Welcome to another episode of the Tax Tuesday show. Host Toby Mathis, Esq., joins our regular guest Eliot Thomas, Esq., Manager of Tax Advisors at Anderson Business Advisors, to help answer your questions.
On today’s episode, Eliot and Toby answer listener inquiries, including a mother and son who want to set up an e-business together, a question about filing an extension for your taxes, which is almost always a good idea, and a question about writing off a pool that is required for a medical condition, (which is a surprisingly common question!)
If you have a tax-related question for us, submit it to taxtuesday@andersonadvisors.
- I had to put more money into my LP for stock options trading- what is the easiest way to handle this addition to my LP? – You can put cash in, or capital contribution – there are no tax implications putting money in, or taking money out.
- Is it a good practice to file an extension? Yes it is – if you rush, you may have to do an amendment…it gives you time to breathe. I don’t know any instance when it is a bad idea.
- If I plan to leave investment property to my children, is it better to purchase and leave it to them in trust, or put their names on title? – They may have stepped up basis issues later on. I don’t recommend gifting things when you are still alive. If the kid is on the title, the child could have liability issues, and you lose the step up in basis.
- No activity in LLC for 2022- Do I need to file tax forms? – if its a partnership and absolutely no transactions, file a ‘no activity’ return. S-corps and C-Corps must file.
- What is bonus depreciation on residential property? Is there a disadvantage for carrying forward a large loss? – Bonus depreciation is just the ‘speeding up’ of straight-line depreciation. No real issues with carrying the loss forward…but it depends on your income.
- What is the best tax structure to set up eBusiness, for a co-owner son and mom – S or C Corp have better tax options than a partnership. Is mom materially participating?
- Pool installation for minor son, is it possible to do a tax deduction? – if it is for medical reasons, it is a possibility. You must document that this is the only option.
- 1099 income, how much to contribute to solo IRA/401K? Employee and employer contributions? – There is a calculation, and a maximum of 66K in 2023, yes, you can- but I wouldn’t. Talk to your tax professional
- Federal tax rate for capturing depreciation on property from a previous 1031? – if its 1250 real estate, or 1245, in order to figure this out you have to do a cost seg.
- My AGI is 300K, I gifted to charity 90K – and thought I could also gift 90K in non-cash. Tax preparer said non-cash giving. – There is a 60% limit for cash donations. Non cash has different limitations, depending on the non-profit.
- My only source of income is from 4X trading, 5K trades a year, 10 hours a day, what are the benefits in creating an entity to pay less taxes. I’m borrowing 15-30K, usually paying interest of 2K a month. – You want to have a note, and records of the interest. A C-corp would allow for some deductions and reimbursements, and be able to write off expenses.
Full Episode Transcript:
Toby: Welcome to Tax Tuesday. Bringing tax knowledge to the masses. My name is Toby Mathis and I am joined by none other than Eliot Thomas.... Read Full Transcript
Eliot: Yes, it’s Eliot Thomas, Anderson tax advisor here. So thankful to be here and thank you for joining us.
Toby: We’re going to have some fun today and we’re going to go over all of your tax questions. We have a big, old list of tax questions to go over and we have a ton of people to answer your questions. We are after the tax seasons so they’ve all crawled out underneath their rocks they have been living under for tax season.
Let’s see. We got Patty, Dana, Dutch, Jared, Kurt, Ross, Serge, Tana, and Troy. Are there any others? No, that is it. There’s a bunch on so you got a bunch of tax attorneys, a bunch of accountants, and then some people just like me that are on there.
We’re also broadcasting on YouTube and via our typical broadcast of Tax Tuesday. Actually that is on YouTube. Where are we also broadcasting, guys? Zoom and YouTube. I have to ask the wall because the wall responds to me.
Let’s dive into the Tax Tuesday questions. If you ask your questions via the Q&A, there will be somebody to answer them. If there are comments, put them in chat. If you ask big questions on chat, we will say please put it into Q&A because it’s too long to be answered in chat. If I see a big whole book being written in the chat, then someone is going to point you right onto please put it in the Q&A. If you have a Q&A, we’re going to answer it.
You can also ask questions during the week. Go to firstname.lastname@example.org. What we do with those is if it’s a good question, we put it into the presentation and answer it live like we are going to do today.
If you are asking for detailed advice about your specific situation, it may arrive to the level where we need you to become a client so that we have certain protections there. Also because we are not just going to go out there and do a bunch of work for free and be your tax people in your situation.
If you want us to engage in activities on your behalf, you have to be a platinum client. It’s not that expensive. It’s $35 a month and you can ask all the questions you want of our attorneys and you can ask written questions of our accountants. We put it in writing because there are usually some nuances there that we want to make sure are documented as opposed to just answering questions.
This is supposed to be fast, fun, and educational. You feel like it’s fast, fun, and educational?
Eliot: Yes, definitely educational.
Toby: All right, and fast and fun.
Eliot: It’s fun.
Toby: It’s not fast. Sometimes I feel like we’re going on slow motion, but we’re going to give back and educate like what we always do in these. I think we are close to a couple of hundred episodes now. We’ve been doing this for a lot of years.
Eliot: It’s 193 you’re at.
Toby: 193? We are at 193 episodes. Apparently, precision is something Mr. Thomas here is good at. These are the questions we were asked this week. We had hundreds of questions come in but Eliot and his team grabbed a few and said let’s answer this one. Is there a methodology that you are using?
Eliot: There actually is. I try various questions. I do look through them, looking for a variety. I look for ones that are maybe three very similar types of questions and then try to get one of those in there. We try and get into as many people in some sense that we can.
Toby: I like it. There are already a bunch of questions coming in here. Let’s get it. “I had to put more money into my LP to be able to continue stock option trading.” Stop that if you’re losing money. Stop what you are doing. If you are just putting it in because you want to continue to invest, I get it. “What is the easiest way to handle this addition to my LP? Loan with interest? Pay it back to me? Or to pay to the C-Corp which is the LP managing company?”
This seems like there’s a lot. We’ll get to this when we answer that for you. “Or can it just be an addition to capital?” This apparently is all one question. “Could the capital be reimbursed back to me without any tax consequences?” We grab your stuff directly as you send it. We try to not do any editing because we don’t want to lose the call to another question. “Right now the LP is unable to pay an interest on a loan.” This is just all one big question. I thought it was three questions.
Eliot: No, this is one big one.
Toby: This is trick Toby day. “Right now the LP is unable to pay any interest on a loan. Some Anderson lawyers state that it is usually easier to use the money as a capital addition and use the return, the capital to me.” We will answer all three of those or whatever they are. We will answer that one.
I like this one. “Is it a good practice to file an extension?” That’s easy. Yeah, I’m just kidding. We’ll answer that one too.
“If I plan to leave one real estate investment property to each of my adult children, is it best to purchase properties and leave them to the children in trust or to purchase the properties as co-owners with me and place their names on title?” We’ll dive into that one for a little bit.
“If I do not make any transactions in my LLC for 2022, do I need to file any business tax forums?” Good question.
“What is bonus depreciation on residential property? And does it apply to all or only some classes of property when a cost segregation study has been completed? Is there a disadvantage to carrying forward a large unused loss instead of claiming less depreciation?” We’ll answer that.
“What is the best tax structure to set up for my son who wants to start an ecommerce business? I will be the co-owner as his mom.” I can’t see any bad things happening.
“My family installed a pool in our backyard this year because of my son’s medical condition. He is a minor. Is it possible to deduct the installation cost in my 2023 tax? If so, how will it be?” Good place to be coming because this guy over here likes to dig into that stuff.
“How much can you contribute in a solo 401(k) if you have a 1099 income?” You’re an independent contractor. You’re not getting a W-2 income. You’re getting just 1099. You’re an Uber driver, DoorDash, you’re a 1099. “No LLC or Corp a consultant. Can you do employee and employer contributions?”
“What is the federal tax rate for recapturing depreciation when you sell? Are there any other ways to defer tax? Can the taxes due from a previous 1031 exchange be deferred other than reinvesting in other property?” On that one, I think because they mentioned 1031, they are only available for real estate so I think we should probably read that one as a real estate question, although it could be your car. When they say property we don’t know if it’s personal or real, but I think we’ll probably focus on real estate.
“My current tax advisor said it is the best advantage for me to keep my two properties which I rent for a short-term under my own name and use a schedule E. Can you advise as to if this is the most tax advantage? As a note, I am aware of the other concerns surrounding asset protection, but I am curious if the advice to use a series LLC would radically change my taxes and subject me to greater taxes?” Good questions.
“AGI is $300,000. I thought I could gift 60%, a $180,000,” I’m assuming they mean to charity, “I gifted $90,000 in cash to qualified charities and I thought I could give $90,000 in noncash to charities, but tax preparer said this was a 50% limit somehow on non cash-giving after 30% cash gifts.” Is he correct? We’ll dive into that one a little bit. I might have to get my calculator out.
Last question. “My only source of income is from Forex trading. I do over 5000 trades a year.” Good god man. That’s a lot of trades. “Spent at least 10 hours a day and I want to know what the benefits are of creating an entity to pay less taxes. Also, I have friends and family members who have trust in me and lend me money to increase my business capital in return for a monthly fee. They let me borrow $15,000–$30,000. I usually pay them interest of $500–$2000 a month. How can I benefit from this interest that I am paying them monthly. Should I create a contract for each of them?”
We’ll dive into those. There are so many issues that can pop up on there. This gets fun. If you like this type of stuff, if you want to listen and watch previous Tax Tuesdays, go to my YouTube channel. You can just type in Toby Mathis in the browser and type YouTube. You’ll probably find me pretty easily, but Patty will also share the link.
If you are on YouTube you can just pretend I just didn’t say this because you are already on YouTube and I am streaming. I can see a bunch of questions being asked. I love the fact that we are answering all of these questions at no cost to you guys. I actually really enjoy that. It makes me feel really warm and fuzzy.
If you are not part of our community on YouTube, you should be. It doesn’t cost you anything. You just subscribe and you get notified when new videos come out. We love putting out new videos. We put up probably two or three a week on different topics. Everything from nonprofits to estate planning, to how to make money because we sit here and look at tax returns of people that make money year after year after year and they tend to do the same things. It’s not rocket science.
Eliot: You got to emulate them.
Toby: If you want to get rich, do what the rich do. All right. This is the first question which is a three-part question.
“I had put more money in my LP to be able to continue stock option trading. What is the easiest way to handle this addition to my LP?” Then they have all these different ways. “Should I loan it? Should I just put more capital in? My LP can’t pay the interest. It means I’m probably losing in the market. Anderson’s lawyers said maybe we should do a capital contribution.” What do you think, Eliot, on this one?
Eliot: From a partnership standpoint, often we would call it a contribution. However, we have a C-Corp in here. I like having to go into the C-Corp or at least a portion of it goes to the C-Corp. It’s percentage ownership at the very least. Or we can call that loan from shareholders. As you mentioned, they can’t pay the interest. You can put in cash yourself in order for them to make that interest payment then you get it right back.
Toby: You can do a capital contribution to the partnership. This is the structure. It’s a limited partnership so it’s a partnership for tax purposes. File is a 1065. The only question is who are the partners. It sounds like the individual list and then they also have a corporation. They have a C-Corp. I actually like the structure because what happens is if there is money made or losses, they just get divided up in accordance to their ownership and it goes to the respective party.
Here’s the deal. If I am struggling and I’m not making money trading, first off, go to infinityinvesting.com and implement strategies to make sure you are always making money in the market. We like cashflow. We are big believers in cash flow. That doesn’t mean it’s all what you do. We want to be able to make some money. In order to do tax planning, you have the whole income thing going on first. You can contribute money to your partnership. Just put more money in. All it’s called is capital contribution. And you can always take that money out. There’s no tax consequence putting money in and taking money out.
Keep it simple in this situation, that way you don’t get into interest and all of these other stuff. It’s just like hey, I’m putting more money in. You’re going to be out of whack with your corporation as far as how much interest you might be diluting them somewhat.
You want to make sure you are documenting how profits are distributed. It might be non pro rata. I may have more than I put into the partnership. Just document it. Work with us if you need to, and all it means is our percentages are set in stone.
Let’s say it’s me and Eliot here. We put money into a partnership and then it just doesn’t go the way we think and I can put more money in. But Eliot says hey, I’m a 20% owner. I don’t want to go down to a 10% owner and be diluted because I am putting more money in. I can agree to put more money in my capital account and not dilute it. […] agree to do that. Then I get paid back that money. It’s important that you do that.
By the way, if you’re doing this with a third party, my advice is going to be a bit different. If you are doing this with a third party, the last thing you want to do is make an additional contribution to things that are going south because you may be waiting in line to the very end to get paid back. you probably want to do a loan.
Let’s say it’s Eliot and I doing a joint venture with flipping a house and it just goes horribly wrong and I’m putting more money in. I want to say to Elliot we’re still 80-20 but I’m loaning the money in and I want to secure the real estate so that if something bad happens, I get paid back. I don’t want to be in a situation where it’s some sort of pro rata. Hey, I have a big interest but they are distributing out the money when we liquidate the badly-run enterprise. I don’t want to find myself on the short end of that stick.
Anything on that one that you want to hit?
Eliot: I think that’s great.
Toby: That’s it. Keep it simple. “Is it a good practice to file an extension?”
Eliot: Yes, it is. I threw this one out in particular because we just got over the tax deadline and we will start to hear about new clients coming in going forward who didn’t get an extension filed or something like that. Toby has pointed out more than anybody I know.
It’s so important to file an extension because it just gives you more time to breathe, to get things, to get all the information in. More than likely if you rush to get that return done, guess what? You’re going to do an amendment, anyway. Especially if you get into syndications. Those K-1s are very well-known to be late. Those K-1s and other practices are out there, your S-Corps and partnerships in K-1s. We always recommend an extension. I don’t know of any instance where you are hurt by it.
Toby: The only time I would say you don’t want to file an extension is if you do a refund and you want your money back or if your tax return is necessary for financing. Like hey, I have a loan and I need my return filed. Otherwise, your tax return is not due until October 15. Your taxes are due on April 15, but on your tax return, you have an automatic extension. You don’t have to qualify for it. You just have to say I want longer.
I always equate this to going back to high school. We’re sitting in class and the teacher says your homework is due on Friday, but if you want, it’s actually the following Friday. There’s somebody who is like I want to do the homework on Friday and then something changes and then the teacher says you know what? There was another question I wanted to add to the homework. The guy that did it was like oh crap. Can I have my homework back? No.
Toby is the following Friday guy. Straight I am, Sherry, because I am going to say a lot can happen in that week. I may learn something during that week that changes my answer. I want to give as long as a period of time so that I can make the most complete answer. On your taxes, we get restated K-1s, restated 1098, we get 1099s, we get restated documents.
We look at our numbers and we can continue to make contributions for last year in a business, for example on your 401(k). We can make employer contributions all the way up until we file our return plus extensions. I can do a cost segregation all the way up until I have to file my tax return. Why on God’s earth would I just slam that and close that door and rob myself of those possibilities when I don’t have to?
Why would I put myself in a situation where somebody else’s mistake could cost me, because as soon as that K-1 gets restated, guess what? Your return is now off. Your K-1 will not match the K-1 that was filed with that return. Let’s say a syndication. They rush and rush and rush. In March they give you a K-1. What these guys like to do is go in and say maybe we’ll do cost seg. Maybe we’ll change this. Maybe the finances were a little different than we remember. We go through and they change the K-1. They actually create a bigger loss. I already filed my taxes.
What does that mean? It means that the K-1 that they file with their final return is going to differ from the one attached to my return. Audit. Boom. It happens all the time.
Eliot: Even in the case where you want to get that return done for financing or something like that, you still want to be penalized by doing an extension. You still want to get your return done early (perhaps), but you won’t be hurt by the extension.
Toby: What I have seen with financing is they’ll take the return that’s completed. They say it’s the final return and then sometimes they’ll say did you file it? It’s the final return. Here it is. If they want to see a stamp copy or something, or a CPA said the return is filed, you may end up amending it. I just don’t want to mislead somebody.
There’s really no reason to do this. There’s no data that suggests that you subject yourself to more audits or less audits by extensions. I would say that what I’ve seen—and we do over 10,000 returns a year here—is that erroneous returns trigger audits. You’re more likely to have an erroneous return, something with mistakes on it, if you’re struggling to get them by April 15.
I know on our staff, they’re just getting blasted from about February on. For those two months, it’s just […], then it spreads out over the summer, and it gets hot again in September and October. The whole point though is give yourself the maximum amount of time to do it right rather than rushing to get it done quicker. I get this every year.
Somebody says, I’ve never been late. I always file my tax return on time. I just have to say, what’s on time? It’s April 15th and that’s technically early because you actually have a six month extension. On time is actually October 15th. Your taxes, you still have to pay. Taxes you have to pay by April 15th.
If you want to be safe, pay 110% of whatever your tax bill was last year. That way you don’t get penalties. You may have some interest , but interest is like half a percent a month. It’s 6% a year. It’s not devastating. But you don’t get penalized so long as you’re paying the right amount. If you are paying quarterly, then you are better.
We tell people if you made more money, pay 125% of what you did last year because realistically, you’re probably going to be just fine as wine. You’re overpaying a little bit, maybe get a little refund back, but you’re not getting interest.
Somebody says, “Why not just do an amendment instead of extensions?” An amendment is going to cost you money. Somebody is going to file an extension plus if you have too many returns, then you can trigger yourself and find yourself in a situation where you are being audited. I’ve never seen data on amendments. How many amendments get audited?
Eliot: I’ve never heard of any connections.
Toby: The IRS just came out with their publication of their annual data. They give it out (I think) twice a year. This is the year 2022 second tranche. When you look at it, I’m always trying to figure out what’s the data trend and I can’t find any on extensions or amendments. It’s just your chances of an audit are really low right now. If you are making between $50,000–$500,000, I think it’s 0.1%. Really low.
If you are an S-Corp, it just went to a fraction of a percent, which means it’s less than half of a half of a percent. Partnerships are the same. They are infinitesimal, like really low. That is why the Congress is trying to give them more money so that they can hammer away at you.
“The 0.5% penalty of the tax owed would be due on April 15th or October 15th?” If you have a penalty, remember your taxes are due on April 15th. If you paid your taxes, there’s no penalty. If you paid 110% of last year, and that’s if your AGI is over $150,000. If your AGI is below $150,000, you can actually pay 90% of the previous year.
Eliot: Or 100% of the previous year.
Toby: 100% of the previous year and 90% of this year’s and you don’t get penalties. You would still get a little bit of interest for the underpayment, but you get away from all the penalties. The answer to the question is, is it a good practice to file an extension? Absolutely, especially if you have a complicated return. If you are doing syndications, real estate, own a business, absolutely file an extension because you are giving yourself time.
Let’s say I have a 401(k) and I am routinely putting in $20,000 a year. I’m like hey, I don’t really make that much money. Then I just start killing it in 2023. I have a bunch of cash. I’m in June or August and I’m looking at it going, I have a bunch of extra cash. I could actually make a contribution for my 2022 tax year.
I could put 25% of whatever I paid myself. Let’s say I am putting in $20,000. Maybe I paid myself $20,000. I can put $5000 more into my retirement plan and it lower my tax bill. Maybe do that. Maybe I will pay myself $100,000. I could put $25,000.
Maybe I want to do a cost segregation on a property last year because I am looking at this year going I have done pretty well. I already have to come out of pocket at that. I could just pretty much do it. Maybe I am looking at 2023 and I’m not doing as great and I am like, you know what? I don’t want to pay as much tax as last year. I want to get some of that money for now and maybe I’ll pay it in the future. You just rob yourself of all those opportunities when you file too early.
Eliot: All of that from one little question.
Eliot: It’s great.
Toby: You ask one sentence questions. That is why I like them.
“If I plan to leave one real estate property to each of my adult children, is it best to purchase properties and leave them to children in trust, or to purchase the properties as co-owners and place their name on the title?”
Eliot: I think you go either way here. I don’t mind going into ownership (I guess) if it was for my kids, but you would’ve had to grant them something as a gift, and I think that’s where we run into a problem. They might have a problem with a step-up basis later on. I think Toby is most often talking about keeping my assets mine and then I give them away or I put them on trust upon my death. Either way, there’s a step-up basis.
If the kids inherit the properties after I pass, they get a 100% step-up basis, which is much more preferable from a tax standpoint. If the kids have their own money, you can go into business with them. But I don’t like gifting things while I am still alive because I feel like I am losing all the tax basis as well as if I have a lot of assets when I pass, then I like to trust and do different things. You don’t want to leave $100 million to kids. I think we have all heard the stories of what happens then and things like that.
Toby: I would add that if you are looking at it from purely a tax standpoint, co-owners mean you’re a partial owner, meaning you’re going to have tax implications to give them that ownership. If I give to them, I am gifting obligations if it’s more than $15,000 or $17,000 that I have to worry about my lifetime gift exclusion.
But here’s the big one. This is huge. If I give a child an interest in a piece of real estate, anything that child does now subjects that real estate to liability. That kid gets into a car accident, they can take the property. That kid has a broken picker and keeps picking the wrong spouse, gets three divorces. Yup, that ex-spouse could be going after that property. Anything that is in that child’s name is subject, plus that entire property is subject to that child’s claim.
You might say I can put an LLC around it. Okay, now at least we are dealing with some of the asset protection, but that LLC interest could be subject to the same things and you lose the step-up and basis. The big one. If you are all doing is, let’s say I have three kids, and I want to have three properties that I want to leave for them. My choices are I can buy those and I can just pay tax on it or recognize that income throughout my lifetime and I plan to give each one to a child. I would do that in a living trust and I would say here’s the specific gift, this property, after I die.
The reason I would do that is if let’s say I did this now. I bought a house and I’m just using a number $100,000, and it’s worth $200,000 when I die. Each child inherits the $200,000. Each child now would be able to depreciate that property at $200,000 not the $100,000. Each child now owns a property. There is no tax obligation.
During your lifetime you have 100% access to those properties because what’s the worst that can happen here is hey, I get these properties for my kids then I need the money. I have an emergency. For whatever reason I need it and the kid says no. Or I get estranged from my children, or one of the kids does some weird stuff, gets into drugs or alcohol and now you’ve just exacerbated the problem.
I get it. If you want to give properties to your kids, I would say give properties to your kids. But I wouldn’t do a joint ownership thing. I wouldn’t say, actually it’s something I want to do when I pass away, then don’t give it now. Put it into an estate plan so that you get the benefits that afforded you under the internal revenue code and during your lifetime, you still have unfettered access to those properties.
You have not put yourself in a situation where you are subjecting yourself to either liability from somebody that you don’t control, their decisions and anything they do, put yourself in a bad situation if you actually need the money and lose the step-up and basis. Best case scenario is when you pass away, your half of that or whatever your interest in that property steps up and the rest of it stays low, so you’re just going to be a tax implication if that child has to liquidate the property. That’s me.
I tend not to be a big fan of gifting assets. Allocating it to somebody and you own it is one thing. Gifting it is another. When I see those two conflated and blended, I get a little antsy. I’m like hey, it’s either a gift, give it now, get rid of it, it’s yours, congratulations, here’s a property. I hope you do with it. You are letting go of it.
You trust them to do whatever is right. You know that it can be taken away from them, that they can sell it or buy a Ferrari, whatever. You’re letting go. Or you’re keeping it and you’re saying hey, this is going to go to you when you pass. Then it’s perfectly within your realm. Then you can do things like hey, you’re going to come visit me? Remember that property? I want to go over that paperwork with you.
Eliot: Something they can think about over time is they can give the $17,000 cash we are just talking about for a couple of years if they want to watch that child get invested, and then they could go into some real estate deal or something like that.
Toby: Loan the money.
Eliot: Or loan the money, yeah. There are different ways, better ways to go about than just gifting it at this point.
Toby: Patty wants the property. She’s like me, me, me.
Eliot: There you go. All about herself.
Toby: Oh, Patty. That’s all right. But again, you lose the step-up in basis when you’re giving it to kids early. I personally prefer that you just keep your assets and your market in your estate plan because you never know. I’d hate for someone to be in a situation where they need those funds, but because they were very active on the gifting side, they gave property to their kids, and then they resent that. They’re angry that they did it, and it’s because they put themselves in a bad situation. Now you’re asking somebody to help you. If they don’t, then it’s even worse, but you didn’t have to be in that situation.
They just don’t want to work on the properties anymore, so they want these three siblings to take ownership and take care of it. There are some more comments. So true, you have to be cautious with gifting in kids. I’ll let our guys answer that one.
All right. “If you did not make any transactions to my LLC, you had no activity in an LLC for 2022, do I need to file any business tax forms?”
Eliot: More than likely you do. It does depend on how the LLC is taxed. If it’s a sole proprietorship, then yes, you’re going to want to deduct any expenses that you may have had. You say no transactions. Maybe we didn’t have any income, but you at least paid a filing fee for that LLC, so you’d probably file a Schedule C with just that one expense. If it’s a partnership and there are truly no transactions, then you don’t need to. It might be advisable to do it anyway.
Toby: Why not just file a no activity return?
Eliot: You can do that.
Toby: You let the IRS know just in case you have the EIN so they don’t try to penalize you. The worst case is that they say, hey, there’s a penalty per partner per month of non-filing. They start trying to hit you with that, and you say, but I didn’t do anything. Just file the return that says no activity. Like Eliot said, there’s going to be money that you spent on at least the filing fees.
Eliot: Yeah, exactly. Your S-Corporation, or if it’s a C-Corporation, you must file those regardless of any activity. You want to make sure you get those out there.
Toby: Again, it really depends on the LLC. The IRS does this, I don’t know what an LLC is. Tell me what it is. It’s either going to be a C-Corp and S-Corp, a partnership, or disregarded to whatever the owner is. That owner could be a trust, it could be a nonprofit, it could be an S-Corp, a C-Corp, a partnership or an individual.
The LLC, technically, is not a tax designation. When I see that we did not make any transactions in an LLC, the question is, how did you, on your SS-4 say it was going to be treated? If you set up an LLC and didn’t actually get an EIN, then there’s really nothing to do with it. It’s what’s filed with the state, but did no activity. It’s not in existence yet, as far as the IRS is concerned because the IRS is going to say, as soon as it has owners, as soon as it has activity.
Filing with the state doesn’t trigger that. It’s actually doing activity, funding it, putting money in it, assets in it, and all that fun stuff. The answer to your question is it depends, which is our favorite answer here. But if you didn’t do anything, it’s that.
Here’s one. “Based on Toby’s response, parents purchased a property and provided all the funds for it, but added their kids’ names on the deeds. Do the parents have to buy out their kids or just amend the deed to take them off?” Prince, we’re getting deep on that one. You’d have to foreclose on your kids. If you had the kids on the deed, then you have an issue. I tend not to like the kids on the deed.
Again, I won’t belabor it. We chat all day about that. I tend to look at it and say, look, if I want to help somebody, I’ll loan them the money, but I’ll have security in that property so that if they make bad decisions, I get paid back. If they have to sell that property because they run into a busload of nuns, and they get the lightning sued out of them, I want to make sure I have a secured interest. I want to make sure that at least I’m getting back the money that I loaned.
You don’t want to just put somebody on a property with you because all of a sudden, that same scenario, they take the property. You’re like, but I own part of it. The courts will say, I don’t care. Undivided interest.
All right. “What is bonus depreciation on residential properties? Does it apply to all or only some classes of property when a cost segregation study has been completed? Is there a disadvantage to carrying forward a large unused loss instead of claiming less depreciation?” What do you think?
Eliot: Bonus depreciation really is just the speeding up of traditional straight line depreciation. If we’re talking about residential, that means that we have done a cost segregation which is just a breaking of the property into its depreciation lives, a 5-year property, 10, 12, 17, 20, whatever it be, 27½, 39. The bonus depreciation just says anything under 20% life, you can take automatically, it used to be 100% up until the end of last year. Now it’s 80% of anything you bought that year in that particular class.
That’s what the bonus depreciation is. It’s just the speeding up of the depreciation instead of taking it over the long haul, 39 years, in the case of commercial or something like that. That means that a cost segregation has already been done on it. We typically have this with real estate.
As far as disadvantages, not necessarily a disadvantage to having a huge unused loss that carries forward in case of a passive rental or something like that, but you might be able to tax plan into something that works for you. If you have a large loss coming on from a bonus depreciation, try and mirror that with maybe some other event that’s creating a lot of income, perhaps in the way of passive income. Or if they’re both non-passive, there are some tax planning opportunities, perhaps, there.
Toby: I would look at their last question. Is there a disadvantage to carrying forward a large unused loss instead of claiming less depreciation? Realistically, no, because you don’t lose the depreciation. If you have a big loss, you’re carrying it forward, I would say yes depending on your tax bracket and depending on how much of this income is taxable.
I’ve seen people, especially real estate professionals, just blow themselves out of the water and have no income. I’m looking at it going, that sounds great. But when they’re getting rid of that last $50,000 of income, it’s hardly being taxed anyway. You’re talking about the 12%, tax bracket, 10% tax bracket, and you’re like, you’re not getting a lot of bang for your buck.
In that case, I might say, hey, let’s be precise about how we bonus. Let me explain how bonus works real quick. We’re sitting here. Here’s Eliot and I sitting here, here’s this desk, there’s the structure behind us, there’s the ceiling, there’s carpeting on the floor in front of us, and there’s the structure of this commercial building.
What a cost segregation does is somebody walks through and says that’s five-year property, five-year property, seven-year property. The tiles up there might be, what would you think those would be? Five-year, seven-year? Whatever they are. The structure is 39-year property, this is non-residential.
The whole idea is that they broken down the components. Once you do that, that’s called a cost segregation. You don’t need to bonus depreciate when you cost seg. Bonus depreciation is saying anything that’s 20 years or less can be depreciated faster, bonus. Here’s a bonus. You get to depreciate this, let’s use the carpet. We have $100,000 of carpet in the building. You could write it off basically $20,000 a year or bonus, you can write it all off this year, or 80% in 2023.
It actually doesn’t matter when you do the cost segregation in the bonus. It matters when you bought the building and put it into service. If I’ve had a property for two or three years, my bonus depreciation even in 2023 is 100%. I look at my carpet, and I have $100,000, I could write off $100,000. Boom, I get a big fat loss.
The only question is, can I use it? Is it worth it for me to use it? Or should I just say, you know what? I’m not going to bonus that. I’m just going to let it write-off over five years. And then I look at the other property. Maybe I have some 15-year property, some land improvement and things like that. Maybe the driveway, I put that in, and maybe I have this amount. I could say, you know what? I want to bonus that. That was only $50,000.
I’m going to bonus the 15, I’m not going to bonus the 5 or the 7. I can be that precise, guys. I can sit there and look at this and go, what’s my biggest bang for my buck? If I create a big fat loss, then now I have an appetite to go buy more passive income.
What are my types of passive income? Rental properties. Maybe I go get syndications. Maybe I could do businesses that I don’t materially participate in. Maybe I’m a silent owner in another business. I do not work in the business, and it kicks out profit. Maybe it’s a restaurant.
I always used the pizza store, Eliot’s pizzeria. I invest in Eliot’s pizzeria, and he’s kicking me out profit. It’s passive. My passive losses will offset that passive income. Even if I have a huge carry forward, I now have an appetite for more passive income. I’m looking around, where’s my passive income? Where’s my passive income?
You know where that passive income might come from? This will trip you out. If you exit a syndication and it was passive, then your capital gains when you cash out are actually considered passive capital gains, and your passive losses will offset them. That’s why you’re talking to tax professionals and looking at it going, I know it’s complicated. But actually, when you start putting them in their little categories, you can say, aha.
Now let’s read the total question. What is bonus depreciation on residential properties? It is writing off the 20-year or less property faster. So my 5-, 7-, and 15-year property. Most of it is 5 and 15.
Does it apply to all or only some classes of property when a cost segregation study has been completed? Now you know. It’s some, it’s the 5-year, 7-year, and 15-year. Anything that’s 20 years or less.
Is there a disadvantage to carrying forward large, unused loss instead of claiming less depreciation? Not really. It’s going to get unlocked anyway. You don’t lose it when you carry it forward. What it might do is focus you in on that passive income. You might start looking at investments differently because you say, I could make money here where I’m taxed as ordinary income.
If I make money here, I have this big huge passive loss carry forward, that’ll wipe out. I don’t have to be as aggressive, but I make more. I net more, I keep more because I’m offsetting it with these losses.
“What is the best tax structure to set up for my son who wants to start an ecommerce business? I would be the co-owner as his mom.”
Eliot: We’re obviously not talking about a sole proprietorship at that point. At the very least, we’re in a partnership, which I typically wouldn’t recommend. It may depend a little bit of how much money we’re making, but I think most would gravitate to an S-Corporation first. You have better deductions and reimbursements available at that point, or maybe a C-Corporation if you want a medical reimbursement plan or something of that nature there.
We really get into the detail of how profitable it is. What are their long-term goals for this business? And so on, so forth. I would probably forego the partnership because you’re going to have a cost of a tax return anyway. Partnership generally doesn’t have as good deductions, reimbursements, and things like that. I’m thinking probably S-Corporation.
Toby: S-Corporation means business, it depends on whether it’s going to make money. Here’s the fun one. Hey, mom, are you going to materially participate? Do you have a big fat loss carry forward from depreciating cost segregating a property? That could answer your question right here because you could actually be an S-Corp and be getting paid distributions that are passive.
Eliot: It just carries us right back to what Toby was talking about in the last question.
Toby: Yup, that’s why it pays to have tax folks sitting around. Or you could be a partnership. In either case, you’re going to be a partnership, S-Corp, C-Corp, or an LLC taxed as a partnership, S-Corp, or C-Corp. You’re going to be one of those three. Eliot’s right. If you’re going to make money, and somebody’s going to take a salary, you’re going to want to be an S-Corp.
If it’s going to lose money, at least at the beginning, it probably doesn’t make a huge difference. It could be a partnership or an S-Corp. I wouldn’t be a C-Corp in that circumstance, because I want to use the losses more than likely. There might be an outside chance you’re a C-Corp if you don’t need the loss. What I would do is make sure you guys have documents that dictate who has to leave if you guys don’t get along.
If something something goes bad, have some buyout mechanism or some way to deal with disputes because it’s family. Over and over again, we see this happen. People get along great, and then everything’s going great until one of two things happens. Either you make a lot of money or you lose a lot of money, and then all hell breaks loose. Make sure that you have some exit strategy.
In your case, if you’re funding it, what I might say is that you’re the manager. Let’s say you’re an LLC taxed as an S-Corp, LLC taxed as a partnership, but you want to be the manager and you’re dictating things. To remove you, it would need a supermajority. It couldn’t just be one of you, you’d both have to agree. In that way, worst case scenario is you still have control the entity. That’s it.
There was a really good question. Jared, you’re answering this, but I want to just point in there. Somebody says, “I’m surprised that on my 20th year of rental property, it cash flows beautifully, but I know depreciation is 27 years. What happens when I exit this strategy? I think some would exchange to get appreciation again, but I’m not sure how warranted necessary it is, especially for me.”
This is John. John, you’re in a fairly common situation. You’ve depreciated an asset. There may be new depreciation. If you’ve replaced a roof, you might find that there are actually different lives. It’s not just 27½, it’s when an item gets put into service or a betterment is made on a property. But your point is well-taken, you don’t have a lot of depreciation.
I’m going to plant a seed just to mess with you. Depending on where you’re at in your life and what your goals are, giving that type of property to charity, you get a deduction for its fair market value. I know you’re probably thinking, but Toby, I don’t want to give it to charity. Okay, but you could actually set up your own charity and let your family continue to control that asset. What you give up is a step-up in basis, and it’s going to be an exempt entity, so we don’t care about depreciation anymore.
It could absolutely be something that creates a legacy just planting that seed because I love real estate that’s been completely depreciated. I like to give away properties to the charities that I work on. Because I still get to control it, but I just saved a whole bunch of money.
I did this last year. The property was around a $300,000 property when I donated it, but I think I bought it for $90,000 or something like that. It was a much lower amount, but the deduction is worth more than the tax bill. That’s why you do that.
Usually, you’re looking for properties that you’ve really depreciated. In year 23, it says, it might be that you wait another year or two, you look and see if there’s anything else that you can suck out of that property as far as depreciation, and then maybe you start to consider that. It is cool when you do it because you’re going to get huge tax savings depending on your tax bracket. It could actually be more than you paid for the property, but you still control the property, and you can put it into service to do some cool stuff for other people.
Veterans housing, residential assisted living, recovery housing, people aging out of foster care. There are just so many out there, lots of different types of shared housing. Low- to moderate-income housing, even section eight qualifies as a charitable activity, so it’s exempt if you want it to be. Fun stuff, we can conjure deductions out of thin air.
Speaking of thin air, there’s the Tax and Asset Protection workshop. We have a live event, by the way, in Orlando coming up. Four days, May 18th, 19th, 20th, and 21st, in Orlando. It’s going to be myself, Clint, Michael Bowman, and just a whole slew of other speakers including Mark Del Guercio who used to speak all the time with us. He does a lot of work on the nonprofit side, especially affordable housing.
Erik Dodds is going to be coming in and talking about the stock market. I have Ryan Gibson with Spartan, who manages over $500 million worth of self-storage properties. It’s a lot of fun stuff. It’s going to be four days. It’s a kick in the pants. We get to hang out and talk tax and asset protection.
You’re going to learn all about LLCs, land trust, corporations, Wyoming Statutory Trust, the living trust, 401(k)s, how 501(c)(3)s fit in. You’re going to learn about the stock market. You’re going to learn about different types of real estate investing and what’s working in 2023. The best part is you can come there and again, we get to hang out live.
If that’s not for you, we have another virtual event on May 6th. May 6th is a freebie. You just go and you hang out with us on a Saturday. We talk about security through obscurity, tax reduction for real estate investors, and a little bit of legacy planning. It’s a packed day, so it’s a lot of fun.
Somebody says, I’m going to Orlando at that time for another event. We should switch it out. We should switch it. You should come to our event. I don’t know who these other people are, unless they’re really cool, in which case, then I would say just have a whole bunch of fun in Orlando. That’s a great town.
All right. Let’s move on. “My family installed a pool in our backyard this year because of my son’s medical condition. He is a minor. Is it possible to deduct the installation cost in 2023 tax? If so, how would it be?”
Eliot: This is surprisingly a popular question. You can deduct the cost if you’re forced for medical reasons to put a pool in their backyard. Probably the most looked to tax court memorandum case here is one from Mr. Cherry. He needed to put a pool in his backyard for his medical condition.
The way the IRS looked at it, I think he put in $30,000 of expenses. It increased the value of his home by maybe $10,000. The court allowed a medical deduction on Schedule A of $20,000. He had gotten credit with the increased value of his home. Any expense above that is what he got a deduction for.
It’s certainly a possibility. but also, Mr. Cherry showed that it was really for his medical purposes primarily. It doesn’t mean you can’t use it for personal use, but he showed that he really didn’t have any other options. All the other nearby pools were closed that the hours that he would be able to swim or what have you. He did look for any document at these things, which is always so critical document, document, document.
An interesting thing on this is also the continuing operation expenses of the pool are deductible as well going forward. It’s not just putting the pool in, but the cost of maintaining there going forward. It was an indoor pool. He was able to take deductions, I believe, for the cleanup of some bacteria that grows around inside and all that.
Continued deductions quite a bit, but he was able to document that it was primarily for him. Not that he couldn’t use it for personal, but he did use it for his medical. Of course, you have to have a medical professional, and he did. He said he needed it for his particular medical condition. That’s a big part of it as well.
Toby: The medical professional has to say not only that it’s needed, but you have to show that you don’t really have another mechanism to get what’s needed. They can’t just say, hey, I want you to go swimming, and then you say, I’m going to build a pool. You have to show that you don’t have access so that it would be impractical for you to access other accommodations.
If a doctor prescribes it, then the rule of thumb is, generally, then you could probably deduct it as a medical expense as long as you’re dotting your Is and crossing your Ts. The old adage is, pigs get fat, hogs get slaughtered.
Let’s say you have a child or a dependent—it didn’t just have to be a child, but let’s say you have a dependent—and they have a cognitive disorder, which the doctor says, one of the treatments for that might be playing the piano. What they allow you to do is to deduct the reasonable cost of a piano and lessons. That’s actually not that uncommon. It’s happened multiple times, and there are cases on it.
What they don’t let you do is go buy a Steinway Baby Grand for $50,000 and write it off. They’ll say, you can get an upright. Here’s the reasonable cost for a piano, here’s the reasonable cost for those, and they’ll let you write that off as a medical expense.
Eliot: It’s a reasonable pool, but not a lazy river through the neighborhood.
Toby: Not a lazy river. In this particular case, it sounds like they improved the value of the home. It wasn’t just like a normal pool, they added some value. The court probably took that into the equation. I haven’t really seen them do that before. Is that fairly common? Did they do it in all the cases?
Eliot: For the pools, yeah. Actually, I learned about this all the way back in the 80s in my undergrad days. It was one that our tax professor pointed out to us. I learned it again in law school. This one goes way back. I think it is 83 decision. This has been around for a while. It’s one that they always like to point to.
Toby: Somebody says, “Will a single member LLC with proper payroll offer the same separation as C-Corp when dealing with child support?” A single member LLC, by itself, if it’s disregarded to you, will not give you payroll. In fact, it can’t pay you payroll because you’re not considered to be an employee of the organization. You’re considered to be a sole proprietor, and 100% of that income flows onto your return and is subject to self-employment tax.
I’ll let my guys answer that a little bit more, which is the individual who asked that. But no, it’s not going to give you that same level of separation as a C-Corp, but I’ll let our lawyers dive in on that. All right, fun stuff. I can’t resist the YouTube folks. They have good questions, too.
“How much can you contribute in solo 401(k) if you have 1099 income, no C-Corp or corp as a consultant? Can you do employee and employer contributions, both?”
Eliot: You can have an element of both, even though you’re not an employee of your own sole proprietorship, but there is a calculation. I won’t go through all of it. But basically, the net profit minus one-half of the employment tax, and then you divide that by 25% or 1.25. That gives you your overall maximum.
The maximum that the particular year is allowed is (I think) $66,000 for 2023. But if you have anything below that from your maximum calculation from your net profit, it’s going to be the lower of those two numbers. But directly to the question, yes, you can. Yes, there isn’t an effect both contributions, even though you’re are not really an employee, but there is a profit sharing portion and an employee contribution deferral that you get to do through the calculations.
Overall, I think it’s $66,000. I want to say it’s this year. As an individual, it’s $22,500. Unless you’re over 50, then it’s another $7500 for a total of $30,000. This again is 2023, not contributions if you’re doing your 2022 returns right now.
Toby: You still get that add-on, even if it’s $66,000. You could be $73,500 or something like that.
Eliot: Correct? Yeah, total max is $73,500.
Toby: If you’re 50 or older.
Eliot: Yes, sir. Over 50.
Toby: If you’re 50, you’re toast?
Eliot: I’m sorry, it’s 50 or over, I believe. I’m actually not sure.
Toby: Yeah, whatever it is. You talk to your tax professional. We’ll look it up. You can see there, 50 or over 50. I think it’s 50 or over.
Eliot: Just get to 51, you’re safe.
Toby: This is always an interesting thing. I tend to look at it and say, you should be taking a salary. I don’t like doing these solo 401(k)s on a sole proprietor because sole proprietors, statistically, are more prone to be audited by a multitude. It’s between 800%–1600%.
More likely, if you’re making decent money, a $100,000 a year or something like that in a sole proprietorship, your chances of an audit, at this point, was literally below 0.05%. It’s less than half of a percent of you’re an S-Corp, and you’re still looking at around 1.4% as a sole proprietor. I don’t even know what that number is now. It’s a lot. It’s more than 1000% higher.
The problem that I have is that the win rate, the change rate was in the mid-90s. The last time they gave us the data, 94%–95% when it was sole proprietors. What I believe happens is your requirements for maintaining good books and records as a sole proprietor is the same as if you’re an S-Corp or a C-Corp.
There’s a myth out there that there are less formalities as a sole proprietor. Oh, they’re easy to run, you don’t have to keep as much paperwork. That’s what they smack you with because with the IRS, they don’t care. There’s no difference between them. It’s books and records. You have to keep good books and records. If it’s a sole proprietor, it’s the same as if you’re an S-Corp, same as if you’re a C-Corp, same as if you’re an LLC taxed as an S-Corp or LLC taxed as a C-Corp.
Yes, you can do it, but I wouldn’t if you’re making any money. Definitely, if you’re over $30,000 a year, the tax savings alone just from the employment taxes. Let’s use Eliot’s example. Let’s say you made $100,000. You would owe old age, disability and survivors, and Medicare on the full $100,000. That amount would be 14.1% when you factor in the deduction for half of the employment taxes on your return. You’re going to end up paying $14,100 in employment taxes.
Let’s say the employer contributes $25,000 into your plan. You wouldn’t owe federal income tax on that, but you still owe the employment taxes. Hey, I’m deferring $22,500 into the plan, now it’s going to lower the $25,000. We’d have to do the math on that. Also, you still have the employment tax if all we did was set up an S-Corp and run the salary out of the S-Corp.
Let’s just say that we ran a lower amount of salary. Let’s just say that we ran $30,000. We would be able to still do the $22,500, but we would save $10,000 in tax thereabouts. It’s just right around that mark. On $70,000, it would be right at about $10,000 that we would save just in the employment taxes.
I know I’m going to have somebody scream and say, but you can’t contribute as much. Then make an after tax contribution because you saved more than you would have saved, had I’d done just the 401(k) contribution. A worst case scenario is to pay yourself $100,000 in salary and do both. You’re no worse off, except your audit rate just got shrunk by a multitude.
I tend to look at it a little differently. I’m not a big fan of sole proprietorships. I just see them get tased, and they lose all the time. It was quite literal. The last time they published the data was publication 55, it was table 17b, and they stopped publishing it about two years ago. They would actually tell us, here’s the audit rate, here’s the success rate from the service.
It was quite literally 94% and 95% success rate, and you’re like, Jiminy Christmas, they’re just tasing these people. Seventy percent of the businesses out there look just like that. I don’t want that.
Toby: A bit of a bloodbath, yes. You couldn’t do it, but should you do it? All right, “What is the federal tax rate for recapturing depreciation when you sell? Are there other ways to defer tax? Can the taxes due from a previous 1031 Exchange be deferred other than reinvesting in another property?”
Eliot: I guess I’m going to do the old jump to the last question here first. Can taxes due from a previous 1031 Exchange be deferred other than reinvesting in another property? I don’t know of any other mechanism, I think you do have to reinvest if you’re going to continue to defer. Backup to one of the recapture rates. Again, that’s going to depend.
Toby talks a lot in great detail about what happens if we had a cost segregation going on. If we do, we do have two different types of property. We still have real estate, what we traditionally call our 1250, and then we have that other one that got bonus depreciated, which is 1245. If there’s any 1245 in there, that’s going to be taxed up to your ordinary rates, so it depends on what your tax bracket is. If it’s the 1250 real estate, then it’s limited to a top of 25%.
Toby: This gets a little interesting. When we’re recapturing, you have the 0%–25%, which is your structural component. That’s your 1250 property is what it’s called. Your 1245 property is the personal property. In order to figure this out, you actually have to do a cost seg.
Remember, I said carpet. We have these walls that we built behind us, the parking lot. That’s 15-year and 5-year property. Those would be recaptured at their value adjusted for useful life. If we held the property for five years, there’d be zero recapture on the carpet. There’d be zero recapture on the structure behind us.
There’d be a partial recapture on the parking lot based on its future value or the value that it has. In some cases, if it’s being torn out, they may still put that at zero. It doesn’t mean that it’s zero tax, it just means it’s zero recapture. It would be considered long-term capital gains if you sold it after five years.
When you write off the walls, the 39-year property or the 27½-year property, it’s taxed at your ordinary rate, maxed out at 25%. Most people just say 25%. But if you’re a real estate professional, you might find that it’s actually lower. If you want to defer that, you have the 1031 Exchange as your option.
We also have something called a qualified opportunity zone that’s floating around out there that would defer it until 2027, but there are a whole bunch of little rules on that. Qualified opportunity zones came out. What was that, the Tax Cut and Jobs Act?
Eliot: Late 2017.
Toby: Yeah, it used to be much more juicy, and there was some step-up in basis. The moral of the story is you could defer the tax, but you can also avoid any gain if you hold the property for at least 10 years, which means this would be something that somebody might do if they’re saying, hey, I’m going to own property for a long period of time. I have a bunch of deferred gain. Actually, you’d have recognition of it anyway. The 1031 is the only one I could think of. You couldn’t even do that in an opportunity zone.
Kicking that can down the road is probably 1031 exchanging, and your exit strategy is to die because then your basis steps up to the fair market value on the date of your passing, and nobody pays tax. You get rid of it outside of a 1031 exchange, you’re going to have recapture of the original property and lots of gain, all that fun stuff. You’re going to have recapture and capital gains.
Maybe you’re okay with it when you’re older. You’re like, hey, maybe I’m in a low-enough tax bracket, it’s not that big of a deal. I always look at it and say, as long as I’m paying a 20% or less effective tax rate, I’m not crying. I’m not trying to get to zero. I definitely don’t want to pay at 37%, 40%, or 50%, like some of you guys in California and New York have to, or Hawaii. It’s like, ah, I just don’t like getting crushed.
You might look at it and say, I’m willing to exit some of these properties, or the other exit is possibly to donate the property to your own charity or foundation and get a tax deduction, or even if you don’t want the tax deduction, you’re removing it from your estate. You’re putting it into a zone that can’t be taken away from yourself or your family, and your family can continue to work for it, draw salary out, and they’ll pay tax sometime in the future as they’re working for it. There are some different exit strategies. Anything you wanted to add on that?
Eliot: No, we’re good.
Toby: I like the rabbit holes, my friend. All right, we have a couple more questions. “My current tax adviser says it is the best tax advantage for me to keep my two properties, which I am short-term renting,” these are Airbnb, seven days or less, “under my own name and to use a Schedule E.” They’re saying this because it’s not a rental activity when it’s Airbnb. It’s just a business.
“Can you advise as to if this is the most tax advantage? As a note, I’m aware of the other concern surrounding asset protection. But I’m curious if the advice to use a series LLC would radically change my taxes and subject me to greater taxes.” Eliot, what do you say?
Eliot: Putting it into another LLC doesn’t have to change anything taxwise, other than moving it in there. Maybe you have some transfer taxes, depending on where this property is located. Aside from that, there shouldn’t be any problem putting anything into the LLCs. Again, looking at the last question first. I don’t see that as being an issue at all.
Toby: Your LLC could be ignored for tax purposes. It can literally have no impact on you whatsoever, and it could still protect your assets.
Eliot: Correct. Yeah, exactly. As far as if it’s going to be on Schedule E, and we don’t have what I would consider a materially participating short-term rental, then if we have overall losses here, I think they’d be passive.
I don’t look at that scenario, necessarily, if it’s advantageous or not. It’s what you do with it. It’s what we looked at at one of the previous questions. If I have a lot of passive losses, what are you going to do if you go and invest in another passive, what I call passive income generator or pig investment? Then those are going to marry up.
Toby: The short-term may not be passive.
Eliot: If you’re saying you have Schedule E, if it’s non-passive, it’s going to be Schedule C. It has to go there. We want to make sure of that fact.
Toby: Let’s break this down real quick. The first thing is, when you’re renting short-term, if the average stay there is seven days or less, it’s not a rental activity. It’s a trade or business activity. We may as well be flipping pizzas. I am just a business. I am not a rental activity anymore. It’s no longer passive because it’s a rental activity. It is a business activity.
The next question is, am I materially participating in that business? What Eliot is saying is if you are, chances are, it’s going on Schedule C. It doesn’t mean you’re subject to self-employment tax, though, unless you provide significant services like hotel-type services along with your Airbnb. But if you’re materially participating, there are seven different tests for material participation.
Let’s just make this even more fun. If you are self-renting, you’re managing these properties yourself. You have two properties, and you’re managing them yourself, that’s probably ordinary loss or ordinary income. It is not rental activity and passive loss if you are materially participating and if you’re doing it.
My guess is that, when you look, you don’t know whether it’s C or E. With the losses, you’re probably looking at E anyway. They’re probably looking at it, and they may not even distinguish. You could do it in either form, in my opinion.
The question is, did you materially participate so that loss becomes ordinary loss that offsets your W-2 income and other income? That’s probably what they’re looking at. They’re scared to change you from going on to there.
When we look at the second question, we can make it so it’s neutral from a tax standpoint. You could still qualify as a material participant in your Airbnb business or short-term rental business. It could still be ordinary loss.
We’re not changing that fact simply by putting LLCs around those properties. You could do a series LLC, it doesn’t matter to me, as long as that LLC is not taxed as a C-Corp. S-Corp, I think you could even get the flow through, but I would probably make these disregarded for tax purposes. That way, your accountant won’t even have to report for it.
I just think that it would isolate your liability because what we do see with Airbnb is there’s a lot of liability. Somebody has a party in there, somebody falls off the deck, everything, you’re the landowner. You have unfettered liability, and they’re just going to sue you and say negligent entrustment or whatever the heck they’re going to say. You’re just negligent, you shouldn’t have rented to them.
There was something lying in a way that you were negligent in the way that you put together the back patio or something that somebody fell off of. They’re always going to sue you. You want to minimize the liability from those activities, and the simplest way is to use a land trust, an LLC, or the combination of the two. If you’re in California, just use the land trust, but everywhere else you want to use an LLC. All right. Anything else you want to add on that one?
Eliot: No, I think that’s it.
Toby: That’s just one of those ones where I always look at it and I go, I get what the tax advisers do. They like the status quo, but they’re scared, so they say, don’t do anything.
Eliot: That’s wrong.
Toby: I’ve had that discussion with many a person. Unfortunately, they listened to the CPA. I’ll tell you, in 1999, I still remember this, we set up a building in California of all places in an LLC. The CPA wrote a letter saying, you could just get umbrella insurance and insurance coverage, and that was sufficient for liability protection. I should have put it up on the wall.
The client was like, they’re saying we don’t need an LLC. You cannot buy a commercial property with financing in California outside of an LLC. They won’t sell you that individually. If there’s a loan, they’re like, I don’t want to deal with all that other stuff that comes along with that individual. I don’t want my property getting raked into divorce court, into a lawsuit, or anything else. They want it to be an LLC. They want to know that this is the party that I’m loaning it to, and maybe you’re a guarantor.
In 1999, I still remember that, I said to the client, have the CPA say that they’re liable, that they’ll indemnify you from any liability that occurs that’s not covered by the insurance or that they deny coverage on. The guy was like, really? I was like, yeah, he’s going to give you crappy advice. He just stand behind it.
Of course, the guy didn’t do it. We use LLCs, and we’ve been doing them ever since. That stuff always comes on. These accountants sometimes will lead you right down the path. I’ve seen clients lose everything because of that exact advice. I’ve seen clients come to us after their bankruptcy because an insurance company didn’t pick up the bill, or there was an exclusion.
We just had one about two years ago that was a massive, massive lawsuit, and then the insurance company found a way out. I’ve seen that over and over again, especially when it’s toxic stuff, mold, or a third-party causing liability they like to back away from, but they’re always when it’s huge. They find a convenient way to get that insurance contract out and say, see right there on line 150A subsection 2, subsection 3, 3rd paragraph. It excludes. You’re always going to find that there’s some where they get themselves out.
All right. “AGI is $300,000. I thought I could gift 60%, $180,000. I gifted $90,000 in cash to qualified charities, and I thought I could gift $90,000 in non cash to charities, but tax preparers said this was a 50% limit somehow on non-cash giving after 30% in cash gifts. Is he correct?”
Eliot: There is a limit. The 60%. First of all, where we’re getting that from is that there’s a 60% limit of Adjusted Gross Income, your AGI for complete cash donations. But there are other limits when it comes to non cash. You mentioned that down here. We put the $90,000, we’re good there. That’s well below our 60% limit of AGI, $180,000 as you pointed out, but then you have this non cash.
The non cash has different limitations, and it can depend on the type of nonprofit that’s being donated to. The non cash, yes, you’re not probably going to get the full $90,000 in your non cash. It’s going to be a bit limited maybe by $30,000 or so, approximately. I’m not sure about the 50% limit exactly, where that comes in. Maybe that’s a misunderstand for the type of nonprofit or something like that, but it would be limited, yes, I would imagine.
Toby: If you have a public charity, the thresholds are 60% for cash, 30% for appreciated assets. There might be some other limitations for collectibles and things like that. I don’t even know if you can write those up, maybe. If you have a private foundation, then those limits go to 30% and 20%. There might be some of that going on.
Depending on the charity that you gave it to, there might be some limitations. They’re saying capped at 50%. You did 30% in cash and you have a 20%, that would equal 50%. That might be how they’re getting there. We don’t know without looking at it more. But no, there isn’t a 50% overall limitation. You have the 60%, and it’s the cumulative 60%.
If I write off 30% with appreciated assets, I can go up to 60% of my AGI with cash. I should still be able to get up there. But unless we know more, I don’t think we could really get into that.
All right, last question. “My only source of income is from forex trading. I do over 5000 trades a year, spend at least 10 hours a day, and I want to know what the benefits are for creating an entity to pay less taxes. Also, I have friends and family members who have trust in me and lend me money to increase my business capital in return for a monthly fee. They let me borrow from $15,000–$30,000. I usually pay them interest of $500–$2000 a month. How can I benefit from this interest that I am paying them monthly? Should I create a contract for each one of them?”
Eliot: I don’t know if it’d be a contract, but we’d want to have a note as far as how much was lent and the imputed interest at the very least amount. You certainly want to have that. Right now, you’re not operating through a corporate entity from what it appears. That interest, you would be limited to your investment and interest income deduction on your Schedule A, itemized deductions. I think you’re probably really hurting yourself with these dollar amounts.
Going through the entities, we like to often use a trading structure where there’s maybe a corporation involved, and the rest is you, perhaps individually, that would allow you to deduct these, perhaps, in the C-Corp and avoid all those limitations like that for your interest. Maybe they would lend to the C-Corporation, perhaps. You also have better reimbursements and things like that that you can take through and you can take advantage of through the corporation.
Toby and I were talking about before we started this show, there is a difference apparently in the type of spot trading, I believe it is. Is that right?
Toby: Whenever you’re involved in forex, you’re going to have spot trading where it settles within two days, or you’re going to have futures contracts where it’s a 1256 contract, in which case it’s treated as 60% long-term capital gains and 40% short-term capital gains. It sounds like you’re doing spot trading. That’s 988 contracts that you would qualify as a trader in securities. I believe that forex would fall underneath that category.
It’s not a statute. We’ve created this in the courts, which is, when does an activity qualify for ordinary and necessary business deductions? The rule of thumb is 720 trades a year, trading 70% of the days, there has to be substantial activity. I think you’re hitting them all. It sounds to me like you’re hitting them all. You’re blowing it out of the water when you’re doing 5000 trades. You’d probably be a trader, and then that allows you to write off business deductions.
Losses are another issue. For a securities trader and you have capital losses, it can turn into ordinary loss if you make a mark-to-market election, but you have to be a trader and make a mark-to-market election the year prior to the election taking place. We could potentially make the election for 2024. It be too late now for 2023. That’s only for losses as trader insecurities. When you’re forex and if you’re doing 988, there’s no such limitation, I believe that is ordinary loss, period, when you’re doing spot trading.
Again, it sounds to me like you’re probably doing spot trading. It’s worth taking a look because what that would allow you to do is if you’re a trader, you fall as a trader, and you’re spot trading, it sounds to me like you don’t have losses. It sounds like you just have income, so what we care about is being able to write off our expenses.
You could do so in a structure, where you have the forex trading in a LLC taxed as a partnership with a corporation as the manager and probably a partner at 20%. That way, if you have expenses, you could run them to the corporation. Or your level seems high enough, you’d probably very easily qualify as a trader, then you can just write off your deductions on your schedule C. It sounds weird, but you’re writing expenses off on Schedule C, and you’re reporting all your trades, more than likely, I think it’d be Schedule D for forex, and you write off all your expenses that way.
Are there other benefits you could have using a trading structure? Potentially. If you decided to set it up, for example, and you said, you know what, I’m going to make this thing go but make it an S-Corp, you could go that route. Or you could have the partnership and corporation mix and possibly have a higher percentage going to the corporation, or pay at a guaranteed payment every month, and then it could turn around and pay a salary to you that you could put into a 401(k), that type of thing. It all depends on you.
Basically, you’re getting down and crunching the numbers to see whether there’s enough benefit there so that the juice is worth the squeeze. But I could see that. I could see that being a benefit.
A lot of traders lose that out because when you’re trading in the market, you can’t contribute to a retirement plan. You’re just kind of, oh, what could you do? I could pay myself a small salary, and everything else would still flow down to my return. I could potentially go that route, then I could fund a Roth IRA, and I could go do forex trading in there, I could fund a 401(k), and I could go do forex trading in there, which is completely tax-deferred, and then I could still be writing off my expenses through my business.
It could be as simple as an LLC taxed as an S-Corp. It could be as simple as an LLC that you tax as a trader. Or it could be as complicated as having a partnership with a corporation. It’s just going through the scenarios to see which one seems the easier fit for you and gets you to where you want to be. My guess is that you qualify as a trader, and I see very few people that qualify as a trader.
I’ve been doing this for 26 years. So often, people come in and they’re like, I’m a trader. They’re doing long-term trades. It’s a bright line rule, you have to have an average hold period for less than 30 days. They still blow through that.
They’re doing 200 trades a year, and they’re not a trader. They have another job or something else. They have another W-2 job. They’re just never going to qualify, you look like you qualify. I rarely see that. You probably have many more opportunities than you realize. It’s smart to sit down and have somebody map those out with you.
All right. If you like this kind of stuff, guys, we’re going to post this recording up on YouTube. Feel free to go grab it anytime. Subscribe to the YouTube channel. I don’t know how many people are there now. A lot. Come join us on YouTube. It’s free. You can get notified when new videos come out, including the Tax Tuesdays are posted.
If you missed something and you said, you know what? What did he say there, you can go back and watch it again. Thank you to Dana, Dutch, Jared, Kurt, Ross, Sergey, Tonya, Troy, and Patty, because they were answering questions. They actually answered 226 written answers. That’s not counting chat. That’s just written questions.
This is our public service. We go out and we like to share tax knowledge. Hopefully it takes some of the anxiety that some people feel. Maybe you’re doing this, I like taxes now, I want to know more. I want to know some more. Come join us. You’re always welcome to join us.
If you have questions in the meantime, send them in email@example.com. Just know that we may take your question. We’re not going to put your name on it, but we may post it up here and answer it live. We get hundreds of questions a week. Every other week, we got a big pool to draw from. Eliot does a really good job of picking them.
I used to pick them, but I had no desire to read through them. I would just take 10, 12, or 15. Sometimes we used to get a little over crazy. There was a time when Tax Tuesdays went on for a couple of hours at a time, but now we’re good. This is an hour and 23 minutes. We’re bad, we’re in timeout. All right, so two weeks. We’ll see you guys again. Any parting words?
Eliot: No. Thank you all so much for joining. Great to see you.
Toby: Yup, it’s fun. To all you YouTubers out there, fire, guys. That was fire. You guys were asking a lot of questions to all the folks on Zoom. Thanks for doing that. Thanks for all your Q&A and all your comments. I love you. I hope you’re very successful.
Don’t listen to all the crap out there. Just keep pushing your heads down, keep making good money, and pay your fair share in taxes, but you only have to pay the legal amount. Nobody says you have to leave a tip. Thank you, guys.