Today’s Tax Tuesday episode covers a variety of questions about short-term and long-term rentals, the IRS rules around those entities, and lots of tips and stories about how to report and document your time so as not to trigger an IRS audit. Toby Mathis hosts, with special guest Eliot Thomas from Anderson Advisors, and some of the staff from Anderson including Dana, Patty, Ander, Matthew, Dutch, Cindy, Trisha, Cristos, Piao – are all online today to help answer your questions. If you have a tax-related question for us, submit it to taxtuesday@andersonadvisors.
- “For a 1031, does acquiring the beneficial interest of a land trust holding title to real estate qualify as replacement property? Same question, but an installment sale for the beneficial interest of a land trust.” First question: When you look at the 26 USC 1031 and I want to say a to e, I believe, are the list of all of the exceptions, you’ll see that the acquisition of a beneficial interest in a trust is one of the exceptions to being able to qualify for a 1031 exchange. Second question: What you can’t do is go ‘no debt’ to ‘debt’.
- “How can the IRS prove we as owners used our short-term rental for more than 14 days or 10% of rental rented days?” How can they prove it, dang it?” The reality is they probably can’t unless they somehow got the ability to go out there, research, find out, bring it into court, and documents were produced, et cetera. The reality is they probably can’t. But I would suggest that you’d be very honest.
- “My wife is the property manager of our small real estate portfolio. What is the best way to document the hours she spends on our business as we are claiming she is a full-time real estate professional to unlock the potential extra tax benefits.”We hire professionals for plumbing, AC repair, and she handles items like semi-annual home inspections, painting AC filter, deliveries, all advertising, bookkeeping, et cetera. Thank you.” Put the date, what the activity was, the amount of time you spent. I’m assuming this is a local property, kind of in your town area, put down the time you drove there, the time it took to drive back, the time on the phone calling, et cetera. Any of that, just document it in an Excel spreadsheet. Use MileIQ if you’re tracking mileage, for example. It’ll GPS you. It’ll also tell you the times and everything along those lines if you want to track everything.
- “I have a Fidelity brokerage taxable mutual fund account. It is not a retirement account. The taxable account has two mutual funds inside. One is a diversified growth and the other is a more balanced 60-40,” probably bonds. “I started investing in these accounts in 1992 and directed all dividends and capital gains to be reinvested in the same funds.” So a drip. “On a positive note, the account has grown dramatically, but the bad news is that both funds have high costs associated with them, i.e., actively traded, high turnover, which drives up costs. I would like to somehow move the money to a more tax-efficient index stocks such as XLY, the Dividend Kings, Dow Diamonds, QQQ, S&P 500, VOO, et cetera. Will I be able to do so with no tax or minimal tax implications?” I think you’d have to sell and that is a taxable event. Now you’re going to have to move it over. We might be able to do things to mitigate that around it—some lost positions or something like that—to offset that gain. But I don’t know personally how you would be able to get that transferred over. So is there a way to avoid the tax on the capital gain? It’s really hard. You could sell other assets that have capital losses and harvest some losses like maybe you have crypto.
- “After using accelerated depreciation on a new Airbnb this year, can I avoid future recapture in the case of a sale through a 1031 exchange? Can I exclude some nights when I stayed overnight on the Airbnb property for the purpose of improvement, say installation of the gutter guards by a company the next day? I had to be there to receive the furniture delivered, which I also had to unpack, move, and put in the right places.” Yes-If it’s used in trade or business, yes.
- “Can I take a primary home loan on a property that has been bought with 1031 exchange funds and live in the property myself?” Yes. But of course, there are rules behind it. I don’t know that there’s a fast and steady rule for how long you have. You have to use it after the 1031 in a trade or business.
- “How does the new corporate transparency law affect our LLC structures? Are you confident that Anderson can figure out a workaround to maintain anonymity? What are the good and bad takeaways from this new law?” Well, every LLC for our clients typically is going to be underneath this because it hits all small businesses.
- “Our family has Christian healthcare medical bill sharing. I’m always told this is not insurance. How does the IRS view this? Can it be deducted for Schedule A? Can it be used as an insurance deduction?” It is not insurance in the eyes of the IRS. It is just a group of people coming together and helping pay one another’s medical claims and so that’s why it is not insurance. Insurance is defined as something that can be deducted. This cannot be deducted. It cannot be used on Schedule A. It cannot be used as medical reimbursement. there is a proposal out there for regulation where the IRS is trying to change that. They’re trying to get to this where this would be deductible.
- “My husband and I acquired a short-term rental this year and are hoping to close on a multi-family property for long-term rental by the end of the year. I am on track with REP status,” that is real estate professional status for 2022. “We have come across several potential listings. However, requiring a gut down in major rehab. The likelihood of having this rental done and rented is slim by the end of the year. My question is if having the listing up and ready for rental is considered in service?” If it’s someone just putting the listing up there, no. It has to be available for service. It is the status you’re trying to get. That means that if you did put it up there, then I could move in there right now. You run the whole risk of needing asset protection if you do something like that.I’ll have it available by the last week of the year. Does that allow me to take the deduction this year? The answer is yes.so you can talk to somebody like Eliot because you are dealing with two or three issues that are very fact specific that we don’t want you to screw yourself up.
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Full Episode Transcript:
This is the Anderson Business Advisors Podcast, the show for real estate investors, stock traders, and business owners. We help you keep more of what you learned and protect what you build. Let’s get started.... Read Full Transcript
Toby: All right, guys. Welcome to Tax Tuesday. We’re bringing tax knowledge to the masses. My name is Toby Mathis and I’m joined by?
Eliot: Eliot Thomas.
Toby: Eliot’s going to sit in for Jeff today because Jeff’s hanging out doing other things. Hopefully, the wonderful tax season just creamed our text staff. We still got a bunch on. I can already see a bunch of names popping in that are there to help.
I saw Ian pop up earlier. Let me see if I can actually make my cursor work. I know we got […]. We got Dana. We do have Patty, Ander, and Matthew to help support you guys. We got Cindy, Dutch, and Piao. We got a really good team to help you guys. Trisha and Christos. You guys got a venerable pack out here of tax knowledge to help you guys out.
By all means, ask tax questions in the Q&A. If you have comments, by all means, go into chat. You use Q&A for your questions. You use chat for your comments. I already see somebody saying hello from New Hampshire. Hey, Ken. If you can, go into that chat and let me know where you’re sitting.
There we go. We got Anacortes. What city and state if you can. Manteca, Roseville, Anchorage, Alaska on the couch. Odessa, Florida, now they’re flying bad too fast. There’s DC. There’s Honolulu, Hawaii; Claremont; Atlanta, Georgia; St. Augustine, Chicago; Seattle; Ashland, Oregon; Wiley, Texas; Bailey, Colorado. There’s some more Seattle, Washington, Fresno, Baltimore, Las Vegas, Nevada. All right. We got at least one hometown. Albuquerque, Los Angeles, SoCal. Tullahoma, Tennessee. Very cool. We’re sitting in Las Vegas, Nevada. Eliot, how are you doing?
Eliot: I’m doing well. I had it a lot easier than Jeff and company with a tax prep, but busy nonetheless. I’m glad they’re getting a break.
Toby: It’s crazy and I know that sometimes it’s frustrating during tax season because everybody’s trying to walk through the same door at the same time and you always want to prepare for it. No good plan overcomes contact with reality. I’ll put it that way. The IRS is just really, really difficult to communicate with right now. If there are any questions that go on, instead of being a five- or ten-minute phone call, it ends up being a two-hour ordeal. It’s really frustrating and really tough.
There’s somebody in Portland, Oregon, the home of the zombie apocalypse. We got people. There’s Brooklyn, Naples, and Incline Village. We’ve got people from all over the country, so that’s fantastic. Thanks for joining us. We do try to make this kind of enjoyable, fast and fun, and answer your tax questions.
Speaking of tax questions, if you have them during the two weeks in between these episodes, by all means, go ahead and send them via taxtuesday@andersonadvisors. We do take a look at them and I do pull questions out of that heap because it is a heap. It’s several hundred questions a week that come in. I can already see tons of questions going to the Q&A, but we have people that have questions throughout the week and you can just go ahead and email those in. We may grab your question, that’s all.
We love the questions. It keeps us going, and it’s so much fun. There we go. Patty’s already communicating with folks from Pullman, Washington because her daughter went to WSU.
All right, here we go. These are the questions we’re going to go over today and we will answer all these in turn, so do not worry. We already got coops going on in the background. You guys are doing pretty good this year, right? If I’m not mistaken. I haven’t paid a lot of attention to college football this year. But let’s see how they’re doing. I’ll keep my eye rolled.
“For a 1031, does acquiring the beneficial interest of a land trust holding title to real estate qualify as replacement property? Same question, but an installment sale for the beneficial interest of a land trust.” Interesting questions. We’ll answer that.
“How can the IRS prove we as owners used our short term rental for more than 14 days or 10% of rental rented days?” How can they prove it, dang it?” We’ll answer that.
“My wife is the property manager of our small real estate portfolio. What is the best way to document the hours she spends on our business as we are claiming she is a full-time real estate professional to unlock the potential extra tax benefits.” We’ll go over that too.
“We hire professionals for plumbing, AC repair, and she handles items like semi-annual home inspections, painting AC filter, deliveries, all advertising, bookkeeping, et cetera. Thank you.” We’ll get into that and we’ll break down kind of the rules. When I say we, it means Eliot.
“I have a Fidelity brokerage taxable mutual fund account. It is not a retirement account. The taxable account has two mutual funds inside. One is a diversified growth and the other is a more balanced 60-40,” probably bonds. “I started investing in these accounts in 1992 and directed all dividends and capital gains to be reinvested in the same funds.” So a drip.
“On a positive note, the account has grown dramatically, but the bad news is that both funds have high costs associated with them, i.e., actively traded, high turnover, which drives up costs. I would like to somehow move the money to a more tax-efficient index stocks such as XLY, the Dividend Kings, Dow Diamonds, QQQ, S&P 500, VOO, et cetera. Will I be able to do so with no tax or minimal tax implications?” I picked that one because it was really long. No, it’s a good question so we’re going to get it.
“After using accelerated depreciation on a new Airbnb this year, can I avoid future recapture in the case of a sale through a 1031 exchange? Can I exclude some nights when I stayed overnight on the Airbnb property for the purpose of improvement, say installation of the gutter guards by a company the next day? I had to be there to receive the furniture delivered, which I also had to unpack, move, and put in the right places.” Good questions and we’ll get into that.
“Can I take a primary home loan on a property that has been bought with 1031 exchange funds and live in the property myself?” Oh, very good question.
“How does the new corporate transparency law affect our LLC structures? Are you confident that Anderson can figure out a workaround to maintain anonymity? What are the good and bad takeaways from this new law?” We’ll give you guys kind of the good, the bad, and the ugly on. They said the good and the bad, so I just threw in ugly.
“Our family has Christian healthcare medical bill sharing. I’m always told this is not insurance. How does the IRS view this? Can it be deducted for Schedule A? Can it be used as an insurance deduction?” We’ll get into that.
“My husband and I acquired a short-term rental this year and are hoping to close on a multi-family property for long-term rental by the end of the year. I am on track with REP status,” that is real estate professional status for 2022. “We have come across several potential listings. However, requiring a gut down in major rehab. The likelihood of having this rental done and rented is slim by the end of the year. My question is if having the listing up and ready for rental is considered in service?” I’ll break that one down. That’s a little bit confusing to me, but we’ll dive into it.
All right. If you guys like getting your questions answered and don’t know the right question to ask, you can go to our YouTube channel. One of the cool things there is we’re always throwing out new content every week, about two a week. Put out videos, podcasts, et cetera on a variety of different topics.
Everything from tax, to financial, to asset protection, to legacy planning, to 501(c)(3). We just go with the gamut. Feel free to join up and sign up and it is free, just like Tax Tuesday is always free, but it does help us to have you subscribe and to interact and to comment things like that because Google likes us better. I don’t know why it matters whether Google likes us. I suppose it helps to have them like us. I don’t know.
Eliot: It wouldn’t hurt.
Toby: It doesn’t hurt, I guess. All right, let’s dive into these. “For a 1031 exchange, does acquiring the beneficial interest of a land trust holding title to real estate qualify as replacement property? Same question, but an installment sale for the beneficial of the land trust?” What do you say?
Eliot: At first when I saw this question, I wasn’t exactly certain how we were getting that beneficial interest. I suspect maybe there isn’t a sale involved, and that’s the real key behind the 1031 is it has to be a sale of land in picking up a replacement that you purchased. If this beneficial interest was in some way inheritance beneficial interest, from land trust, or you put it in there, that would not qualify.
If you’re saying hey, I’ve done the 1031, gotten a replacement, I put it in a land trust, and now I’m getting the beneficial interest, I believe that would count because it’s all disregarded. If that was what we’re trying to get through with this question.
Toby: All right. Let’s break this down. I think they’re saying I’m selling a property under a 1031, and if I buy a beneficial interest in a land trust, does that count as the purchase of a property under a 1031 exchange?
Toby: Right. It’s actually specifically listed as excluded from the same way stock is excluded and it’s the same as a beneficial interest in a trust is excluded. If you are the grantor of a trust, then you might be able to get away with it. If I am going from trust to trust, you could probably do it.
I would say my personal preference and I think that of most the qualified intermediaries would be that you go name to name. It has to be the same name or you’re going to get scrutinized. If you are going from Eliot Thomas to buy a beneficial interest in a trust, that would not work. If it went Eliot Thomas to Eliot Thomas as trustee, that would probably be looked at. Then what they would really care about is whether you’re the grantor. The IRS considers the grantor, the owner of the property, so the person that creates the trust.
Eliot: On a revocable trust.
Toby: Yeah. And an irrevocable trust, then it’s not going to work then. You can do the Delaware statutory trust. They look at that kind of thing in a different vein. Those ones they’ve actually had, I think it was either a revenue ruling or a private letter ruling where they said that it’s the underlying property that you’re acquiring when you buy the DST. You could go from your name to your name buying the DST, and they’ll consider you buying the underlying property, but that’s a completely different issue.
When you look at the 26 USC 1031 and I want to say a to e, I believe, are the list of all of the exceptions, you’ll see that the acquisition of a beneficial interest in a trust is one of the exceptions to being able to qualify for a 1031 exchange. They’ll make it really easy.
Then the question about an installment sale, you always have to put the equity. You can get financing on something else. I don’t want to step on you. Were you going to answer that one?
Toby: If I sell a property, then buy another property, if it has debt on it when I sell it, I can get the same amount of debt on the other, otherwise I can go in all cash. What I can’t do is go no debt to debt. What you would do there is, and it’s actually going to be an answer coming up in a little while, you would close and then not incidentally. It can’t be something that was necessary with this property, then you would refi it. We’ll dive into that one a little deeper a little bit later. Anything else you want to throw in there on those 1031 exchanges?
Eliot: No, just always be aware of the same title or less rule. That’s probably where people are having the most difficulty.
Toby: Here’s the final one. How about the executor of an estate and they’re buying out the heirs? Can you do a 1031 exchange? You have a step up in basis when you’re the executor of an estate. The chances are there is going to be no game, but let’s just say that there was. No, because you’re selling a property and you’re buying a replacement property.
1031 is a fancy way of saying, I’m taking real estate and I’m buying equal or greater value of real estate. It doesn’t matter what type of real estate, how many pieces. I sell one property and I could buy 10. What happens is the basis of the first property gets spread out amongst the 10 that you’re buying. It’s basically a deferral technique so you don’t have to pay tax on your gain or your recapture right away.
We kick it down the path away and all you have to do to never pay tax is die, and then your basis steps up and your heirs can sell it. Somebody says, I am selling a commercial building into the estate’s property. I’m an heir and also an executor.
If you’re selling and you’re buying replacement property, then yes. What would happen is the new property that you purchased from the estate, it’s kind of weird if you’re the beneficiary, you’d already have a step up in basis. I’m not sure whether you’d be disqualified here. I know that there are rules when you’re selling.
Kevin is sending this via chat. You guys can’t see it. What I imagine is Kevin is saying, I’m going to sell a piece of property. I want to buy the property for my other heirs. I don’t think that’s prohibited, so you’re buying out the remainder of their interest. The only question is whether you’re buying as a tenant in common, which I assume you probably would be to make this valid. I think you just have a longer holding period. I think it’s like two years before you sell and you’d be okay.
Again, I’m buying in a family LP, then it has to be LP. I think that if you’re buying in the family LP, you’re going to have an issue. It needs to be name to name, and it has to be the real estate itself. You can’t buy out the LP. You’d actually have to buy the underlying asset. It would be a specific interest, probably a tenant in common in that property.
Go ahead and throw that also in the Q&A. Our guys might grab a hold of that one. It’s kind of fun. There are a few other comments in the Q&A, but I’ll just sneak on. Otherwise, we’ll be answering that question all day long.
All right. “How can the IRS prove we, as owners, used our short term rental for more than 14 days or 10% of rental days?”
Eliot: What do you say?
Toby: Oh, come on.
Eliot: The reality is they probably can’t unless they somehow got the ability to go out there, research, find out, bring it into court, and documents were produced, et cetera. The reality is they probably can’t. We have an honor system in our Cox Code.
Toby: It’s facts and circumstances. The same way how can the IRS prove that I got paid for all of the widgets I sold or I’m selling burritos at a stadium. How do they know how much cash? They don’t, but if you don’t report it, it’s called tax evasion and you go to jail. Somebody says, looking good.
Eliot: She’s on my team. I pay him to do that.
Toby: It’s good. Somebody says Eliot’s looking good. I think you look good. Anyway, the IRS doesn’t have to prove it. You have to report it. If you can’t support your position that you rented it for enough days, they’re going to ask you about the days that it wasn’t rented. They might do fact-finding. They may want you to say, hey, you never stayed at it. In which case, if they catch you, then the ramifications are pretty severe.
They don’t have to prove. You have kind of a burden when you create your tax return for a position and then they might say, hey, can you provide support for your position? That’s about it. They don’t really have to prove much of anything. But I would suggest that you’d be very honest. If you’re using the short term rental, they might look at your bank statements. They might get testimony from somebody. It might be bad if you got caught in a lie.
Eliot: Upset neighbor was on the whistleblower. Whatever it is.
Toby: It’s always an ex-spouse, ex-lover, ex-business partner. Somebody always comes up and says, did you know that Eliot’s been staying there for 30 days every year and he lies on his tax return? That’s why they have the whistleblower program in the IRS.
Eliot: That actually happened to one of my professors in law school for tax. One of his students was at a bar and a guy was spouting off about how he got away from some things on his tax return. The student had left and graduated and gone to work for the IRS. So there was an IRS attorney right there and some guys blabbing off in a bar about. He gave him an audit and went after him.
Toby: He says, hey, that’s what you get.
Eliot: That was that.
Toby: If somebody says if the IRS suspects use over 14 days, they can track your receipts and cell phone records during your stays. They can go in there and they can get discovery. They’ll get it. They’ll absolutely do if they put their ears back and come after you. The best thing is to avoid the IRS.
Let’s just be honest and do everything we can to not cause their ire. I tell you, you never win. Even when you win, you lose. You just try to avoid it. Try to stay off their radar. Do things that don’t cause scrutiny. By the way, when we do our returns, say we do over 10,000 a year and it’s less than a dozen audits every year, it’s not that many. We try to make sure that we’re keeping our clients from the things that cause consternation and inquiry.
That’s why we don’t like sole proprietorships and home office deductions. We try to keep that form from being filed or that Form SE if you may. It’s kind of like putting a little beacon on yourself or filling in as a trader. If there are things that will cause the inquiry, those are a few of them.
All right, let’s talk about this one. This is a good one. “My wife is the property manager for our small real estate portfolio. What is the best way to document the hours she spends on our business? As we are claiming, she is a full-time real estate professional to unlock the potential extra tax benefits?” Real estate professional is a fancy way of saying your passive rental losses could be considered ordinary active loss and offset your W-2.
“We hire professionals for plumbing, AC repair, et cetera. She handles items like semi-annual home inspections, painting, AC filter deliveries, all advertising, bookkeeping, et cetera.” What’s the best way to document what she’s doing?
Eliot: All of those things that you list out, talking to a plumber, AC repair person, et cetera, put it on an Excel spreadsheet. Put the date, what the activity was, the amount of time you spent. I’m assuming this is a local property, kind of in your town area, put down the time you drove there, the time it took to drive back, the time on the phone calling, et cetera. Any of that, just document it in an Excel spreadsheet.
You may even want to check the time that those individuals are spending on the house as well. That gives you a full documentation that the IRS can see what actually went on. You will have to make sure you’re hitting the overall tests for real estate professional status. I don’t know if we want to go into depth on those.
Toby: I think it is necessary. I use phone and I can easily put something on my calendar, spend this much time, and then take it and put it in a spreadsheet. There are some programs that you can use that are time-tracking apps. If you want to do that, you can do that too. I would suggest that you use MileIQ if you’re tracking mileage, for example. It’ll GPS you. It’ll also tell you the times and everything along those lines if you want to track everything. That’s another way.
Sometimes it’s easy. You pull up to a building, you’re there, you’re doing your supervision, you’re working on the building, and you leave. Those little timestamps are actually good. If you say hey, I spent five hours there, and the IRS wants you to substantiate it even like, hey, can you give me any details? You already have it. Hey, see, this is the time I pulled up. This is the time I left. It was five hours exactly. That type of thing. It certainly helps and it keeps you out of harm’s way.
Eliot: Maybe take photos too if there are repairs being done.
Toby: Yeah, but the real deal is when you say real estate professional, there are two tests for real estate professional status and then there’s one test to apply it to your small real estate portfolio.
The first two-part test, it’s under 469(c)(7). It’s this provision that was enacted in 1986 that basically high income people were buying real estate to offset their high income and Congress shut the door on that by creating the passive activity loss rules, which is section 469.
Basically, people were complaining saying hey, I know you shut it down to stop the doctors and the lawyers and stuff from using it as a tax shelter, but I work in real estate. This is what I do. I deserve this. They get to write off their equipment. Why can I write off my property? I think it was probably 92 or 93, they carved off this provision called Real Estate Professional.
If you spend more than half of your time, and either spouse you can qualify for either spouse. Either spouse can qualify by doing 750 hours in real estate trades or businesses. It doesn’t have to be yours. It could be any real estate trade or business, development, construction, the sale, management, brokerage, et cetera. Even if it’s other people, 750 hours and more than 50% of your personal time.
More than any other job you do is basically the easiest way to remember. One spouse. I could be a spouse working full time as a lawyer. My spouse could be working 750 hours in real estate and qualify as a real estate professional.
The second step is where I think this comes in. The second step is I materially participate in my real estate activities and you have to aggregate them. What I mean by that is you treat all of your rental activities as one activity. Otherwise, you have to materially participate in each separate activity. The courts actually wrongfully interpreted that to mean 750 on each property so you have to aggregate your properties together. And then you have this thing called material participation.
This is why it’s relevant. There are seven rules under material participation. There are really only three that we pay attention to that are applicable. Number one, I provided substantially all of the work and labor done on those properties. We already hear there’s AC filter, painting, plumbing, AC repair, so there are other people doing stuff so we nix that one.
Number two, I do 100 hours and more than anybody else, this one could apply. Your wife would have to make sure she’s spending at least a hundred hours on your real estate portfolio as a whole and nobody else is spending more time than her. That’s where you have to actually get how much time these people spend. I doubt you’re going to need that type of stuff for a plumbing or AC repair.
But if you have a property manager, my guess is that whoever is managing those properties, you might have to get their time. How much time are you spending on my properties? They might say four hours a month, in which case you’ll be way ahead of them. You just have to do a hundred hours or more than anybody else. You would track your time for that.
There are two types of time you’re tracking. Real estate professionals, which could be property management on your properties. Otherwise, it could be doing construction. Otherwise it could be doing development for other people in your side job, whatever it might be. Maybe you’re a real estate agent and you’re helping other people buy properties. Then you have to track your time on the material participation on your properties.
Do you guys track those separately on a spreadsheet or do you just have them pick which ones it hits?
Eliot: I would track it by property. Break it out by property and what the event was the time. The more detail you can provide—we don’t want you killing yourself trying to put this document together. But the better you do, the less argument you’re going to get from the IRS because they don’t want to take on good documentation.
Toby: What I would do is I would just document your time aggregating and adding it all up. If you know that you’re above 750 hours, I wouldn’t do it. I would just be like hey, I’m not going to go through all those extra steps. I can if asked, which is what’s quite common. People go back and look. And then I’ll add it all up.
Just make sure you’re doing so with an accountant. There’s actually a really good case. There was a girl that gave all her time, but she didn’t do the travel time. And she added up to about 650 hours without her travel time. Then on appeal, she added more time. She said, I screwed up. I didn’t add all my time.
They allowed her to do so and they found it credible, but she got herself a problem because she didn’t have an account that knew what they were doing to say, I’m not going to turn in your time if it doesn’t meet 750 hours.
Eliot: As I recall, even the court harassed her to go back and get that time in there. They were trying to help her out. It shows that if you’re a credible taxpayer, they want to work for you. They don’t like to see the big IRS coming down on the little guy.
Toby: Which is weird. I could tell you right now, the IRS, that is not their position. Some of the quotes that have come out of the very few audits, but I talked to other accountants, remember old Ronnie? He shares with me in real time some of the crud that’s coming out of these new agents. They think they’re going to get all these new agents.
I’m sorry. It’s not happening and the people they’re getting are just jerks, to put it mildly. No offense. I love most of the folks. I know a lot of the attorneys and things like that work for the IRS, they’re great. But holy kashmali, some of these people that are being hired as agents, they don’t know the basics of depreciation and they’re being put out there to audit people. It’s silly.
Anyway, I get frustrated with it because it wastes accountants’ time. You’re spending three hours explaining basic depreciation. Somebody says that’s why Scott […] said goodbye to them a long time ago. Scott […] was a great tax attorney with the IRS. He and I have handled many cases together. He’s a really good guy.
Here, guys, it’s going to get worse. They’re going to bring in more agents. They’re going to put pressure on them to do more audits. Think of that, it’s going to generate greater returns, but they say really ridiculous things like we don’t care what the law says. My job’s to represent the interest of the government. That is not legal. That is absolutely against the law, but they do it because what are you going to do? You’re going to basically take it to internal appeals. They’re going to fix it later, but you have to deal with the nonsense of these folks in the beginning.
The IRS, since 1997, passed the kinder and gentler IRS laws. They can’t actually take positions that are legal just to harass you and take extra money out of you. They’re supposed to do it. They did it in the case we were talking about where the gal didn’t substantiate but they knew she actually met the test and they said, hey, take another whack at it. You missed it here. But it’s not because you lack the time. We need an accurate account of your time. They actually did find her very, very credible. And they went out of their way to make sure that she did get the relief she was seeking realizing that the accountant messed it up.
All right, more fund stuff. Talking about insanity, let’s talk about mutual funds. If you’ve ever listened to us, you know we’re not juge fans and here’s why. “I have a Fidelity brokerage taxable mutual fund account. It is not a retirement account. The taxable account has two mutual funds inside. One is a diversified growth and the other is a more balanced 60-40. I started investing in these accounts in 1992,” way to go by the way. You got way ahead of it, “And directed all dividends and capital gains to be reinvested in the same funds. On a positive note, the account has grown dramatically, but the bad news is that both funds have high costs associated with them.”
Mutual funds are bad. On an average, it’s between 4.8% and 5.8%. “I actively traded a high turnover, which drives up costs.” They call it cash drag, tax drag, you got to maintain liquidity, and all sorts of bad stuff. “I would like to somehow move the money to more tax-efficient index stocks such as XLY, the Dividend Kings, Dow Diamonds, QQQ, S&P 500, VOO, et cetera. Will I be able to do so with no tax or minimal tax implications?” What do you think?
Eliot: I wouldn’t know how. I wouldn’t think so. I think you’d have to sell and that is a taxable event. Now you’re going to have to move it over. We might be able to do things to mitigate that around it—some lost positions or something like that—to offset that gain. But I don’t know personally how you would be able to get that transferred over.
Toby: Yeah. Mutual funds are taxed in a multitude of ways. Number one, as a holder of a mutual fund, you are paying tax on all those sales. So when you see, hey, I have high costs because there’s high turnover, they’re actively trading the account, you pay that as the mutual fund holder. You can actually buy into a tax liability in a mutual fund. It’s weird.
Somebody says the keyword is taxable account. Correct. It is not an IRA. It is not a Roth. It is not a 401(k). It is not an exempt account, but it’s in their personal account. It’s going to be taxable to them. So they’ve been paying tax all along on those funds that are being reinvested.
The same way is that if Eliot here got a dividend from Altria and they paid him $300 a dividend, he said, go ahead and reinvest it. He pays tax on the dividends at long term capital gains rates. He reinvested the amount. So in a mutual fund, you’re paying that as you go as they actively trade it. That’s why it can be kind of surprising that you get these tax forms every year. You’re like, I didn’t sell anything. They’re like, we did, inside your account. You’re paying tax on that.
You’re paying tax on interest, if there are bonds and things like that. So you’re paying that as you go. You reinvest it. You have a basis in those shares. If you sell that mutual fund, you owe tax on the capital gain. So is there a way to avoid the tax on the capital gain? It’s really hard. You could sell other assets that have capital losses and harvest some losses like maybe you have crypto.
Maybe you have something that’s gone down in value, and you say this is a good time to sell it. Even on crypto, you could sell it and buy it back and harvest that loss to offset your gain. You could still do a qualified opportunity zone, which means that you sell it and then you buy something that’s in a qualified opportunity zone. You put together the qualified opportunity zone fund, buy something, and you can defer it until 2026. I don’t know if I would recommend that.
The other thing you could do is you could actually donate it and take the entire deduction for the entire donation. If you control the charity in which you donate it, maybe it’s in a private foundation or charity, you get a nice deduction on your side, you still control those funds on the other, and then you could reinvest it in there.
So there are few options that you could use, but there’s nothing that allows you just to sell it and buy something as a replacement and avoid the tax. There’s no 1031 exchange for stocks, unfortunately. Is there anything I’m missing?
Eliot: No. I think that’s just hitting those opportunities. I think that’s of questionable use, and it would only defer and I think it causes more problems down the line. But if you could harvest any losses, I think that’s your best bet.
Toby: There is one other thing that you just keep it and you say, man, it sucks. And then borrow against it. If it’s Fidelity, usually, it’s a stock account that they’ll loan on. I know that for sure, you can do a security-backed line of credit. But if you own this for long enough, they may say, hey, we’ll let you borrow against it and then reinvest those funds.
I don’t think I’d be doing that in the S&P. It might be something that’s maybe real estate or something that’s a little more backed. But if I could borrow the money, and I have a dividend that’s being paid out on something that—again, I keep using Altria, just because they’re like 8% dividend right now. But maybe I’m borrowing the money, I don’t have to pay any tax. I borrowed at 4%. I’m getting a decent-sized dividend that’s covering more than that cost.
Maybe I do that, then I don’t have a taxable event. But it really depends on your risk tolerance and your assets. If you have a lot of money, then maybe you do that to avoid the tax. How much is the maximum I can donate to a nonprofit? It’s 60% of your adjusted gross income if it is cash. It’s 30% if it’s appreciated assets. If it’s a private foundation where it’s not doing anything but you just use it as a holding vehicle to donate to other charities, then it’s 20%, I believe.
Anyway, you could actually do a combination of that. I could actually say, hey, I’m going to sell some, but I’m going to donate some and then sell some. The reason I do that is I’m going to take the donation and that charitable in my income tax deduction to offset the gain on the rest of it. It’s long term capital gains so it’s going to be taxed at 0, 15 or 20%. I should have answered right at the beginning that if you make less than $80,000 a year and you’re married, you’re probably paying zero anyway.
So let’s take a look at that. Maybe you recognize gain over a couple of tax years. You’re okay paying 15%. You just don’t want to pay higher. If you’re making less than half a million dollars, married filing jointly, you’re in the 15% category for long term capital gains. So you might be like, hey, I’m okay with that. I’ll pay it now and get out of that high price fund.
Speaking of high prices, there’s nothing worse than the high price of not knowing how to protect yourself, create a legacy, and use taxes to offset a lot of your income. Feel free to join us at our tax and asset protection workshop. It’s absolutely free. We have November 12 and October 29. We have one coming right up. What is today? Oh, it’s Saturday? Well, Clint and I are teaching it this Saturday, you can come join us. Sometimes I forget.
All right. “After using accelerated depreciation on a new Airbnb this year, can I avoid future recapture through a 1031 exchange? Can I exclude some nights?” Let’s answer that one then we’ll answer the rest of it. Can I 1031 exchange an Airbnb property?
Eliot: Yes. Wow. If it’s used in a trade or business, yes.
Toby: But I took accelerated depreciation. I wrote off 30% of that property, can I really do a 1031 exchange?
Eliot: You can. I don’t like the word avoid. You can defer future recapture. Unless that you eventually leave that to your beneficiaries if you pass.
Toby: Or donate it.
Eliot: Or donate, thank you. That would get around it. That would avoid it. Yeah.
Toby: Yes, you can even if you write off a huge chunk of it. Can I exclude some nights when I stayed overnight in the Airbnb property for the purpose of improvements, say an installation of the gutter guards by a company? And then hey, I had to be there for a few furniture being delivered. I had to unpack, move, and put it in the right places.
Eliot: Yes, if as long as you’re there that day or substantially spend the whole day doing the repairs and maintenance and things like that, that will not count as a personal day.
Toby: Yeah. First off, if it’s 14 days or less, we don’t care because they don’t count any of those days. If you’re over 14 days of personal use, then we really have to start tracking it or if this would put you over. If you are rehabbing, repairing, and you’re there not for personal use, like this isn’t because you’re staying there to get the benefit of the property, but you’re there because you’re working on the property then they’ll exclude it from personal use.
The IRS actually tells us that you can do that. Two pieces of good news for you. Whoever the Airbnb king is or queen, you get a star. You’re going to be very, very happy. Hopefully, they’re listening, right?
“Can I take the primary home loan on a property that has been bought with 1031 exchange funds and live in the property myself?” In other words, can I convert a property that I purchased in a 1031 exchange? Can I move into it and borrow against it?
Eliot: Yes. But of course, there are rules behind it. I don’t know that there’s a fast and steady rule for how long you have. You have to use it after the 1031 in a trade or business. You’re going to have to run it as a business. You can’t just get it and then move right into it. The rule of thumb out there is maybe two years or run it as a trade or business is often what you’ll see. Then you can move into it. Once you’ve picked it up and you’re living it, then yes, you could do whatever loan you want to.
Toby: Yeah, so I would say this. Number one, primary home. If you buy a replacement property, there’s a period of time. I don’t know if it’s a year, two years where it has to be an investment property. In other words, you can’t just move into it. Then the code actually contemplates this happening. You have a 121 exclusion, which is a capital gain exclusion. Normally, you have to live in it tow of five years. You can’t do it every two years.
When it’s a 1031 exchange property, I think you have a five-year waiting period. But you could and then borrowing against a 1031 exchange, I don’t know I’m sorry, if you already said this. I was reading all the chats. Did you get into borrowing against the 1031?
Eliot: I did. Well, after they’ve moved into their primary residence. I was just saying that you could, but we have the other issue that if you donate that.
Toby: You have a general rule that you can actually borrow even after your 1031 exchange, so long as it’s not part of the exchange. In other words, hey, if I 1031 into a property and it’s not relevant to the closing, in other words, I have enough monies to close then you could borrow, you can use it to lever in take money out of a 1031 exchange. There are actually a couple cases.
Eliot: But like I said, in the two years, they get to live with it. That’s just kind of what a lot of people see out there. I think the most important thing is that you show that it was used in a trade or business. That may take two years. It’s just all up in the air on that. I think they use it as a safe harbor. But it doesn’t mean you necessarily have to wait two years.
Toby: We have somebody out there that looks like their mortgage broker something and says for 1031 to a primary home, you really need to get in. If you’re doing a loan against it, you need to make sure you have your documentation in place. My guess is that somebody is moving into the property and then taking a loan out I think is what you were advocating. But if somebody is hey, I want to move into the 1031 exchange but I can’t unless I need money out of it, then probably do.
Well, you already own it, maybe to extinguish a loan on another piece of property or something, Then, yeah, you’d have to make sure you’re crossing your T’s and dotting your I’s with the mortgage company, for sure. But anyway, so the good news is yes, you can. The code actually contemplated. Yeah, you can do both. You can take a primary home loan on a property and move into it.
It’s just making sure if it’s closing as a 1031, then it’s going in the investment category loan. Exactly, Rick. So you’re never going to be able to just move directly into the house. If I 1031 exchange, so I sell a commercial property and I buy a property, I am not moving into that property after the close. I am waiting a period of time, probably a year, maybe at least six months, but you got to show that it was an investment property when you bought it, and then you can convert it to a primary home.
All right. “How does the new corporate transparency law affect our LLC structures? Are you confident that Anderson can figure out a workaround to maintain anonymity? What are the good and bad takeaways from the new law?”
Eliot: Well, every LLC for our clients typically is going to be underneath this because it hits all small businesses. The exemptions are there are like 23 that really deal with your publicly trading companies. The companies that everybody knows all about, anyway, so it’s more geared towards smaller businesses.
Is there a way to maintain anonymity? Well, we never had anonymity to begin with the government. The purpose behind this is that there is going to be the FinCEN Agency and law enforcement that are supposed to be the only ones who have information to this.
Toby: The Corporate Transparency Act was passed. They’re doing regs on them and they just came out with final regs a few weeks ago. I think my partner, Clint, put something on his YouTube channel going over in a really fancy way. Was it FinREN? What is it?
Toby: FinCEN. Financial reporting.
Eliot: Financial criminal.
Toby: So it’s a government agency that cannot share your information. You’re reporting the beneficial owners on all entities where there’s a beneficial interest, and it can be corporations, LLCs, trusts, et cetera. They want to know who’s behind them. They’re trying to prevent money laundering or bad people, and also create a criminal act to go after those folks that they don’t disclose.
If they find out that an oligarch from some country where I’m really mad at is investing in the United States, they have additional crimes that they can tack on and go after those assets and go after that business. But it’s not a public disclosure. In other words, the government’s not sharing that information. Look who’s behind this LLC. No. It’s no different than what the Bank Secrecy Act requires now.
After 9/11, these laws were put into place where the bank has to know who the owners are. The United States is pretty lax compared to Europe. I mean, it’s nasty in Europe, but they just want to know, hey, who the customer is, who’s the beneficiary, and they’re going to want to know who that individual is.
To your politicians, look to your left and right, they’re the criminals. John, yes, but they have to disclose under this too. But I do know what you’re saying. This will have zero impact on the anonymity that Anderson advocates, which is from the public record. In other words, I don’t want to create liability by having somebody be able to go to a public record and look up my ownership or my involvement with an entity.
That’s no different than if I get into a car accident. I run up and say, by the way, I’m really, really wealthy, and start telling the other person how much money you have, expect to get sued. They’re just going to be, oh, that’s great to know. Then they go to a lawyer, and they said, well, what do we know about that individual? I don’t know. They said, they’re really rich.
I have a really good friend that owns an agency. They said, they always tell doctors, please do not tell the other party that you’re a doctor. The claim just went up considerably once the other party knows that. We want to not create liability for ourselves. Hey, look, I have 30 properties in the city. You want people to not know that information. This does not impact that.
The Corporate Transparency Act will not affect your ability to maintain anonymity. But there’s no workaround on the Corporate Transparency Act. It’s a law. We’re going to follow the law, just like everybody else is going to have to follow the law. And anybody that’s a Registered Agent, or a formation company is going to have to disclose who’s doing it. We have to disclose who we are and the beneficiaries.
So, are there people that are going to mean criminals tend to ignore the law anyway? Are there going to be criminals that have other people open up bank accounts on their behalf and give them the money? Yes. The real crooks are always going to do that, or they’re using cash or crypto now. They’re not using regular transactions, for the most part. There might be some that still do, but they’re not generally not going to be the United States if they are.
It just gives the government more tools to prevent certain types of behaviors from occurring, and it gives them a remedy in the event somebody does that. I don’t know what else to say about that. It doesn’t really impact our clients for the most part. Our clients are pretty…
Eliot: As far as we know, they’re there clean.
Toby: They’re on the up and up. “Our family has Christian health care medical bills sharing. I’m always told this is not insurance. How does the IRS view this? Can it be deducted for Schedule A? Can it be used as an insurance deduction?
Eliot: We get this question quite a bit, especially during tax deadlines. It isn’t. You’re correct. It is not insurance in the eyes of the IRS. It is just a group of people coming together and helping pay one another’s medical claims and so that’s why it is not insurance. Insurance is defined as something that can be deducted. This cannot be deducted. It cannot be used on Schedule A. It cannot be used as medical reimbursement.
However, in researching this just to see what was the latest on it, there is a proposal out there for regulation where the IRS is trying to change that. They’re trying to get to this where this would be deductible. They recognize the similarities. It’s just that the proposal hasn’t really just passed, if you will, to be something that we can rely on yet.
Toby: When we had Obamacare and you had the requirement to carry insurance portion. The courts had come through and said we recognize the medical sharing arrangements are meeting that standard.
Eliot: Correct. It has had that level of acceptance within the tax and legal realm, but it’s not quite where we can deduct it yet. But again, there’s a proposal out there. We just have to wait to see what happens.
Toby: Yeah, HSAs still don’t work. You can’t treat it as insurance.
Eliot: That’s part of the problem is that’s actually the HSA law, from what I read on it. I read a really in-depth research paper on this. The laws are a little bit different for HSA. There’s the problem of trying to make it fit or what’s called Section 1213. I think it was like 1223 or something like that for the HSA. The IRS is trying to balance the two. They’re basically really just to say, look, we understand there’s a difference in the language, how we use it. But we’re saying go ahead and allow it as a deduction. That’s what they’re proposing. It just takes time to get there.
Toby: We will see but yeah, so to answer your question. The IRS does not view it as insurance. It views it as though like you helped your brother pay some of his bills. It’s a gift, right, if it’s not deductible? No, it’s not deductible on Schedule A and no, it cannot be used as an insurance deduction. Correct. As of right now. So maybe they change it. Lobby your Congress people and say, hey, this is unfair that if I buy from United Healthcare, I’m good. But if I buy from Medishare, I’m not.
“My husband and I acquired a short term rental this year, hoping to close on a multifamily property for a long term residential by the end of the year. I’m on track with rep status for 2022. We have come across several potential listings however, requiring a cut-down and major rehab. The likelihood of having a rental done and rent is slim by the end of this year. My question is, if having the listing up ready for rental is considered in service?”
Eliot: If it’s someone just putting the listing up there, no. It has to be available for service. It is the status you’re trying to get. That means that if you did put it up there, then I could move in there right now. You run the whole risk of needing asset protection if you do something like that. Because if you’ve ever been around constructing a house, you have a renter in there, a tenant, there’s a lot of things that could injure that individual. So you’re definitely going to want to have your LLC set up in place and insurance, et cetera. But if they can’t move in right now, then no, it’s not available for rent. So no, we would not get that deduction by 1231.
Toby: Unless it is available. If your question is, hey, I’ll have it available by the last week of the year. Does that allow me to take the deduction this year? The answer is yes. If it’s not available for rent, you’re not done with the rental by the end of the year, it’ll be in 2023.
Here’s the problem I see. It says I acquired a short term rental and a long term rental and I’m on track for rep status. Short term rentals do not count for the material participation of your rental activities together. So that time would only count towards qualifying them to 750 hours, not under material participation. Because a short term rental, if it is seven days or less average rental—listen to me carefully—it is not a rental activity. It’s a regular trade or business activity.
Whenever I hear short term rental, I say pizza shop. So I acquired a pizza shop this year and I’m hoping to close on a multifamily property for long term rentals by the end of the year and I’m on track for rep status. Did you include the pizza shop in your reps calculation because unless you’re managing the short term rental, that’s not going to fly. It’s a completely different material participation test. It sounds weird, like why is Toby talking about pizza? It’s because it’s a completely separate activity.
The way you bring that underneath the same umbrella as your long term rentals is you set up a corporation to be the host of that short term rental and you rent the property to the corporation on an annual basis. Now for you, that is an investment property for purposes of qualifying for a real estate. If you want to be a real estate professional for 750 hours, you can add that time together because you owe more than 10% of the corporation. So you can take that time.
But magically, it can be considered a long term rental for purposes of aggregating and meeting the material participation test. I know you asked a few questions on this. This is one of these situations where I would strongly urge you to reach out to us. If you’re platinum, make sure you’re meeting with somebody. If you’re not, make sure that maybe you should become so you can talk to somebody like Eliot because you are dealing with two or three issues that are very fact specific that we don’t want you to screw yourself up.
Because when I see rep status and I see short term and long term, I immediately think, oh, crud, seven days or less short term rental pizza shop, it’s not a short term rental anymore. How do we make sure that we don’t miss the material participation on all of your properties because you’re not going to get to have any material participation on the long term rental, unless you do in the build out yourself, or you’re there supervising. It’s going to be really tough for you to materially participate in that.
You’re going to meet your material participation test more than likely on working in the short term rental, and you can’t count that when it’s a short term rental. So it’s going to be really difficult for you to meet rep status. You may not need it if you’re going to depreciate the short term. You may not need it if you’re okay taking the long term rental into next year, and you’re going to meet the material participation tests on the multifamily next year. But it is absolutely critical that you understand the different type of timekeeping. I just want to make sure that I mentioned that.
Eliot: Easy to mix that up.
Toby: Yeah, and unfortunately, the rules, not everybody understands it. You want to make sure hey, I do this. I want to make sure that I am tracking those things accurately and I set myself up for success on that.
Speaking of setting yourself up for success, make sure that you join our YouTube channel. Again, it’s free. You can set yourself up to get notified by turning on notifications when new videos come out. So if you like this type of information, we do put our Tax Tuesday recordings up there too. If you saw a few people were saying, hey, can I get a recording of this? Yes, you can absolutely go there and do that.
Now speaking to the folks that have been getting their questions answered, there have been 165 written answers thus far. Another 16 that are waiting. Thank you for patiently waiting, but Patty, Dana, Matthew, Lanzi. I think Piao was on. Dutch was on. Ian was on. Christos was on. I think I already said Lanzi. Who else? Trisha was on. I think we hit everybody else. But there are a lot of folks answering your questions. They will get to your questions.
Kevin wrote in a much longer reply, Patty, maybe grab that one and shoot it over to me. So I can make sure that we get somebody answered, so that we can give you some guidance because it looks like there’s more facts coming our way on that one.
Hey, if you have questions during the time in between Tax Tuesdays, go to Tax Tuesday, or you can email in at email@example.com. Somebody says, “I have issues with the last question both.” Okay, we’ll make sure that we get with you, Roseanne. I think that Patty is communicating with you. But if you have questions on taxes, general questions, just go ahead, shoot them in at firstname.lastname@example.org.
Visit our website, if you want to sign up for our Tax and Asset Protection or look at our other training. We do provide a lot of free training. The reason we do that is because smarter clients are better clients, more successful people become our clients. It doesn’t do us any good if you don’t make money because it’s hard to do tax planning for people that don’t make money. Legacy planning goes hand in hand with good investing and good business planning.
We actually have an interest in making sure that you are successful. It makes us more successful. Plus, we just like doing good out there. So we will absolutely provide you with tons of free training if you allow it. Again, our YouTube channels. My partner Clint has a very good channel as well. You could pop in there if you want to. You could also come into our website just at Anderson Advisors and then of course you could reach out to us at any time at taxtuesday@andersonadvisors. Eliot, do you have anything to add?
Toby: Thanks for stepping in.
Eliot: Thanks for allowing me.
Toby: You did a great job. Sometimes I step on you, I apologize.
Eliot: No. Not at all.
Toby: It’s my nature, right? So anyway, thanks for coming in and stepping in for Jeff and I hope Jeff is feeling better. We will see you guys in two weeks. If you have a question waiting to be answered, hang tight. We will answer it and we will make sure that we get you some responses.
Thank you for listening to today’s podcast. Show notes for links to everything mentioned in this episode could be found on our website at andersonadvisors.com/podcast. Be sure to subscribe to our podcast. And if you are already a subscriber, please provide us a review of what you thought of this episode.