in an LLC and I give you more than 50% of its units, I’m going to probably reassess. If I sell a property to somebody else, even if I sell them the beneficial interest in a land trust, that’s a transfer. But if it’s just me, that’s not a transfer for purposes of reassessment.
There is the new proposition that came out this last year. If you’re going to make something into an investment property, you’re going to have to re-assess it when the primary beneficiary of this passes away. But the county just asked to see the documents. Usually, they just want to see the provision that says you’re still the beneficiary and you still have beneficial use of the property.
“How can a large capital and recaptured depreciation be reduced?” Somebody says, “I received bad advice about selling an asset and made too much money this year as a realtor.” The only thing you could really do other than using offsets like creating deductions here by charitable giving, or by accelerating depreciation, or doing something else, realizing some losses and something else you have, maybe.
By the way, if I have a bunch of losers in the stock market that I’ve been sitting on, this is the year that you take them to offset that large capital gain. Or you do something like a qualified opportunity zone where you have extra time for you. You probably have until next June to create a fund and then reinvest it. Then you’re deferring that and you’re going to have to recognize the tax in 2026, is when it’ll be taxable to you. You don’t have to pay the tax right away, but you will still have to pay it.
“Buy and hold property. How long do I have to hold to pay less tax when sold 1031 exchange?” In real estate, the one year stuff is BS. Nobody cares about that. What they care about is, is it investment property? Is it available for use? Is it something that is actually investment property?
Let’s say that I sell some property and buy a replacement property, how long do I have to hold it? Technically, I could do another 1031 exchange in a short period of time, a month later or whatever it is. There’s no timeframe. What they care about is, did I buy investment property and exchange it for more investment property?
As long as it’s an investment property, you document your intent, you buy it, and then let’s say that you exchange into a property A and you don’t like property A so you exchange into property B, is that going to be okay? That should be okay, but you deal with a Qualified Intermediary, the 1031 exchange facilitator, and you tell them what’s going on, and they can advise you there.
Technically, there’s not a, how long do I have to hold it? There’s not this year thing. It’s, did I relinquish real estate investment property and acquire new real estate investment property? If I did, then I 1031 into that new property, and then am I releasing that one to acquire more investment property? If the answer is yes, then I can do it.
This is the last one guys. I know it’s been a long session, but I think that there are just a lot of questions. “We withdrew money from an IRA to fund a real estate purchase with the intention of reselling the property within a 60-day window. The purchase took longer than expected and now we’re not going to close in the 60-day window. I have access to a former company 401(k), and explore options of either doing a direct or indirect rollover, or even in withdrawal to bridge fund payback of initial IRA until properly resale closes. What tax pitfalls or complications are created by doing the indirect rollover or withdrawal from the former company 401(k)?”
Here’s what’s going on. Once a year, I can roll over an IRA to another IRA, and I have 60 days to complete that rollover. If I take $100,000 out of an IRA, I have 60 days to put that money back. That’s what we’re into. There’s a property that’s causing us problems, that’s causing all this liquidity.
“Can I do another rollover and avoid tax?” The answer’s no. I can’t go do another 60-day rollover. You can do once a year. I think that the fact that you just did one and then you’re going to do another, I think that’s not going to be qualified. The money that you take out is going to be taxable.
If you have a 401(k), what I would do depending on the amount of money is I’d probably roll that into a solo 401(k) off of one of your businesses, which you can do, and then borrow the money. You can borrow up to 50% of that up to $100,000 between a married couple. If you need money to give yourself a tide over, technically, you could borrow that money, and then I would use that money or any other money I’ve lined around to put into your IRA, so it’s not taxable.
If you do not do that, then it’s not like the deal blows up, you just have a taxable distribution. Depending on how old you are, you’re going to end up paying a 10% penalty in income tax on that IRA. That’s all it is.
If it was a Roth, then I don’t think you’re going to be paying the penalty. You’ve already paid the tax. I think you might pay tax on the gain. I can’t remember what the penalties are in a Roth. I’d have to go look it up for early withdrawal. Generally speaking, I was trying to think off the top of my head. I can’t remember. I’d have to go look it up. But you’d have some penalties, for sure, so I wouldn’t do that. What I would do is, again, I would roll over the monies and see if I can borrow them from my own 401(k).
If you are allowed to, you could talk to the administrator of your former company 401(k). Usually they roll that into an IRA, so the fact that it’s still sitting in there, you might be able to borrow the monies from that. Or you roll it into a solo 401(k) and then borrow the money from that. You’d have to do it pretty quickly. It sounds like the 60-day window is really at a close. Anything you can get to put that money back in there, borrow money from somebody else, refi your house, do anything else prevents it from being taxable.
If you talk to an accountant, they should be able to tell you what the actual penalty is going to be. You might say, oh, that’s not so bad. I’m okay with the distribution. I wish I hadn’t but it’s not like the deal blows up. Hopefully you made some money on a resale. Real estate purchases, yeah. It sounds like you flipped a house. It’s not uncommon that it takes longer than 60 days. We tracked over 500 of them and they were 90.6 days with crews just churning and about a 15% average profit.
I don’t do them anymore for that reason. It’s a lot of work for not a lot of benefit. It’s better just to buy and hold. But if you made some money on it, fantastic. You may have a little penalty here for not getting that money back in there, but maybe you have some other options.
Maybe you’re able to get that money quickly out of the 401(k) in the form of borrowing it. If you withdraw it from the 401(k) and put it back in, all you did is you traded one penalty for another. It’s the same penalty, so it doesn’t matter.
That’s it. Hopefully you guys got a lot out of this. I know that I went a little long and had a lot of questions. I actually kind of like that. If there’s anything that you need for clarity, by all means, send it in at email@example.com. Send in your question. Or if you need something clarified again, send it on in there and we’ll make sure to address it.
In the meantime, this is the last Tax Tuesday before the holidays, so Happy Holidays, Merry Christmas. Hopefully you’re able to spend time with your family and loved ones, be merry, and hopefully you’re giving and thinking of the less fortunate during this time, too. I’m not going to guilt you into doing anything, but I know that a lot of people do a lot of good out there.
We don’t need the government to do it, we can do it ourselves. The taxes are a way of giving you some incentives. Again, if you’re charitably-inclined, those charities and setting up foundations is a great way to create something that’s a legacy for your family, but also get a bunch of tax benefits. They’re there for a reason. A lot of incentives.
Again, any questions, shoot them on in. Otherwise, have a great holiday season. Again, you could still be doing the Q&A. Our guys should be answering questions all throughout this, so you can certainly go to the Q&A and get your question answered right now if you’re impatient. Otherwise, do the firstname.lastname@example.org.