How To Reduce Taxes From Your Rentals For Non-Real Estate Professionals

Eliot: Eliot Thomas, Manager of the Tax Advisors here at Anderson.

Toby: And we’re going to have another fun Tax Tuesday. We always like doing the Tax Tuesdays. These are supposed to be fun, by the way. Some of you guys get a little […]. Yes, live questions via the Q&A in Zoom. If you have a lengthy question, put it in the Q&A. If you just have a comment, by all means, put it in the chat.

We have a whole bunch of folks that are on, that have been with us forever. They always say hey, you can absolutely put where you’re at in the world so we can see that. What city and state? And don’t say I’m intoxicated. That’s not a state that we recognize.

There we go, Las Vegas, Nevada, right here with us. Clermont, Honolulu, Sacramento, California, San Diego, Reston, Virginia. New Jersey, Vancouver, Washington in the house, Washington DC. NOLA since my brother is in Slidell. Confusion. I think that’s an Eliot state. Minneapolis, Rhode Island. I am in a state of confusion. That was a good one, wasn’t it?

Eliot: That was pretty quick.

Toby: Capital AE, there’s Mark. Always love having Mark on. Carmel, Rio Verde, we got some Arizona, Kansas. Hey, lost in Kansas. We love you guys. Anyway, these are supposed to be fun. I have to say the rule.

You can ask any question you want. If you start harassing our staff to answer three pages long… Somebody got mad at me because I started laughing because I can’t even say that with a straight face. I love you guys, but no, they’re not going to answer volumes. They’re going to try their best.

There’s Snoqualmie, Washington. I love Snoqualmie. San Juan, Puerto Rico. I’m jealous, it’s beautiful. I love Rio Grande down there. Clearwater, Florida. San Juan is gorgeous, too. Have you been to San Juan, Puerto Rico?

Eliot: I have seen it on TV.

Toby: You absolutely should because it’s like being in old Europe.

Eliot: Great tax breaks.

Toby: If you can live there and pay very little in tax. All right, if you need a detailed response like something that’s very specific to you, please become a platinum client and then ask your question via the platinum portal. This is a free service. We do not bill for our time here. We answer all your questions.

We’d love to answer your questions. But if you start asking specific questions about your tax return and this, that, and the other, we’re probably going to invite you to become a client. And it’s supposed to be fun. If I do start to laugh, it’s not because I’m making fun of anybody, it’s because we’re having fun. It should be.

Taxes always get angsty. We’re not going to be angsty because they shouldn’t be angsty. They’re a pathway to diamonds and gold nuggets. We’re going to follow all the tax rules to get us there.

All right, let’s talk about our questions today. We have a whole bunch. I have my screen over here because I’m in a different studio.

“I’m selling a property that was willed to be in 2019. I’ve been renting this property out since receiving it. It will sell for a profit of over $360,000. Would I pay taxes on the full profit or the difference between value at the time the property was willed or do I pay taxes on the difference between the profit and $250,000?” Interesting. “Single and property would be considered investment, not primary.” We’ll answer that one.

“What are some simple easy things that can be done to reduce taxable income and reduce taxes paid on each of my paychecks?” We’ll answer that one, good question.

“Options for tax write-off, reducing tax burden if I have rental real estate, but I am not a full-time real estate professional. Both my wife and I have W-2 jobs that we don’t foresee leaving anytime soon to become real estate investors.” We’ll get into that. That’s actually a really great question. It’s really helpful, especially nowadays.

We’ll talk about cost segregation, bonus depreciation, real estate professional status, active participation, activities that aren’t actual rental that you might think are rental that aren’t. We’ll get into all that.

“Augusta Rule: We have put our properties in a Wyoming entity and the Texas series LLC in late December of 2022, but have not started using it yet. Can we use the Augusta Rule in 2022 throughout the year for our business purposes, even though we’ve not completed setting up the business?” We’re not going to answer them yet. I just have to give Eliot the look.

Eliot: I got the look.

Toby: “When a rehab required property acquired for long-term hold…” I don’t know what that means. What is that? Maybe it’s just me. “When a rehab required property acquired for long-term hold, when is the right time to do the cost segregation study? Before the rehab or after?” Okay, I can get to the bottom of that one. We’ll dissect that, we’ll restate it so it’s a little bit easier to understand.

We actually take these questions right out of hundreds of questions, and Eliot grabbed these ones. He just grab them and put them in here along with most of the typos. Every now and again, we take a profanity out or sometimes it’ll do a quick spell check, but that’s about it.

“Anderson created my S-corp entity in November of 2022. I’ve only had expenses for the year end 2022, but no income or property purchases yet. What am I required to file for my S-corp regarding the expenses I’ve incurred?” Great question. This is so interesting because it’s so different than if you had done that in your individual name.

“I created my two LLCs both with real estate assets with rental income in 2022. Also, I created a holding company that holds both the LLCs.” That’s perfect, probably holding company in Wyoming. “I have a W-2 job. When do I file the tax for the holding company? Is it one tax filing that combines all the LLCs and my W-2? Thanks.” Good question. We’ll break it out for you.

“Curious to hear an open discussion about one and how to utilize section 179 and/or bonus depreciation for vehicles.”

“What are the steps to take in order to withdraw money from a C-corp account? Are there any tax consequences involved?” Good questions, and we will answer all of these. We have three more to go.

“How to save taxes as S-corp, and is it better to do a standard deduction?” Standard deduction or itemize for tax. Depending on where you’ve been. I’m in Vegas because we would get massive deductions throughout this place. You get a standard deduction or itemized for tax.

“Can you please touch upon what depreciation recapture is and how it impacts taxes?” We’d love to.

“I work from my home office. How do I claim this?” Oh, boy, we love open-ended questions. If you love open-ended questions, come on to my YouTube channel. You could absolutely pop on. It’s free, you can subscribe.

We actually put our Tax Tuesday recordings. We break them into pieces and put them up on YouTube as well. Subscription is free. You can click that little bell and it will tell you when a new video is posted.

My partner Clint has an awesome YouTube channel himself. He does more on asset protection. I spend much more time on tax and financial planning, but he’s also fantastic, so join that. It’s free and you can just go to this link.

“Is this recording available somewhere that we can access it? Mate, yes, YouTube. Pop on there and you could absolutely. Somebody says, great segue. Hey, we love open-ended questions. Hey, I like doing the YouTube. It’s free, but it gives me something to look at. I can always get feedback and I like feedback.

All right, “I’m selling a property that was willed to be in 2019.” First off, somebody passed away. In 2019, it sounds like they inherited it. “I have been renting this property out ever since receiving it.” They got it and they’ve been renting it out to a third-party. “It will sell for a profit over $360,000.” The question is based on what? Is it $360,000 based on what it’s going to sell for? Or my parents bought it, or whoever bought it and willed it to me, that’s what they paid. We’re going to get into that.

“Would I pay taxes on the full profit or the difference between value at time property was willed or do I pay taxes on the difference between profit and $250,000? Single and property would be considered investment, not primary.” What do you say?

Eliot: I think the last sentence gives us a little more on track. The $250,000, we’re probably talking about the exclusion. Because this is for a primary residence and because we mentioned it’s going to be rented here or has been rented, I’m thinking it probably wasn’t a primary residence. It’s probably just a rental. I’m just going with that assumption.

We can look at other scenarios here. But just going with that, it’s a rental property, they’re going to get the basis that they received from their parents upon inheritance or whomever gave it to them. That’s going to be their depreciable amount.

Because we’re renting it, we have to have depreciation probably over 27½ years. You take that depreciation over the years that you’ve taken, you subtract that from your original basis that you got on inheritance—that gives you what we call adjusted basis—and then you would subtract that from the sales price, which if that was 360 here, that difference would give you your taxable gain if you have a little bit of depreciation recapture. That’s the deal for a straight rental.

Toby: Yes, so in English, Eliot. We like to make it complicated sometimes. You inherited it in 2019. It says you’ve immediately started renting it out, so it’s investment property. It’s not going to qualify for the capital gain exclusion of living in our primary residence for two of the last five years. First off, there’s no 250. There’s no 500 because you’re single, but there’s no 250 either.

What it is is when I inherited that property, when the person passed away, not when I received it, when the person passed away, their basis stepped up to the fair market value on that date. If they died in 2019, you would want an appraisal or an idea of what the value of that property was on that date, and that would be your basis. When you sell it, it’s just the difference between your purchase price and that basis with one other adjustment, which is depreciation that you could have taken. Even if you didn’t take it, they make you recapture the depreciation. That’s what you’re going to get.

If you sold this, you say profit over 360, let’s say that they’re selling it for $500,000. When you received the property, it was worth $400,000, but your parents or whoever it is that willed it to you had purchased it for $200,000. We’re not using $200,000; throw that out. We’re going to use the $400,000 that you received. That’s what you received when they passed away and then it got willed to you.

Your basis is $400,000, which means that the primary gain is that $100,000 minus some expenses. That’s what your gain is. You’re going to have some recapture, you’re going to have 2019, 2020, 2021, and 2022. Four years of recapture, which isn’t going to be a huge amount. That’s what it is.

Eliot: My bad. I said there was no stepped-up basis. I was completely wrong on that. Sorry.

Toby: It’s cool. When somebody passes away, it’s going to step up.

Eliot: That’s a pretty common, easy answer in tax.

Toby: What else do we have? You could 1031 this thing if you wanted to and avoid tax entirely by selling it, then just acquiring property and a 1031 exchange. Then you don’t have to worry about tax at all. You can 1031 exchange inherited property and avoid tax entirely. That’s probably the route I would go. I would say, hey, if you’re going to sell this thing and you don’t want to pay tax, go over and 1031 it.

All right. “What are some simple and easy things that can be done to reduce taxable income and reduce taxes paid on each of my paychecks?”

Eliot: We were talking about this a little bit before. Certainly, you can contribute to a retirement plan that would allow maybe some deferral of taxes. Also, everyone talks about getting a refund. Note that the refund is you getting back money you’ve already paid into the government, so from your withholdings on your W-2.

If you had a better idea of what your expected liability for the whole year is, you can track that out and just have less withheld, so more money in your pocket. It’s not really like you’re getting less in taxes paid. It’s just that you’re getting to hold on more of your paycheck each paycheck because you’re not waiting for a refund possibly 12 months later.

Toby: There’s that. But if I wanted to really reduce my taxes and I’m an employee, what am I going to do?

Eliot: Contributions to retirement plans, HSAs, IRA, and a work plan like a 401(k) if you can contribute to both of those. Maybe if you have another material business that you contribute to that might give you some deductions depending on what’s going on, if there are other things on your return.

Toby: They said simple and easy things to reduce taxable income. IRA, HSA, 401(k), those are pretty simple and easy. Take your standard deduction, be mindful. If you’re a giver, maybe lump up your giving into every three years or something so you can use your itemized deductions once in a while depending on what your situation is so you can give to charity.

But instead of spreading it out where you might not get any taxable benefit, just save it up and do it in chunks every five years or something like that. You could do that. That’s about it. I can’t really think of too many other things. Giving money away always helps. You could see that and you could do that.

“What if he lived in that willed house with his parents for the last two years?” They’re going back to this first question. They said, “What if you lived in it?” The rule is you lived in it two of the last five years. It’s not the last two years, but two of the last five years. Your name would have to be on it, you’d have to actually have occupied it. You’d meet the occupancy. It’s doubtful that you would have met the ownership requirements, but it’s possible. I guess it’d be something that’s worth digging into if they lived, but don’t you love hypotheticals?

“Options for tax write-off, reducing tax burden if I have rental real estate, but I’m not a full-time real estate professional. Both my wife and I have W-2 jobs that we don’t foresee leaving anytime soon to become real estate professionals.” What do you think?

Eliot: Along with what we said on the previous question, you’d want to hit the things like the HSAs, retirement accounts—the easy stuff. If we’re not getting to where we’ll have professional status for the real estate status but you have real real estate, then you want to look at if your AGI (adjusted gross income) is a little bit lower, maybe under $100,000, you can take up to $25,000 of the passive losses. You’d have that going for you.

It could be if you had enough passive losses, maybe you have some other investment, maybe it doesn’t have anything to do with real estate where you get some passive income and that will net against it—that passive loss that you ordinarily would not be able to take—there are a few things you could still do that would not require the real estate professional status.

Toby: The reason this is even relevant is because when you have rental real estate losses, it’s considered passive. Passive losses only can be used against passive income. There are two exceptions. The exceptions are if you’re an active participant or if you’re a real estate professional. They just ruled out real estate professionals. Eliot nailed it. If you’re an active participant in real estate, you can write up to $25,000, but you have a phase out between $100,000 and $150,000 AGI.

Somebody just asked, “Is it possible to have rep status when working as a full-time W-2 employee?” No, almost impossible. In fact, here’s the deal, you’d have to spend more time as a real estate professional than you do on your W-2 job. The courts have routinely rejected that saying, there’s not enough time in the day for you to do both. It has to be more than 750 hours and more than 50% of your time. They’re saying they’re not.

Then we look at it and say, what else could we do? Let’s look at the rental real estate and examine that. What if it’s Airbnb? It might not be rental real estate. It might be that it’s because if it’s seven days or less average usage, it’s ordinary loss and you can actually go through it, and you can still use it. You can actually use it to offset your W-2 income under those circumstances. There’s that.

What else do we have? If it’s real estate activity that perhaps is transitional housing, renting to people that are below the median income or would qualify for Section 8, then that activity actually could be considered nonprofit, and you can actually change the structure of your rental. You could actually get a huge tax deduction and then never pay tax on that.

There are things you could actually do as we dig into it, but I don’t know enough here. If this is just straight out single family residences, it’s just regular old rentals, and maybe it’s more higher end property, then you’re not going to get to use those passive losses right now. But good luck or good news, you don’t lose them. They carry forward until you get rid of the property. As Eliot also said, or you have other passive income. It means hey, I need to go out and make more money passively.

It’s not just rental real estate. Passive income can come from businesses in which you do not materially participate. Eliot and I could have a pizza company and we sit there. I’m the silent owner and he runs everything. That’s passive income to me, active income to him, and then I can do it.

I could see somebody in the chat saying, hey, I’m looking for an answer for something from a few weeks ago. Just grab the chat logs, guys. Better yet, grab the Q&A.

Carmel, if you would send it back in, we’ll make sure we get you an answer. They can knock that out today while you’re here, because we want to make sure that you get answers to your questions. We don’t want you sitting here confused. All right. Anything else on that one? Augusta Rule. What is it, first off?

Eliot: Augusta Rule, that’s just what we call 280A most often. That’s the ability to rent out your home. Dwelling is the proper term for no more than 14 days a calendar year. The income you receive, you don’t have to pay tax on.

Toby: You need an accountable plan. You need a corporation, either C-corp, S-corp, LLC taxed as a C-corp, LLC taxed as an S-corp, or a 501(c)(3). All of those work, and they can absolutely get you what’s called 280A, where you rent your house to the organization and have its meeting and it pays you. As long as it’s 14 days or less, you don’t have to recognize the income, you don’t report it on your return, and the business takes it as an expense.

Now, it actually has to be paid and the meeting actually has to occur. According to this, the business wasn’t in existence. You could not grab those meetings. In order to do this, you have to have the business set up and it has to adopt an accountable plan with its employees. Unfortunately, no, you’re not going to be able to use it for 2022, but you can use it going forward. It’s something else just to have fun with.

Somebody asked a question. Going back here, somebody said, “If I have a W-2 job, but my wife puts in the time to be considered a real estate professional, we file a joint return, and we’re married, does that unlock the loss to make it from passive to ordinary loss?” The answer is absolutely could. She’d get through the first prong if they qualify, and then you’d still have to do material participation.

Anyway, I just couldn’t resist. Let’s see, oh, shoot. There’s Clint. Clint and I, about every other week, we teach the Tax and Asset Protection workshop. They’re always fun. They’re on Saturdays. If you want to learn about land trust, LLCs, corporations, S-corporations, dealer status, bonus depreciation, cost segregation, you want to dive in a little bit deeper, even learn about living trust and legacy planning, it’s absolutely free.

Feel free to join. We do it all day. We go from 9:00–4:00 is what we go, Pacific Standard Time. They’re a kick in the pants, so I would strongly encourage you. Clint does a great job on something that I call security through obscurity, which is getting your name off of your assets so nobody can find them or nobody can tie you to the asset.

What that does is it takes the bullseye that is sometimes printed on your back when you have too much stuff. Everybody knows you’re rich, you got a bull’s eye on you. You got to take that bullseye and put it someplace else. We’re just going to put it anywhere else but on my back. I just don’t want to get sued because I’m rich.

Also, let me just stop here for a second because in that Q&A, we have Ander, Patti, Ian, Dana, Matthew, Jared, Piao, Tanya, Troy, and Dutch, a multitude of CPAs, by the way, in our Q&A. If you ask questions in Q&A, you’re going to get really, really smart people answering that question.

I’d be remiss if I didn’t say public thank you to Ian and to Piao for years. I don’t even know how long it is because we’ve been doing this for so many years. They’re always coming on and answering questions. This is their last Tax Tuesday, but they’ve absolutely been rocking it.

A lot of folks, every now and again, somebody gets a little snippety with me that gets mad because their question isn’t answered right away. I’m like, we are answering hundreds of questions absolutely free on a live event. Give them a little bit of slack because we love them. They’re doing their very, very best. Some of your questions get a little complicated sometimes.

Just cut them a little slack. They’re doing a great job. I don’t know any place else where you can come and get a CPA to answer your questions for free. Anyway, it’s so much fun.

All right, fun stuff. Somebody says they left a question in the land trust on YouTube. If somebody could go grab that for me, I’ll absolutely respond. They usually grab all those questions and throw them.

“When a rehab required property acquired for long-term hold,” that’s the one sentence that I don’t understand what it means, “when is the right time to do a cost segregation study?” I do understand, “Before the rehab or after the property, after the rehab.” I think what they’re saying is, hey, we acquired a long-term hold, and we’re going to rehab it. When should we do the cost seg study? What do you think?

Eliot: First of all, once you purchase a property or after the rehab, you could do it either way. The thing that’s going to happen if you wait before the rehab, then when you do the rehab, you’re going to have to make sure that you break out your costs into the relevant 5-, 10-, 15-year type categories, classes for depreciation, or 27½ or something like that. But really, you could do it either way.

Toby: Here’s an easy way to visualize it because some people don’t know what cost segregation is, and you’re probably hearing that term for the first time. Pretend you’re watching TV, you see one of these flipping shows on TV, and it’s the crappy house that is scary-looking, they’re going to tear a lot of it down. Somebody buys it, they’re going to make it into something beautiful, and they’re done. It’s the day that they do the open house.

They always say, it’s two weeks to the open house. Oh, it’s one day before the open house, they’re bringing in all the little plants and the shrubs, they’re putting in some pitch, they’re putting a fence around it, they’re doing the backyard, and they’re putting in a deck and all that stuff. Just imagine you’re walking up for that open house. You’re seeing a single family residence.

Most people look at that and go, 27½-year property. That’s what I see. I see something I can write off over 27½ years. You cannot write off land, you can only write off that improvement.

You’re looking at it going, the new roof, the new carpeting, everything, 27½ years. Look at all these trees they put in, 27½ years. Look at that fence, 27½ years. Go in the backyard and that deck, 27½ years. That’s what your accountant sees, and that’s not the reality.

The reality is somebody who does real estate for a living and who does this consistently is looking at it going, shrubs are 15-year, trees are 15-year, fencing, 15-year. Hey, that driveway is 15-year property. It means I can write it off twice as fast. I go into the carpeting, five-year property. Cabinets, what are cabinets? Seven, five?

Eliot: I’ll go with seven.

Toby: Seven-year property. I walk out back. Oh look, there’s a deck, 15-year property. Hey, they’re out in the back, hey, there’s all this pitch and everything else, 15-year property. Because there’s a useful life for every item. But if you don’t do what’s called a cost seg study, the IRS will let you treat it all as 27½ years.

Get this, that’s impermissible. You’re not supposed to do it. You’re supposed to write items off over their useful life. But the IRS will allow you to write off that single family residence over 27½ years because you’re hosing yourself.

When you do a cost seg study, you’re breaking it out into its pieces. You get to write it off much faster, and you could actually use something called bonus depreciation. It’s 26 USC 168(k). It’s not hidden anywhere. It’s magic.

That’s the code provision that says, hey, for anything that’s 20 years or below, you can write it all off in one year if it’s 100% bonus depreciation. In 2023, it’s 80%. In 2022, it’s 100%. If you bought anything in 2022, you can write off all those pieces I just named and write them off in one year. It creates this massive loss on most of it.

Let’s go back to our question. They’re saying, when should I do that cost seg study? Before or after? It depends. What I would probably do is say, it doesn’t hurt you. Roof and siding, that’s all 27½-year. Windows, 27 or are they longer or they’re shorter?

Eliot: I think they would be shorter. I don’t know off the top of my head.

Toby: Anybody know out there, Ian, Dana, anybody?

Eliot: I think window is 15.

Toby: I have a list. Somebody says it depends. I have no idea. It does depend on whether or not you’re going to get the cost seg because I don’t think it really matters. What I want to do is break the items out. But if you’re going to do a massive rehab, I might wait till later.

Windows is 27 years. Microsoft Windows is two years. That’s horrible. Ian, we’re going to miss you, man. That’s about right. I would say six months on Microsoft Windows or actually six minutes because it’s been killing me. I don’t know about you, but it has been wearing me out, the numbers. I could not get Google Meet to where I restarted.

Eliot: Google problem was more with this afternoon getting logged in here.

Toby: Yeah. Thank you, Bill Gates, for creating. It’s like Bill Gates and IKEA, like two people that create the most frustration. IKEA likes to sell puzzles and make it into a sofa. Microsoft likes to fix it till it’s broke.

Eliot: Even the carpet can be different between whether it’s tacked down or glued down. It has a different life expectancy on the depreciation.

Toby: Yeah, because you don’t want it to be part of the structure. If it’s removable, then you can write it off for over five years. The whole point is that, hey, I can write these things off. If I am doing a rehab and I’m just improving the property, then I can see those items. It’s easy. I could do the cost seg study beforehand and then get the invoices and fix it. Or you just say, you know what, I’m going to wait till the rehabs are over and then I’m going to do it.

It’s easier for your cost seg company because engineers coming in and valuing everything. Here’s all your five-year property. The 5 years, 7, and 15-year property should be about 30% of your improvement value. If you buy a house, $500,000, the land is $100,000, you can use your assessment or you can use your appraisal to figure out the ratio, but you’re trying to figure out what percentage of the total price is land.

Let’s say it’s 20%. You have a $500,000 house you bought, the depreciable basis is probably $400,000. Thirty percent of $400,000 is about $120,000. That’s probably about right. You’re going to get $120,000 first-year magic, big loss. Depreciation is going to offset all the rents and it’s going to do that for all of your rental properties. That’s why people use it because if you don’t want to pay tax, that’s an easy way to accelerate your depreciation and use it to write things off. If you have too much loss, you just carry it forward.

Somebody says, “What about a property that has been straight line depreciated over 10 years already? Could you still make sense to cost seg after substantial improvements?” Robert, absolutely, because what it does is the year that you put it into service dictates the amount of the bonus depreciation. If it was 10 years ago, that would be 2012 or 2013, probably 50% bonus depreciation, but it’s 10 years already.

The five-year property is 100%. Seven-year property is 100%. The 15-year property is two-thirds. You can immediately write all that off, and you’ve been spreading it out over 27½ years. Robert, it’s worth a study.

We have a company that we work with. We don’t do the cost seg studies. We use Cost Seg Authority. Erik Oliver comes on and he’s on my YouTube channel. They will do an analysis for you absolutely free. They’ll get your address, look at your taxes, and say, this is what it would save you. They could tell you.

Again, I want to know how much money does it put in my pocket right away. Is it going to save me a $30,000 deduction that is worth $6000 and it costs me 2000? I’m not going to do it. If it’s going to save me $30,000 and cost me $1000, then I’m going to do it absolutely. All that fun stuff.

We’ve seen some big ones, hundreds of thousands that get saved on these things. Again, it all depends on how much real estate you have and what type it is. Manufactured housing can be 80%. If it’s stick-built, you’re probably looking at maybe 30% to sometimes as high as 40%. Warehouses are different from storage, which are different from apartments, which are different from single family. That’s why you actually get the analysis done. Do not use software or some CPA. Actually, it has to be an engineer, the types of studies they look at.

All right, “Anderson created my S-corp entity in November of 2022.” Right at the end of the year, so they have two months that they’re operating. “I’ve only had expenses in the year of 2022, but no income or property purchases yet. What am I required to file for my S-corp regarding the expenses I’ve incurred?” Eliot.

Eliot: You’re going to have to file your tax return for that S-corp. It is what we call an informational return. In other words, your S-corp doesn’t pay any tax, but it does have a tax return called an 1120-S. It is an important one because the IRS really puts the hammer on if we’re late on that one, so we don’t want to be late.

You can do an extension, it’s due March 15th with extension up to September 15th. But if we failed to do it timely, then it’s approximately $200 per shareholder in this case per month, the late filing. It’s quite steep, but you do need to do that return in your situation here. Even if you have just losses, that’s okay. Those losses typically would be ordinary, and we’ll help offset ordinary income on your return.

Toby: If you’re an individual and you do this, they’re not going to let you take any loss because they’re going to say you’re not in business yet. As an individual, they need to see your purchases.

If you set up a business, a lot of businesses are trader businesses. If somebody sets this up, they have the startup costs which is the cost of setting up the entity, they have anything that they’ve run any expenses that they paid out of the business. Maybe they don’t have any or maybe it’s just the setup fee. You would still take that loss. You want that loss.

Entity is going to be probably $3000, filing fees, accounting fees, and the cost of setting it up depending if you used an attorney. If you went cheap, it might be a little bit less, but I wouldn’t use those bylaws.

Let’s just say you set it up or if we created it, then you would still get that deduction for whatever the cost of setting it up. If you did the Business Essentials program, for example, you’re less than $3000, you got a whole bunch of stuff included in that, I get a $3000 lost right now. It’s going to offset my other income. If I’m in the highest bracket, that’s going to save me $1200–$1300. I like that, and it doesn’t matter.

If you’re an individual, you’re not writing anything off. You’re just waiting. Eventually, when you do start your business, you can grab it. Potentially, if you incorporate it, you could grab it as a startup expense. It’s kind of funky.

“How do we ask questions anonymously?” The button on the Q&A is great. We respond confidentially. You could just remind them, please respond confidentially. You guys can’t see the questions. We want it to be private so they don’t see it, or you become a client and then we answer it. We answer through a very secure portal, which is our platinum portal, which is protected.

All right. “I created two LLCs both with real estate assets with rental income in 2022. I also created a holding company that owns both the LLCs,” which is exactly what you should do. There are three layers. There’s the property, how do we get the property out of a name directed to an LLC, that LLC has great inside liability protection, the property does something, it doesn’t come get you. Then the third layer, the holding company prevents anything you do from going down and getting those properties.

There are three levels. There’s anonymity, there’s inside liability, and there’s outside liability. It sounds like you have all three layers. But what do I have to do from a tax standpoint? We recommend that the holding company becomes a partnership. Why did we do that?

Eliot: A couple of reasons. (1) A partnership files its own return just like the S-corp we talked about in the previous return. It’s an informational return. It doesn’t pay any taxes, but it will file the related rental activity from all these LLCs that you just mentioned. It’ll go on to the 1065 partnership return and then it will be a K-1 come over to your personal return, but it keeps it off your return. All people see on your return is just K-1, that’s it. They don’t know anything more about it.

Also, it helps from a lending standpoint. Typically, lenders are able to lend more to you being that the property is in a partnership than if it had been in a direct disregarded LLC.

Toby: The other thing is when you do a 1065, you’re keeping that activity off page one of your Schedule E. I was reading this. Did you mention that at all? All right, good. Did you go to Freddie and Fannie?

Eliot: No, I didn’t.

Toby: All right. Freddie and Fannie will use 75% of your income on page one of your Schedule E. They use 100% of the income off of page two of your Schedule E. If you’re building up a real estate portfolio, and you want to get a loan, and you have $100,000 of income on page one, they’re going to move that down to $75,000. If you have $100,000 of income that goes through the partnership, that’s a full $100,000. Plus, it’s just easier from a compliance standpoint.

Everybody gets stuck and underwriting when they have 20 properties sitting on their page one of their Schedule E. You just don’t do it, unless you like paying higher interest rates. You make sure that you’re running it through a partnership because it takes it all and puts it on the partnership return, and that gets summarized on a K-1 that goes on page two of your Schedule E. That’s what you want. It makes your return go from this thick to that thick, and they use it more of the income.

The old adage is, do what the rich do. If you want similar results, do what the wealthiest investors do. I can tell you, they’re not putting it on page one of their Schedule E. They’re all using a partnership at the top. That’s a big reason right there. It’s so much simpler for them to get their personal loans.

When they go to do a portfolio loan, if you don’t have that return or if you go to sell properties, and you’re selling commercial properties, for example, and you don’t have a separate return and they start looking at your return to figure it out the taxes of those properties for the last three years, don’t expect the underwriter to react positively. I’ve seen it really ruin deals over, and over, and over again. Get that separate return on your real estate activities.

All right, “Curious to hear an open discussion about when and how to utilize section 179 and/or bonus depreciation for vehicles.”

Eliot: All right, I’m actually going to jump back to last year and the last couple of years, where we had what’s called 100% bonus depreciation. That just means that for certain assets, instead of deducting them over 5, 10, 15, 20 years, you can deduct them all at once in the current year. We talked a little bit about that on the previous questions.

Bonus depreciation was a really big factor in the last couple of years because of our Tax Act and Jobs Cut program from 2017–2018, and then the Cares Act brought it back a little bit, some aspects of it. But we’ve had this bonus appreciation 100% for a long time, so we’ve ignored 179.

The reason why is bonus depreciation can create an overall loss, as Toby was talking about earlier. We don’t have a problem with that loss, unless we’re talking about passive income or passive losses. If it’s just a regular business that it’s ordinary loss, that ordinary loss will offset against other income on your return.

With 179, though, you’re limited. You can only take that as a deduction if you have net income. You can’t use a 179 expensing to create a loss. You might be limited in how much you can deduct from your 179. You will get a deduct at all, it just may take a couple of years to get there. It just depends on your scenario. For the longest time—whoever asked this question, it’s a great question—we haven’t really dealt with 179, but now that’s starting to change.

Toby: It could be in your state, they don’t have bonus depreciation and we might use 179. But again, you better be in a profit situation where you’re making money. Not to interrupt you, but how important is how much you use it for business?

Eliot: Very important. You have to use at least 50%. We’re going to tell you to use 100%, but you have to have it. That’s just part of the rule, over 50% business use. Why the distinction? Why do we really harp on being 100% for business use? Because any personal use is actually taxable income to you. That’s one distinction there.

Toby: The other thing is there are limitations. As Eliot probably said, it was on passenger vehicles. Where you see the 179 come up is when somebody has a property or a vehicle that’s 6000 pounds gross vehicle weight or higher, it qualifies as equipment. You can write that off 100% if you’re using it 100% for business.

Here’s the cool part. If I use it 100% this last year, like you bought it in 2022 and only use it for business, you can write the whole thing off. As long as you stay above that 50% business usage, you never have to worry about it. You dropped below, and you’re going to have recaptured ordinary rates the amount that you’d appreciated. It can be a little bit of a sticky wicket. You have to be a little careful.

The other thing is, why not just do mileage reimbursement? It’s like 65.5¢ a mile right now. It’s your car. You can use non commercial insurance. It could just be your car that you use. If you let employees use it, that goes out the window. You have to have a commercial policy. But if it’s just you, why go through and have that added expense and aggravation?

I’ve done the numbers, it’s pretty darn close if you’re using it. Let’s say you’re using it 30% for business, you might be doing 10,000 miles a year, that’s $6500–$6550 that the company writes you a check for. You don’t have to recognize it as a reimbursement if it’s an accountable plan, if it’s an S- or a C-corp or an LLC taxed an S- or a C-corp. Otherwise, if it’s a rental property, even in a partnership, it could reimburse you mileage and things like that, too.

You don’t have to recognize it, that’s the big one. It’s hey, it’s easy money, I don’t have to worry about what’s the exact percentage, I don’t have to worry about recapture, and all these things. I’m just writing it off as they go. To me, the difference is sometimes a few hundred dollars. I would rather have the peace of mind of not having to have that gun to my head and worry about the vehicle being used enough in business to qualify for 179(k) or 1608(k).

Eliot: Especially with our clients we have a lot in real estate who might be realtors themselves, I have rents here in the Vegas valley. They drive all over. They can put 30,000–40,000 easy a year on their vehicle for mileage, and that’s a lot of reimbursement. At 60¢ a mile, that basically pays for the next car within two years.

Toby: I think Troy just asked me to repeat something. Let’s say you buy the Range Rover, and it’s over 6000 gross vehicle weight, you paid $110,000 for it, but you use it 50% for business, you’re not getting $110,000 deduction. You’re getting a $55,000 deduction, and then you have to make sure you don’t fall below that amount forever because that’s what you took. You took the bonus, wrote it all off in one year.

You have to make sure that you don’t fall below that 50% during its useful life, so you have five years. Otherwise you’re looking at recapture which is nasty. I know that there are people that do it and I’m always like, don’t ever buy a car because your tax guy says you can write it off. It’s a horrible idea. You’re still spending the money and you’re getting very little bit back.

If you have advertising on your vehicle, does it count as 100%? No, not at all. They don’t even care. You can write off the rap that you put on your car, that’s it, but the mileage never becomes business mileage.

“What are the steps to take in order to withdraw money from a C-corp account? Are there any tax consequences involved?”

Eliot: It depends.

Toby: I knew it was coming.

Eliot: The thing I really press on clients and when I’m talking to our fellow colleagues here, with a C-corporation, the first thing I’d like to look at are the reimbursements. You got your corporate meeting which really isn’t reimbursements. You’ve been paid for renting out your house under 280A for 14 days. Augusta Rule, we talked about it in the earlier question. You also have the accountable plan, which just means reimbursement for business expenses that can be having an administrative office in your house, mileage like we just talked about, cellphone, internet, and things like that.

Toby: Those are all deductions to the business. You don’t have to pay tax. Not to interrupt you, but let’s say Eliot and I, we go out and we decide for the business. Somebody says, hey, bring pizzas back and I’m like, oh, shoot, Eliot, I forgot my wallet. Eliot’s puts out $100 and buys a bunch of pizzas.

He comes back to the office and we write him a check for $100. Does he have to report that on his taxes? The answer is no. We just reimbursed him for an expense. That’s all you’re doing under all of those things. You have an accountable plan reimbursing you for the use of your home, we have an accountable plan for your home office, we have an accountable plan that is paying you with an accountable plan.

We don’t have to worry about it. If it’s paying you for 280A, it’s not even an accountable plan. It’s just paying you for the use of your home, and it’s 14 days or less. The tax code says don’t report it, and he still writes it off. Like your cell phone. If Eliot has a business, he has an S-corp, and he wants to write off his cell phone, and let’s say I work with him too and he says, hey, I’ll write off your cell phone too, as long as I’m using it for his business, even if it’s 10%, I write up 100%. What about the data? 100%.

There’s a reason that these things exist so that the business can’t take advantage of its employees. The businesses usually get sued because the business says everybody has a cellphone. You have to use your cell phone whenever you go home. When you’re on your job, hey, we have you traveling and you’re going to use your own stuff, and the court says no, no, no. If you force them to use their cell phone, you need to reimburse them for the business use of that cellphone.

“Can you get mileage reimbursement from the C-corp?” Yup, absolutely. What is the mileage deduction for 2023? I think it’s 65.5¢ a mile? I think that’s it. Where is the corp writing this off on the 1120?

Eliot: Other deductions?

Toby: Yeah, other deductions or if it’s a lease. If it’s doing your home on the 280A, it’s probably corporate meetings or lease.

All right. If you like this type of stuff, guys, I’ve already mentioned this before, but please go to our YouTube channels. I have one that’s just focused on tax, and that’s where the Tax Tuesdays live. You can learn a lot about this.

There’s one, I’m looking at it right now. “How to pay zero taxes on capital gains?” Yes, it’s legal. Yup. Here’s a hint, don’t sell it, leverage it. Buy, let things appreciate, leverage it like crazy. You’ll learn everything from living trust. I’m just looking at what’s on top. I had 1.6 million views on How To Make Your Assets Invisible. Clint, really excellent at that, too.

Just make sure you’re signing up for the YouTube channels because it’s going to prompt. Usually it’s other people’s questions. We get it every week because we literally get hundreds of questions. We grab 10 or 15. Half the time, I’m looking at it going, that’s a really good question. You see us going, it depends. That’s why it’s just filling your brain with more good stuff.

“How to save taxes as an S-corp? Is it better to do than standard deduction or itemized for tax?” Let me ask you this because I don’t understand this.

Eliot: Okay. The S-corp has a lot of advantages to it to save on taxes. Some of them we just talked about, again, in our two previous questions or so. It has an accountable plan, which means that your S-corporation, again, it files its own return. It’s only an informational return when it comes through to your personal return, but we take the deductions for the business on the S-corp. That’s going to be like administrative office

You can get paid from your corporation for having an office in your house, tax-free to you, deduction to your S-corporation. That would be your cellphone, internet as well, mileage from wherever you leave the office, the corporate meetings, and you only have to pay yourself a reasonable wage.

If we had net profits of $100,000, if you weren’t an S-corp, if you were a sole proprietor, 100% of that is going to be taxed not only at your tax bracket rate, but also hit self employment tax, 15.3%, a nasty amount addition there. Whereas you only have to do a reasonable wage under the S-corporation. Maybe only $40,000 is paid as W-2 wage or the other $60,000 not subject to that.

Toby: All that means is that, let’s say it’s $100,000, if you had a net profit of $100,000 as a sole proprietor, you’re going to pay 15%. It’s actually 12.4% of old age, disability and survivors, insurance plus, 2.9% Medicare, and you get a half deduction for half of it. The numbers end up being you’d pay $14,100 in self-employment tax on $100,000. If it was with an S-corp, you would pay about 60% less, because you only have to pay yourself a little bit of salary that triggers the old age, disability and survivors, and Medicare. The rest of it is not subject to that tax at all.

That’s why S-corporations are so potent. The tax savings just on that. Let’s say you’d be paying $14,100 as a sole proprietor. You’re probably paying closer to $5000 if you are an S-corp. It’s going to save you about $9000, plus you get the added benefit of 280A, plus you get the added benefit of doing an administrative office in your home which is compared to a home office deduction, two very different things.

One of them, I get to reimburse, I don’t have depreciation recapture. The other one, I have to reimburse on a separate form. The safe harbor is $5 per square foot.

I just did this. There was one, it was $6900 as an administrative office per year that they could reimburse themselves, pay and reimburse the expense. They got $6900. The sole proprietor got $750. That’s how big of a difference it is. Between those things, 150 square foot room and a house where they had five equally sized rooms, three bedrooms, two others.

You start looking at these things. The S-corporation should give you tax savings of greater than 10% of your net income, which is driving up your profit margin or not 10% of your net, it’s actually 10% of the gross on $100,000. We ran the numbers, it’s about $11,000 savings, two companies side by side doing nothing differently except following the rules that are respective to a sole proprietor versus an S-corp.

What’s the downside of the S-corp? You have to file another tax return, but it’s the same exact information that is on the Schedule C that’s going to be attached to your 1040. It’s just a separate return, but it’s not separate information.

Eliot: And far less chance of an audit.

Toby: Somebody says, “What about a recommended reasonable salary?” The courts almost universally apply one-third. You always see it, but technically you could go look up a reasonable salary for somebody in that profession. If you’re an attorney that would say, hey, what’s the reasonable price you could pay? It’s be a range, you could pick the lowest of that range and pay yourself that amount.

You make $200,000 a year, the reasonable range might be $70,000. You have $130,000 that is not subject to any self-employment tax. That’s great. In that way, there’s a little bit of a phase out on the old age, disability and survivors, but I don’t want to make your heads pop.

The other one is, “What’s better, a standard deduction or itemized for tax?” It depends. What standard deduction comprised of?

Eliot: Standard deduction is just a flat amount. It just depends on whether you’re single, head of household, or married filing joint.

Toby: It was $12,950, was it?

Eliot: $12,950 for last year, single, $25,900, married filing joint last year. This year, 2023 is going to be $27,700, married filing joint, $13,850 for single.

Toby: Just think about that, $27,700, married filing jointly, you get to write off your return. If you do the itemized, you add up to $10,000 of state and local taxes. Any amount for your medical that went over 7.5% of your AGI if your AGI was $100,000, anything that you spent over $7500 that wasn’t covered by insurance, so nothing. Your mortgage interest that you paid and your charitable donations. If you got hit by a hurricane, you could add that one in there, too, casualty losses.

You add up all those things. Let’s say it’s $20,000. You would take the standard deduction because it’s $20,700, or for last year would be $25,900. You’re always looking to say, what’s in my best interest? You don’t have to pick either. You get to say, I’m going to pay the tax, but you get the choice. I would take the higher of those numbers, it makes it really simple.

What’s better? It depends. Don’t you love that? That’s why everybody, they go to law school so that they can make hundreds of thousands of dollars a year saying it depends over, and over, and over again. That’s the rule. They just go in there and they’re like, repeat after me. It depends. It depends. It depends. You do that for three years and eventually, it gets drilled in.

Eliot: I didn’t do much more than that myself.

Toby: “Can you please touch upon what depreciation recapture is and how it impacts taxes?”

Eliot: That’s a wonderful question. I hate to say it depends, but it does depend a little bit on which type of asset you have. Basically, when you have an asset that’s been used in a trade or business, we don’t deduct the full cost of it immediately. We take a little bit over time, we call it depreciation.

Then when you resell, you might have what’s called depreciation recapture on that depreciation that you took over the years. It does depend on what kind of asset it is. If it’s tangible property versus real estate, what we call 1245 versus 1250 property, they might have different rates of depreciation recapture. But basically, it’s just the recapturing the depreciation you took over the years on your return.

Toby: And it’s capped at…

Eliot: Twenty-five percent for the 1250.

Toby: It’s your ordinary rate capped at 25%. It can be less.

Eliot: Yeah, it could be.

Toby: If you can get your income, if you take a big, hey, I’m a real estate professional, I do a cost seg, I get this huge loss, I get down to zero, guess what my recapture is? It’s going to be really low or is it going to be calculated if anything?

Eliot: It could be really low, especially if you had the asset long enough and you could zero out some of the assets.

Toby: I have to share with you guys a really sad story. I thought this was really interesting. I asked old Maude how she lost her husband, she told me her sad story. We needed a blood transfusion, but his blood type was not on record. The doctors asked me if I knew where he was as they urgently needed to know in order to save my Norman’s life. Tragically, I’ve never known his blood type, so I only had time to sit with him and say goodbye.

Horrible, they didn’t know their blood type. But he was so supportive of me. In fact, he was so positive that even as he was fading away, he kept whispering to me, be positive, be positive. I just think that even when somebody’s on their deathbed…

Eliot: Can have a sense of humor.

Toby: Sorry. If you guys don’t get that, then I feel it. I like that. All right. I had to break up the tax. Somebody sent that to me, I couldn’t help it. Nobody likes that. Patti says, I get it. She’s the only one at this point. Everybody else is like, ah, crap. We just lost 6000 people.

All right. We got a few people that get it, all right. Somebody says, yeah, it was kind of funny. My wife’s a nurse, she got it. You just be positive, be positive, be positive. I am Norman. I am being positive, it’s B+!

“I do the work from my home office. How can I claim this?”

Eliot: Again, you can either tuck the cost of the office depending on whether it’s a sole proprietorship or maybe an S-corp or a C-corp. We have the administrative office. We’ll talk about the little differences there. If you have a sole proprietorship, you can take a deduction for basically the percentage square use of that house, is an easy way to describe it.

Toby: If you’re not a sole proprietor, you can’t do it.

Eliot: No.

Toby: What if I work from my home office and you’re working for an employer? Can I write off anything?

Eliot: No, out of luck.

Toby: In 2017, they took away unreimbursed business expenses. Everybody says, the trump of them, oh, they give all these tax breaks. No, they took away entertainment, and they took away unreimbursed. They made it really, really hard to write certain things off. Somebody says, “I am a negative person.” See, somebody got it.

Eliot: That’s a good one.

Toby: All right. But if you do work for an employer, you could ask them to reimburse you. You say, hey, usually it’s if you have a choice. If I could work in the office but I want to work from home, you’re not going to get anybody to reimburse you. But if somebody says, you have to work from home, then it might be worth having a conversation about hey, what we reimburse? There might be a reimbursement available for you.

How do I claim this? Here’s the difference. If I’m a sole proprietor, I write it off as a home office deduction. The safe harbor is $5 a square foot. If you have a 10 by 15 foot room, it’s $750 a year. Some people are just getting it. But if you have a corporation, it can reimburse you the percentage use of your home using any reasonable methodology for calculating that.

Somebody says, “I read that joke once, but it had a typo (Type O).” I love you guys. Every now and again, you guys just come out and kill me. I’m just dying right now. I can’t even look at you guys’ comments. I just love it.

All right. If you could get reimbursed, then it could be 20% of your house. By the way, that includes mortgage interest, property taxes. If you have somebody coming in cleaning your house, your utilities, if you’re spending $25,000 a year to run your house, 20% would be $5000, you reimburse that, where do you report it on your 1040?

Eliot: If it’s a sole proprietorship, it’s just a reduction there. If it’s a reimbursement, you don’t put it on at all.

Toby: It’s nowhere on your return. That’s why we love that.

Eliot: You can have depreciation as well.

Toby: Yeah, you get a piece of depreciation.

Eliot: Without any depreciation recapture.

Toby: Yeah, which is different. When you’re a sole proprietor, do you have recapture on that, too?

Eliot: Yup.

Toby: Oh, boy. This is fun. Hopefully, you guys had a little bit of fun.

Eliot: Best hour they’ve had all day.

Toby: The best show I’ve stopped watching is Tax Tuesday right at the end. All right, email us your question, taxtuesday@andersonadvisors. That’s where we pick these up. Eliot grabbed these ones this week.

You can visit us andersonadvisors.com and learn more about the courses that we offer. We teach a lot, guys. We like to teach because (a) we like to give back and (b) because it makes really smart people. Really smart people then decide, hey, I like the people that taught me that, and maybe they reward us by doing their business.

Come to the Tax and Asset Protection event. Learn all about land trusts, LLCs, LPs, Wyoming Statutory Trusts, why we use Wyoming, how to create a dynasty doing a living trust that lasts a really long period of time, and all that fun stuff. It’s absolutely free. We do that one every other Saturday, but Tax Tuesday’s every other week.

Big, huge kudos to Ander, Matthew, Patti, especially to Ian, Dana, Jared, Piao, Troy, and Dutch. We have a bunch of accountants, a bunch of CPAs answering questions for you. We do have some open questions, so I know if you have a question—there are about 22–23 questions that are still open—don’t worry, hang tight. We will answer them.

We end the event, but you could stay on. We’re not going to end the webinar until we get those questions knocked out. Good luck to you in 2023. Hopefully this is starting off all right. Markets are starting to come back. People are realizing that there’s this thing called supply and demand. No matter what the Fed does, they can try to taper it.

We are good 5 million units underbuilt in this country. If you’re a real estate investor, take heart in that. No matter what they try to do to blow it up, it’s almost an impossibility. Never bet against the Fed screwing things up if they really, really want to, but they seem to slow down.

People need housing. If you’re in real estate, don’t back off. This is really something, and we’ll make sure. Carmella is asking. Hey, Patti, could you get Carmella’s information so that we can make sure that we get her squared away? I don’t see her question in here, but I want to make sure she’s getting and knows where to look for a response so we can take care of her.

You’re special to me, Carmella. We’re going to make sure you get your answer. I don’t care what we have to do. We will get there. That is it for me. Anything you want to add?

Eliot: No.

Toby: All right, guys. What I’m going to do is I’m going to mute ourselves and we’re going to go into hibernation. You could keep on and get your questions answered in the Q&A. If you have a question that’s hanging up, they’ll continue to knock that out.

Yes, we do record these. We put them on the YouTube channel. If you go to my YouTube channel, just type in Toby Mathis on YouTube. You’ll see that it’s really easy to subscribe. There’s no cost to it. We never ask for money. We just try to ask for ideas and good questions that we can answer and provide more content.

Everything else takes care of itself, so good luck to you, guys. Thanks to Eliot for stepping in for Jeff. He’s been doing a great job. We’ll get Jeff back one of these days.

He’s got a lot of things on his plate, so we’re just going to bring him back, although it’s always fun to hang out with another attorney and a tax guy. It’s always a katoosh. All right, guys, thank you very much. We’ll see you at the next Tax Tuesday in two weeks.