How To Reduce W-2 Taxes By Owning Rental Property

Jeff: Hello.

Eliot: And this is where, as Toby says, we bring the tax knowledge to the masses, so this is driven by your questions.

We pick out a few questions. We got 11 today that will go through. Of course, through the chat, people will be coming in. Please, if you would, submit your questions through actually the question section. We have a question section on Tax Tuesday. It’s a little bit different, like I say, than the Zoom meetings that we do.

We do have a group that will answer your questions consisting of some of our CPAs or EAs. We got Dana, we got Dutch, we got Piao, we got Troy. Bookkeeping, all kinds of resources there to help answer some of your questions. We’ll get started right away.

First of all, the rules. If you could ask it through the Q&A feature. If you have any questions, please submit them through the email. Email questions to taxtuesday@andersonadvisors.com. That’s where we get the questions that we’ll be asking today.

If you need a more detailed response, please feel free to become a platinum client or a tax client, and we’ll be able to assist you with that. We try to make it fast, fun, and educational. It’s our way of giving back a little bit of education and help to our clients, and we appreciate you joining us today. We’ll go through, first of all, the opening questions. Just walk through the questions that we’ll be answering today.

First of all, “Can you please explain the difference between an LLC, a C-corp, and an S-corp? Can an LLC also be a C- or an S-corp? I understand that C-corps and S-corps are tax elections, but are they also a type of entity?” Very good question. Very popular question we get asked a lot.

Next for an HSA (health savings account). “Are the limits for contributions a monthly or annual amount? On irs.gov, the limit as listed is $3200 for single and $7200 for family.” We’ll talk a little bit more about that.

Number three, “My accountant thinks I should switch from an S-corp to a Schedule C,” that’s a sole proprietorship on the 1040, “because my profits are below $80,000–$90,000, and the S-corp is expensive, and I’m just one person, so I do not want to grow any bigger, and I’m happy with the sales. My question is, what is the best for me, not the company? What happens if I switch? What is better for retirement and social security as I am 56 years old?”

Next, “Can you convert a personal vehicle into a business vehicle if you only use it for business? What if you only own one vehicle? Can you deduct mileage, gas, or anything else?”

Next, “Can I reduce my W-2 taxes for my job by owning rental property?” That’s a broad question there. We’ll certainly have a lot to say about that one.

Next, and it’s a two-part here. “I have a C-corp staffing business. Since Covid, I’ve been using my home office. The home is in mine and my son’s name. How can I count for the space used as an office for a tax deduction? Number two, what is your advice for a small business owner on employing people who only have their ITIN number pending the social security number?”

Jeff: I’m curious if we’re going to come down on the same landing spot on that one.

Eliot: Not sure.

Jeff: We’ll see. Go ahead.

Eliot: The anticipation builds. What are they going to say? “Can you discuss the step by step process of completing a 1031 exchange?

Next, “I have a question regarding investing with my HSA. Does an HSA function like a Roth IRA in terms of paying UBITs (unrelated business income tax)? In other words, if I invest my HSA in crowdfunding or syndication, for example, will I have to pay UBIT?”

Next, “Can I write off a loss selling my bitcoin with a $10,000 loss? I bought it at $26,000 and bought it right back at $16,000.” Getting into the wash sale rules there.

“My understanding from a tax perspective, an LLC taxed as a C-corp and a traditional C-corp receive the same benefits such as medical reimbursement, administrative office, retirement plan, et cetera. (1) Can you explain the positions of the LLC taxed as a C-corp? Do I still need a president, vice-president, treasurer, secretary, or just member managed? (2) Why would anybody form an LLC taxed as a C-corp over a regular C-corp? If there is no plan to take it public, why choose one over the other? Cost to maintain, paperwork required, et cetera?”

I think last, “Is it best to start an Airbnb business now or wait until the beginning of the next year for tax purposes? I’m estimating two more weeks of getting ready. December 1st is my goal. Some details, nothing major like a roof or air conditioner was needed in 2022 to get it ready.

Next year, I will do some major upgrades, but the house is actually looking pretty good, super clean with new paint and beautiful terrazzo floors.” I won’t say that in Italian. “Didn’t buy any major tools or capital equipment. I didn’t buy a 6000 pound vehicle either. No income this year except for social security retirement. Going to refinance in 2023. What do you think the best options are?” Quite a bit there.

All right. Before we begin, just remember, you can get through our YouTube. Subscribe on aba.link/youtube. We do have a whole YouTube channel with a lot of training videos and things like that, which again, we are towards the education side, so that’d be a great resource. We also have our podcasts at andersonadvisors.com/podcasts. Lastly, we will have the replays for all this in your platinum portal.

Opening question. “Can you please explain the difference between an LLC, a C-corp, and an S-corp? Can an LLC also be a C- or an S-corp? I understand that C-corps and S-corps are tax elections, but are they also a type of entity?” What say you, Jeff?

Jeff: Welcome to Tax Turkey Tuesday. I’ve been waiting all day to say that.

Eliot: Right, there you go.

Jeff: We’ll get LLC out of the way first. LLC is a legal entity, it is not a tax entity. When you create an LLC, if you don’t tell the IRS how you want it to be taxed, it’s going to depend on whether you only have a single member—it’s going to be disregarded to you—if it’s got multiple members—it’s going to become a partnership. If you want anything else like an S-corporation or C-corporation, you actually have to tell the IRS that.

Eliot: Make an election.

Jeff: Yup. What else have you got?

Eliot: To the second part of the question, yes, an LLC could be an S- or a C-corp. It could be either one, depending on the election to make. As Jeff points out, it can be disregarded, partnership, C-corp, S-corp. It’s got a lot of flexibility is the bottom line. If you don’t do anything, it goes through those defaults. Disregard for one person, partnership if there are multiple players in it, members in it.

I think the confusion that happens is that also at state common law, you have traditional C-corps and S-corps. Those really aren’t any different than an LLC taxed as a C or an S. They both have the same tax treatment. The only distinction between them is a C-corporation is a true C-corporation which would be a common law corporation that’s something that’s not an LLC taxed as a C. It has stock, and we can use something called 1244 stock loss.

Jeff: We’re going to talk about that later. There is another question on this.

Eliot: Yup. We’ll get into more depth about that. But really, there isn’t a difference from a tax standpoint between the LLC taxed as a C-corp.

Jeff: You’re saying there’s no difference for tax. What about legally?

Eliot: Legally is what we’re going to get into. This is one of our future questions that we have here today. It’s considered a little bit easier to run with the LLC because it doesn’t necessarily have the requirements. Most states don’t have overbearing requirements for meetings and things like that. It’s supposed to be a lot easier to run. We’re going to learn that that’s not necessarily a good thing.

We look at another question, but it is considered a little bit more simplistic with the LLC. Again, it is a state creation. Every state actually has different rules for how they treat their LLC, but most of them are in conformity with each other.

Jeff: Let’s say I form a corporation in one state and then move to another state. How easy is it to convert it to that other state if it’s an LLC versus a corporation?

Eliot: Conceptually, it’s not all that difficult. You just go to the state. Each state will have its own rules on how they do that conversion from an LLC to a proper C-corp. Not every state necessarily offers that, so you do have to look at the state.

There is a great deal of flexibility as far as moving entities across the various states in our country. But every now and then, you just really have to know the state you’re leaving from and the one you’re going into, what the rules are on that.

Generally, it’s the state you’re going into that’s going to control that situation. As you can imagine, if you look at some of those, California can be a little challenging if you try and leave, whereas they typically will allow anybody to come in. Everybody can go into the black hole, but can you get out?

Jeff: Just speaking of moving, it’s usually not necessary. If I’m incorporated in (say) Kentucky and I moved to Nevada, there’s not necessarily a reason to move where I’m incorporated.

Take for example, national banks in this country, 99.9% of them are incorporated in Delaware. Even though US banks are headquartered in Minnesota, I believe, Minneapolis, Bank of America is headquartered in California and so forth, but they’re all incorporated in Delaware if they were banks as far as laws go.

Eliot: Especially if you have a trading stock, you’re going to see your Delaware entities. But as Jeff said, you can be set up in one state and actually live in another. We might have to file a form if you are receiving a W-2 income because you become an employee in that other state. These things that can be done, certainly. Maybe it is easier to move it, maybe you don’t want to move it. You might go back and forth between the two states.

I’ve had jobs where I went between Nevada and Arizona, back and forth, et cetera. Sometimes that happens. Maybe you want your entity in both states and consider employing both. There is some flexibility out there.

But if you ever got into the situation and really wanted to know what’s going on, of course, a lot of this depends on what actually is going on in your world of investment if we would choose one option over the other, but for all intents and purposes, you can feel pretty much secure that the LLC taxed as a C or an S is primarily the same as a regular S-corp or C-corp.

All right. “For an HSA, are the limits for contributions a monthly or annual amount? On irs.gov, the limit is listed as $3200 for single and $7200 for family.” I didn’t get a chance to really check those numbers. I’m not sure those are actually up to date.

Jeff: No, I want to say it’s $3350 and $7700 for 2022. I think it’s going up fairly significantly in 2023. But to the question, the contribution limits are annual amounts. What some employers do who have employees is, if they’re going to fund the HSA for the employees, they may be doing this at the first of the year. The reason for that is then that money is available to use for medical expenses as the year goes along.

Eliot: A very popular benefit to give to your employees and a deduction to the person paying for it.

Jeff: It’s so hard to take that medical deduction on Schedule A anymore because of the high standard deduction and then the limitations on the medical deduction. This is actually a nice benefit to have. You do need a high deductible health plan to go along with this. I don’t remember what the definition is of that.

Eliot: $1400 for an individual, $2800 for a family.

Jeff: Are you talking about the deductible?

Eliot: Yup.

Jeff: Okay. What the HSA allows is, if you’re putting money into an HSA, it either comes out pre tax, like through a 125 plan. Anyway, it reduces the amount of taxes withheld. That includes medicare, social security, federal, and state. If your employer doesn’t do a pre tax, you still get to deduct it, but it gets deducted on your 1040. Whereas if you just tried to put these payments on your Schedule A, you have a good chance you’re not going to get to deduct any of them.

Eliot: Yeah, almost the word impossible comes to mind. You have to get over that. That’s such a burden. You have to be itemizing to begin with. Not everybody’s itemizing. Then you have to get over 7.5% of your AGI as Jeff’s pointing out. HSA is a nice option, I guess I would say.

Jeff: I think I calculated. For me to be able to deduct a penny medical on my Schedule A, I’d pretty much have to die. Then at that point, it doesn’t benefit me anymore.

Eliot: A whole lot, yeah. Usually, death and taxes. What do you want? They walk hand in hand. Hopefully, that helps out with the contributions. Yes, it is an annual amount. I don’t think one actually usually contributes monthly, they just write a check. Again, it can be you as an individual putting into this as long as you have a high deductible plan.

Jeff: If you’re involved in an HSA that you’re contributing to through your employer, you may get to the end of the year and have not hit these limits. Most employers will allow you to put in a lump sum to hit the limit so you can take advantage of that deduction. Where’s that money go?

Eliot: It’s in adjustments, above the line adjustment to your income.

Jeff: Any money you contribute that’s your money to pay for your future medical bills.

Eliot: Exactly. We’re going to learn, maybe you can do some other things with it too on one of our future upcoming questions here in the next half hour.

All right. “My accountant thinks I should switch an S-corp to a Schedule C,” that’s a sole proprietorship on your 1040, “because my profits are below $80,000–$90,000. The S-corp is expensive and I’m just one person, so I do not want to grow any bigger, and I’m happy with these sales. My question is, what is best for me, not the company? What happens if I switch? What is better for retirement and social security as I am 56 years old?”

Jeff: Let’s talk about a few things. First, the expense. If this is an LLC taxed as an S-corporation, the filing fees with a state is going to be the same, regardless.

Eliot: Often, you’re looking at the same amount. However, there are the states out there that have peculiar S-corp rules, so you want to be aware of that. I don’t know what state we’re talking about here, but I know New Jersey has special rules, Massachusetts. But usually, Massachusetts, you have to have quite a large amount of income, so I don’t think that’d be applicable at $80,000–$90,000.

Jeff: Californian that avoids $800, it’s not going to matter. You’re going to pay the $800, regardless. You are going to pay for a tax return to the S-corporation that you wouldn’t have to pay for extra on the Schedule C.

However, having done this for quite a while, there’s some work to do to put that Schedule C together. Your 1040 may get a little more expensive.

Eliot: And your S-corp runs properly, you can take advantage of an accountable plan for reimbursement for administrative office, mileage, and things like that. You don’t have to pay all $80,000–$90,000 as wage, whereas you would in Schedule C. It’s going to all be subject to employment tax, 100% of it. Yes, you will get 50% of it back for an adjustment again on your AGI.

Your S-corp has things like the 280A corporate meetings and things like that that can help reduce that $80,000–$90,000 maybe realistically down by $20,000. If we reduce $80,000 by $20,000, we’re looking at $60,000, and that would have been money you’ve got in your pocket for reimbursements. Now your reasonable range may only be $30,000.

It’s difficult at $80,000–$90,000 for me to see where the S-corp is more expensive than a Schedule C if it takes advantage of all these things like the accountable plan and corporate meetings.

Jeff: If you have a health insurance plan for yourself that you’re paying for, that should be paid for by the S-corporation. It will save you a good deal of money.

Let’s talk about the downside if you take your LLC that’s an S-corp and revoke the S election to make it a Schedule C. There are a couple of steps there. You have to revoke the election, and then you have to file 8832 to say it’s a Schedule C now, it’s not a corporation. You cannot change back to an S-corp for five years.

The other thing is if there are any appreciated assets, you’re going to have to pay. You may have to pay tax on that. Likely, you’ll have to pay tax on that.

Eliot: It does. We’re jumping out as we just talked about one of the previous questions here. If we’re talking about an LLC taxed an S, it is as Jeff pointed out, you’re going to do the revocation letter to the IRS, and then you’re going to do an 8832, because that 8832 form is built. It’s called the check the box form for LLCs only.

Jeff: Literally, it’s called check the box form.

Eliot: Yeah, because you just check the box. But if it’s a regular S-corporation, then the revocation would turn it into a C-corp, and we don’t get to check the box. That is another factor here as well. We jumped to the idea that it was an LLC, but I guess it doesn’t have to be. Now you really have to just dissolve.

You can’t go from a corporate form. Okay, well, maybe some states will allow it. You have to check your state. They may allow you to transform from a corporation into a limited liability company, but that would be very state-specific.

Jeff: Yeah, I don’t think you want to do that. This is going to make it more expensive to do, because if it is a true S-corporation that started out as an Inc, you’re going to have to dissolve that entity. You’re going to want an LLC for your Schedule C, and that’s going to cost you a lot, about $1500.

Eliot: Yeah, I would think. Not to argue with your accountant, but you might want to run through these things and see if it’s really a better move or not. I would suggest that probably if you’re taking advantage of an accountable plan, which you cannot do on a Schedule C, if you’re doing your corporate meetings, which you cannot do on a schedule C, then it’s probably going to come out ahead. Stay in S-corp.

Jeff: I want to address social security. If you’re worried about social security and you want to put more into it, just pay yourself more through the S-corp. Any payroll taxes you pay like the other half of the social security tax, that’s a deduction to the S-corporation, so it lowers your income all around.

I think for $80,000 or $90,000, I probably would have switched to an S-corporation at this point. I don’t think there are enough savings here to make it worthwhile, if any savings, to change it back to a Schedule C.

Eliot: Exactly. I would keep it as an S. I think you have more potential problems. Like I said, if you have to go from S to C and then you dissolve, I think you’re looking at far more problems and headaches, so I would probably just keep it.

Jeff: And you don’t want to create a new LLC because you may have accounts and stuff tied to the old LLC. It may be merchant accounts, it may be bank accounts.

Eliot: Big headache.

Jeff: A huge headache when you get payments sent electronically to you to an account that doesn’t exist anymore.

Eliot: All right. “Can you convert a personal vehicle into a business vehicle if you use it only for business? What if you own only one vehicle? Can you deduct mileage and gas or anything else?” Personal vehicle into business.

Jeff: You can do that, but you have to actually contribute the vehicle to the business.

Eliot: It’s got to be titled in the name of the business. What if you only have one vehicle? Does that cause us any concerns?

Jeff: That causes a ton of concerns.

Eliot: Do tell, Jeff.

Jeff: Because what we don’t want is a lot, if any, personal use of this vehicle.

Eliot: Why not?

Jeff: For one thing, it lowers the amount of your deductions. You can’t take any accelerated depreciation. You can’t take bonus depreciation. The solution to this is to track your mileage and deduct mileage.

Eliot: If you did title this all the way over into your business, and you only have the one vehicle, and you do use it for personal use, that’s taxable wages to you. You got to watch out for that. It does depend on the type of business you have.

All these questions depend on what kind of business entity we’re using. If it is an S-corp, a C-corp, or as we’re learning, an LLC taxed as an S or C, you’d have an accountable plan reimbursement. You can be reimbursed for mileage and things like that without titling it in the name of the business, because you keep it in your personal name. You just get reimbursement. That’s cash coming to you tax-free, out of the S- or C-Corp, and they get a deduction for it.

That’s probably as good as it gets. Your business gets a deduction, you get free cash in your pocket. That’s all because you kept it in your personal name. If you are one who drives a lot, the more you drive, the more mileage, the better this comes out, because what is our rate? 67¢ a mile or 67.5, or end of 2022, I believe for reimbursement.

Jeff: That’s 4¢, I think. It’s quite a bit.

Eliot: It’s up there. The point being, if you had 10,000 miles, that’s $6700 of cash in your pocket for reimbursement and a deduction at the same time to your business if you keep it in your personal name, if it’s a corporation and use the accountable plan.

Jeff: Toby often talks about the expenses of a car in a business or hire in your name. You’re going to need commercial insurance, because they’re not going to insure in your name if you don’t own a car. Commercial insurance is more expensive.

Also, I feel like if you’re in a bad accident where you’re at fault, if it was in your name, you might be liable. But now by having it in LLC or the business’s name, you pull both of you into the same.

Eliot: Yeah, and all your assets in your business. That may seem counterintuitive, because we like to use the business for asset protection. If you had a lot of assets in that business, they’d be exposed. Whereas typically, your personal insurance handles it if you’re just driving personally.

I often tell my colleagues here at Anderson and clients who ask this type of question, just getting back to the expenses, that commercial insurance, I’ve had one client come back to me after we talked about this, and the commercial costs were four times as much. It’s something that you have to take into account. Now with all the other types of vehicles coming online, who knows what the insurance commercial rates are going to be for that.

I don’t typically recommend it and put it into business, but could you? Yes. If you only have one vehicle, that’s a really tough situation because we know you’re using it for personal use. The IRS knows you’re using it for personal use. It becomes an audit risk if you put 100%.

Even if you didn’t use it personally, you’re going to have to convince the IRS that you’re not. I think that becomes something that would get their attention on a return seen 100% business use when you’re marking that you don’t have another car.

Jeff: I do want to say that I said math is hard. I want to attribute that to Ian who says that frequently.

Eliot: Ian, can you put two and two together? He does a fantastic job. He has joined the group and Dutch to answer questions as well here, it looks like. We got Christos. I guess we don’t see the number of questions answered here on ours. Anyway, they’re busy typing away. I’m doing that often myself on the other side. What did I do? I heard my name. Ian’s calling you out.

Jeff: I mentioned how math was hard and just wanted to give you credit for that one.

Eliot: Fifty-six answers so far. They’re running through it. There we go. Ian’s math abilities.

All right. “Can I reduce my W-2 taxes from my job by owning a rental property?” That’s a loaded question. What say you, Jeff?

Jeff: It depends.

Eliot: That’s a real ‘it depends.’ First of all, I think we want to ask, what do we mean by rental? Are we really talking rental or are we talking short-term rental that might be part of the discussion, you think?

Jeff: Let’s talk about short-term rental first. It’s a shorter answer. If you are materially participating in your short-term rental—it’s not really a rental to trade or business—yes, the losses from that could reduce your W-2 income. Again, if you’re materially participating, meaning you’re doing everything or most everything.

Long-term rentals, we have a couple of rules in play. It’s called Section 469, passive activity loss rules. Long-term rentals are a passive activity. Normally, you cannot deduct passive losses against active income. There is an exception. Tell us about the exception.

Eliot: There’s one exception, it depends on your adjusted gross income. People often ask me what AGI is. It’s a combination of all your income with a few adjustments. Like we talked about earlier, the HSA contributions. Maybe you put into a retirement plan like a traditional IRA that would give you a deduction. Those are all called adjustments.

We impact our AGI with those adjustments, and we get this AGI. If our AGI is $100,000 or less, then the IRS would let us take $25,000 of passive losses against it. That works really well. That’s a quarter of your income at that point.

They’re having a long-term rental. I don’t really care if it’s passive or not because $25,000 would be a really great deal, perhaps. But as your AGI goes from $100,000 up to $150,000, we slowly evaporate or phase-out that $25,000. Each $2 of increase of income, you lose $1 of the $25,000. By the time you get to $150,000 AGI, it’s all gone, and we get no deduction for that passive.

Jeff: My gross income then has been adjusted. If that’s $100,002, I’m going to be able to deduct $24,999.

Eliot: That’s correct. Exactly. We wouldn’t get the full $25,000, but you get very close to it, just $2 off. That is where rental property could help your W-2s if we are all in the passive world. But because there’s passive, there must be something else. We call that non-passive or active. What about those rules?

Jeff: Non-passive or active?

Eliot: Yeah, for long-term rental under 469.

Jeff: That’s a non passive rental for the REP status. Real estate professional is a two-prong rule. They always call it two-prong, but I feel like it’s three-prong.

Eliot: It’s two-plus.

Jeff: It’s a two-prong rule. The first rule says you have to materially participate in real estate businesses that you own 5% or more and have 750 hours in those businesses. That can include your rental property. The second test is you have to materially participate in your rental business.

Eliot: In each rental activity, which is key for each rental property.

Jeff: We’re basically talking about a 500-hour test at this point, right?

Eliot: Correct, most often.

Jeff: If I got five properties and I have a W-2 job, I can guarantee you that I do not have 2500 hours in those five properties, cumulative. There is what’s called an aggregation election that lets you combine all those properties into one activity for this test, in particular, to meet the hours.

Now I only have to have 500 hours and all my properties, now that I’ve aggregated them. A couple of things happen is you can’t free up passive losses when you sell one. You still have to recognize a gain or loss on that property. What else? Anything else important?

Eliot: Those hours for the 750 have to be, if it’s a married couple, one spouse has to obtain that status, a real estate professional.

Jeff: Yeah, that’s a good point.

Eliot: Really, a real estate professional says it has two prongs. It does. It’s the over 750 hours in the real estate trade or business as designated under 469. The IRS actually goes out under 469(c)(7)(C) and lists those 11 types of businesses that you specifically can work in. You have to put over 50% of all your time into those real estate trade or business as opposed to any other type of business.

I think more often, you have to materially participate. That’s really where people get caught. The material participation rule, basically, you have to run it. You can have a third-party property manager. There, you can use both spouses. Again, if it’s married filing joint, both spouses can add that material participation to that 500 hours. There are seven different tests, but we go with a 500-hour test most often.

There are other tests. That’s just the easiest to talk about. As Jeff points out, you can aggregate them all into one pile, but there’s give and take to that. I don’t recommend doing that until you absolutely have to in order to meet your real estate professional status, but you do have to materially participate in each of those rental properties themselves too.

Jeff: To give an example, because you did mention more than half of your time, and they call it service time? More than half your service time?

Eliot: Yeah.

Jeff: In this case, if you’re working full time, let’s say 2000 hours—I know that full time is 2080—that means you have to have 2001 hours in real estate activities. The only time this isn’t really a problem is if you have that W-2 job in a business that you own and you’re earning that many hours. This is moot.

Eliot: Exactly, and it’s in a real estate trade or business, so one of those 11 that they list out there. Other than that, if you have a regular W-2 job, it’s very difficult to meet that status. The tax courts are going to be skeptical. You’re going to have an uphill battle.

As I tell people on the code, you can check all the boxes. It doesn’t mean you’re going to get it. You have to really be able to prove it. Prove and put in more time. Anybody else improve what their hours were. I’ve read cases.

There’s a very prominent case out there in regards to this, where the individual had, I think it was a condo in a big building. He couldn’t prove that he put more time into that because he didn’t know how much time the custodians within that building had spent on it, and because he couldn’t say how much time they put on the courts. It’s reasonable that they put more time in, therefore the status was disallowed. You really have to track not only your time, but everybody else who touches the property.

Jeff: There are several areas. This is one. Trader status is one. There are a couple others, where the courts are landing all over the place. Sometimes it just matters who you get as a judge if you have to go to tax court.

Eliot: It always matters who you get as a judge, and what day they’re having, and your attorney, and what day they’re having.

Jeff: And if you decide to defend yourself.

Eliot: Yeah, don’t ever do that. That’s what we call mincemeat right there. All right, so back to the original question. “Can I reduce my W-2 taxes by owning a rental property?” It’s plausible, but you’re going to have to be within these parameters, short-term rental, or long-term rental and meet the criteria for it.

All right, next. Number one, “I have a C-corp staffing business. Since Covid, I’ve been using my home office. My home is in mine and my son’s name. How can I count for the space using an office for tax deduction or reduction?” Any thoughts on that?

Jeff: I have an issue where this house property is jointly owned.

Eliot: Okay.

Jeff: What do you think? Does he only own half of this property?

Eliot: It depends.

Jeff: On where it’s at or?

Eliot: I guess, because it’s not a married couple. I thought about community property rules when applying, I would think.

Jeff: If he owned this house in its entirety or with his spouse, easy argument of reimbursing you for the administrative office assuming it’s being used exclusively for the corporation. I’m not so sure about with the son owning.

Eliot: Joint ownership creates a potential hiccup here because he owns half of that room or the offices as well. Like I said in the earlier question, you can check the boxes if using that room solely for your C-corp and exclusively, and on a regular basis. But again, it’s not all your home.

Jeff: I love my kids buying and putting their name on my house.

Eliot: I don’t know. I haven’t seen where the IRS has actually made it. I’m sure in the number of cases that have come up where they’ve actually made a decision about that, but I honestly don’t know off the top of my head. I suspect that you would not be able to because it’s probably 50/50. I would think that you’d probably need over 50%.

Jeff: I think at best, you’re going to get to deduct half of what you’d normally get to deduct. We could be wrong about this. I think at worst, you get no deduction.

Eliot: Yeah, I would go along those lines. Between the two parameters, at best, 50%. Unless you had some agreement in there that that office area is in my, so to speak, part of the house, and there’s another office that my son uses. Maybe you have that argument. I think that’d be a little weak.

Jeff: Are types of ownership that changes this argument, like joint tenancy with right of survivorship or?

Eliot: I don’t see it being applicable until that right of survivorship takes over, because you’re still 50/50 in a sense. I haven’t seen that. Again, if you have some way of reasonably breaking out, you probably can get by. But under audit, they may discredit the deduction a little bit. I don’t know. I guess we could probably research it a little bit more.

Jeff: This one would be a bad question for platinum.

Eliot: But I wanted to bring it up just in case because it is a really good question that hits to these details. We can take a deeper look at it.

Jeff: What about question two?

Eliot: “What is your advice for a small business owner on employing people who only have an ITIN number pending getting their social security number?”

Jeff: Eliot knew the answer to this. I did not. I disagreed with him and looked it up. My golly, he was right.

Eliot: The Google was right, again. What I was able to find on this is that, basically, you’re not allowed to have people with an ITIN as employees. They have to have a social security number and be registered in the US to be here. It doesn’t mean if they have a work visa, then that’s a different set of rules. I’m not going to get into whether they have an ITIN or whatnot. Work visa allows them to work

Jeff: Flat out from what I was reading is you can hire people with ITINs. They are not eligible to work in the United States. Once they are eligible to work in the United States, they have to apply for a Social Security number. I would think that may also apply to the work visas.

Eliot: That might be part of the application for that work visa that they meet this criteria, perhaps. I’m not really familiar. We don’t do a lot of immigration, so I don’t know the ins and outs of that. But I do know, like Jeff said, from what we’ve seen, you’re not allowed to have an employee without a Social Security number.

Jeff: People with ITINs can still invest within the United States. They can come from Morez or Vancouver and buy property in the United States. That’s okay. But also, typically, if they don’t have a right to either green card or some type of work permit, they’re also required to leave the United States every so often. That makes it a little hard to employ these people also.

Eliot: In the end, I would recommend talking to your immigration attorney that’s working with these individuals or your own representative. Immigration attorneys will probably have a far better idea of exactly the boundaries. But as a general rule, no, you’re not allowed to employ them.

All right. “Can you discuss the step by step process of completing a 1031 exchange?” There’s not too many there, right?

Jeff: No.

Eliot: We talked about this a little bit beforehand. It’s one that often Jeff and I bring up, especially in our tax hour that we do. Get a Qualified Intermediary (QI). You got to have that. That’s number one. I wouldn’t even consider this without that. That’s your number one step. Then it gets into, well, you have some options on things. I think you decide if you want to do a regular, I’ll call forward 1031 or reverse. Any idea of the difference between those?

Jeff: Reverse 1031 is just what it sounds like. Let’s talk about forward 1031. Forward 1031 is you sell a house, and then you replace it.

Eliot: Yup, relinquished property.

Jeff: The reverse 1031 is you buy the new house first, and then you sell the old property. I like the reverse 1031, but it’s very expensive to do, because at some point in time, you’re going to have two mortgages. Now, when the market was really hot and when it was a buyer’s market, the reverse mortgage or the reverse 1031 actually made more sense.

Eliot: It’s about all you could do.

Jeff: Yeah, because what the problem people were having was, I sell my house, I go out and look for a house, and you can identify up to five houses for your 1031 exchange, and bam, bam, bam, all five of them sold out from under me.

Eliot: It was a real challenge. We’d hear this over and over 2 years ago, 12 months ago, even.

Jeff: Since the buyer’s market has cooled off quite a bit, still an expensive market, but we’re not dealing with some of the craziness we were before. The forward 1031 makes more sense, because keep in mind, you cannot touch the cash. That’s why you need the Qualified Intermediary and make sure it’s somebody who knows what they’re talking about. Ask them lots of questions because they’re going to be the person that keeps you out of trouble.

I sell my house to Eliot, Eliot pays the intermediary. All the money goes to them. When he goes to buy my next house, the replacement property, the intermediary pays for it with the money that I had. You also need to cover any loans, correct? If I had an old loan on my old property, I need to have a new loan or loan on my new property, or at least have put enough additional cash in to make up for that difference.

Eliot: Correct. Exactly right. Again, (1) You need that Qualified Intermediary. (2) Determine if you want to do, I guess we’ll call it a forward 1031, a regular 1031, or do you want to do a reverse? Make sure you don’t touch the money. You have 45 days. It’s the first step of determining what you want for that relinquished property or what property you’re going to sell in the case of a reverse, and then we have to have it all done in a total timeframe of 180 days that starts from the beginning of where we started the process.

Day one, we start the process we sold or we bought a house, 45 days to get the replacement or which one we’re going to sell, and then 180 total from that first day to get this all wrapped up. You want to make sure it’s moving along. That’s another thing that your Qualified Intermediary can assist with, keeping the process moving along, and help with any challenges that are coming up, but don’t touch that cash.

Then we get to our 180, we close out, and then you’ll get the property, but the same title rule becomes a real important issue here. However you sold it, if you sold it in your ABC LLC, you have to pick up that property in the same title, ABC LLC, and you can’t change tax statuses. If it was disregarded, keep it disregarded. If it was a partnership, keep it a partnership, and so on and so forth.

Jeff: The general rule of thumb, we talked about section 121. What section 121 used to be like in the 90s and earlier was the old rule that if I sell my primary residence, I don’t have to pay taxes as long as I buy something more expensive. Kind of the same rule for the 1031. You need to put into your new property as much as you sold the old property for.

Eliot: As much more. You really want to buy a more expensive property. Let’s say the sales price for what you relinquished was $500,000, pick up one for $550,000. If you had debt of $200,000 that’s going to be released from the sale, well, then you want to pick up debt of more on that new property of say, $250,000. If you meet those criteria, you’re going to get your 100% deferral on it.

Jeff: You can buy multiple properties. I wouldn’t go crazy about how many I get, but I’ve seen clients do five, six, seven properties to replace one.

Eliot: Yup. There are some limits as far as pricing and all that, and ratios. But yes, you can do that.

Jeff: Let’s talk about boot. I sold my house, bought a new house. My total gain that I’m deferring is about $100,000.

Eliot: It’s not now.

Jeff: But what happens with that 10%?

Eliot: That boot that he’s talking about, that cash, that is the amount you’re going to get taxed on. You can’t defer that amount. That’s why it’s critical that you’re buying a more expensive house, you’re picking up more debt than you unloaded. That’s what keeps you from getting boot. Of course, cash is put in by the other party, et cetera. Boot equals the amount, typically, that’s the amount of your gain that’s going to be taxable, and then it’s subject to depreciation recapture.

We got that. Why? Because if we started this whole process, this building that you’re getting rid of or going to pick up, they all have to be used in a trade or business, so we’re not talking about your personal residence. Anything else we got to that process?

Jeff: Nope.

Eliot: All right. “I have a question regarding investing with my HSA. Does an HSA function like a Roth IRA in terms of paying UBIT? In other words, if I invest my HSA in a crowdfunding or syndication, for example, realtymogul.com, will I have to pay UBIT?”

Jeff: I was going to say the Roth IRA is actually a decent comparison. You can invest in things. You’re not going to be taxed on the income or the gain with one exception. The reason for that is, unlike the Roth IRA, they’re figuring any money that comes out of this HSA is going to be used for medical expenses, so they’re not going to tax any gain.

Talking about an HSA in general, if you pull money out and don’t use it for medical expenses, that money is taxable as ordinary income. Now, what’s the area that he mentioned here where you could get hit with tax?

Eliot: The UBIT (unrelated business income tax). That means that you’ve basically gone into something that has an operational business behind it. These are really trust by the background or where they came from, the IRAs, the HSAs.

The code is written so that you don’t have an unfair playing field. To keep it even, the code doesn’t want you investing in operational businesses, because they may not have to pay tax. If that’s the case, then our other private businesses out there will suffer, because they’re at a disadvantage. They have to pay tax. McDonald’s has to pay tax on the hamburgers, happy meals, or whatever.

To equal the playing field or level it, the IRS hits its UBIT. UBIT is a skyrocket up the tax bracket. I believe it does run along the regular tax brackets as an individual. We call it trust. It’s a trust tax bracket, but it goes up really fast.

Maybe it takes me $500,000 of income to reach the 37% tax bracket, but it takes all about $10 with UBIT to get up there. It takes very little income, maybe $15,000. I’m already in a very high tax bracket, so it rises really quick. The idea is to punish people to keep them from investing in these kinds of businesses within a protected field like an HSA or a Roth.

Jeff: They mentioned crowdfunding and syndications. Again, it’s an ‘it depends’ answer. If you’re investing in real estate rental like your syndication or even your crowdfunding is an apartment complex, that’s not going to be subject to UBIT, because that’s not trade or business income. What are some of the syndications I’ve seen lately?

Fetch is one that they were syndicating, if some of you probably know what fetch is, or building low income properties. That’s going to be a trade or business, and that’s going to be subject to UBIT. It’s possible you may have operational income within a real estate syndication that you may be subjected to UBIT at least in part.

Eliot: Yeah. Also, we have a subset of UBIT. They use debt. If they use debt in the purchase, that also creates a UBIT situation. I can’t remember our acronym with it, UDFI. Unrelated debt financed income, there it is. It just says that if debt was used to purchase part of this, well, then guess what? You’re going to get hit with the UBIT tax rates. If debt is on that syndication, that could be a problem.

Jeff: If I invested it in a syndication that’s just real estate rental—my apartment complex—I’m not going to get hit with UBIT. But if they got a mortgage to build that or buy it, then I could be subject to UDFI.

Eliot: Exactly. You need to be very careful with the investments that you’re going into. To your question, yes, it’s subject to your HSA, it’s subject to UBIT.

Jeff: A couple of cautions with investing in syndications and stuff like that. Keep in mind that this HSA is designed to be for your medical expenses. If you invest in a real estate syndication, those typically run four to five years. That money’s going to be locked up in a hard asset that you can’t get to, so just a little caution as to what you’re investing in.

Eliot: Very good point. Yeah. Got it. If you need it for your medical, you want to make sure it’s available for your medical.

Jeff: Don’t get sick.

Eliot: Yeah, there you go. Better yet. All right. “Can I write off my bitcoin loss with $10,000? I bought it at $26,000 and bought it right back at $16,000” I think we’re getting to the wash sale rules that are so popular lately. What about that in your crypto?

Jeff: For the moment, there are no wash sale rules with cryptocurrency, virtual currency, whatever you want to call it. If I sell today and recognize that $10,000 loss, I can buy it back within minutes.

Eliot: Yeah. No problem with that.

Jeff: And the loss is not disallowed. What the wash rules say is that for securities, I bought Boeing, I had a big loss on it, so I sold it to get the loss, and then I bought it back. That’s not allowed. It’s not allowed for you to recognize a loss on that.

Eliot: You got to wait 30 days.

Jeff: You got to wait 30 days before you buy back that security. Now, I’ve heard a rumor that this is going to change as far as crypto.

Eliot: It could be. There are a lot of rumors out there.

Jeff: Especially with crypto.

Eliot: Exactly. It was in the fifteens just the other day when I was looking.

Jeff: It left us all still hovering around 16, but it did take a pretty big hit because it was over 22 weeks ago.

Eliot: Yes, it’s struggling. With this new fiasco, they’re wondering about some of the other related… It’s a domino effect. Are we waiting to see the next disaster in the crypto area?

Jeff: Good news, the former chairman or CEO of Enron is going to fix FTX. No, actually, he was the CEO during Enron’s bankruptcy.

Eliot: Been trying to get out of it.

Jeff: Yeah.

Eliot: It looked like a good number of the assets were used for properties in the Bahamas. There you go. You got hard assets there, real estate. That’s good. But yes, you can go ahead and take this loss, buy right back. At least currently, you don’t have to worry about the wash sale rules.

All right, “My understanding from a tax perspective is an LLC taxed as a C-corp and a traditional C-corp receive the same benefits such as medical reimbursement, administrative office, retirement plans, et cetera. (1) Can you explain the positions in LLC taxed as a C-corp? Do I still need a president, vice-president, treasurer, secretary, or just member managed?” Let’s just start there.

Jeff: Those positions are usually required by state law. It has nothing to do with how they’re taxed. It has to do with how they’re formed. An LLC is typically going to say, you have to have members and managers or member managers.

I know in my corporation, somebody of the stage requires, like you said, a president, vice president, treasurer, secretary. You see the same person listed on every single line. Yeah, that’s going to be determined at the state level. You can have a president and all these positions with an LLC corp, but you’re not required to do that in any place that I’m aware of.

Eliot: Exactly. That gets back to our previous question talking about complexity or whatnot. Usually, LLCs are considered a little bit more flexible. You could set up a regular traditional board and have these traditional officer positions, but you’re not required to. You could just say, hey, it’s a manager. That’s your officer, and act accordingly.

All right, “Why would anyone form an LLC taxed as a regular C-corp if there’s no plan to take it public or why choose one over the other costs, maintaining paperwork, et cetera?”

Jeff: Go ahead.

Eliot: As we mentioned earlier, we alluded to, if you have what I’ll call the true C-corp, if the regular C-corp, it does have stock. It can take advantage of a 1244 stock loss, which basically says if you’re single or married filing joint, it’s $50,000 or $100,000, that you could take as a loss against ordinary income on your return, should your investment and your C-corp fail, and you have the stock loss.

LLC, even though we can mirror it towards an LLC taxed as a C-corp and runs very much like a C-corp, it doesn’t have stock. It has units as an LLC. The 1244 does not extend to your LLC taxed as a C-corp. That’s the major difference between the two.

Jeff: And they’re asking, why would anybody choose an LLC taxed as a corp. Are LLCs typically cheaper and/or easier to form?

Eliot: Yeah, easier form, less criteria behind it, like a C-corp is required to have certain meetings, et cetera. You don’t necessarily have that with the LLC. But as I alluded to earlier, that’s not necessarily a good thing. You want to have those meetings.

You want to show that you’re operating this business, taking control of things, and being responsible with having meetings. While the complexity lacks for the LLC, usually, the things that you don’t have to do, you want to do just to show corporate formality.

Jeff: I think I asked this earlier, but I’ll ask it again. Is the liability different from one to the other?

Eliot: Not really, because as a shareholder in a C-corp, you just lose your investment. As an LLC member, which is the owner of an LLC, you just lose your investment, typically. Now, as an officer, of course, if you do something abusive, like go out and buy $121 million of Bahama property, egregious acts probably break through the protections for officers under any of these. If you do something really bad, you’re still going to be held liable.

As far as paperwork, again, just typically, it’s often thought. The thing you’re going to find online is that they just say LLCs again are easier to run, less requirements, et cetera, less red tape, and so on, so forth. But some of that red tape having meetings again, probably a good idea. I don’t really look at that as a plus or minus.

Jeff: And if you’re a C-corp or LLC taxed as a C-corp, you can change to any other entity you want.

Eliot: I would say that. Yeah, we touched on that earlier. I’d never really thought about that really until the day when we were answering that earlier question. As far as that, you can take from a C. It will be a dissolution, but you can turn it into a regular LLC, disregarded, or partnership, et cetera.

Jeff: You could also make it an S-corporation.

Eliot: Yes.

Jeff: By filling out one piece of paper.

Eliot: Yeah. It’s very, very simple there. That would be one thing. Now, it doesn’t mean there wouldn’t be tax consequences, because you are going from a corporate to a non-corporate. But the point is that you could, so that is something. Of course, now you have to look into the states and what their rules are for that.

Next, “Is it best to start a new Airbnb—we’ll call it short-term rental business—now or wait until the beginning of the year for tax purposes? I’m estimating two more weeks of getting it ready. December 1st is my goal. We got some background here. Nothing major like a roof or air conditioner. It was needed in 2022 to get it ready.

Next year, I will do some major upgrades, but the house is actually looking pretty good, super clean, new paint, and beautiful terrazzo floors. I didn’t buy any major tools or capital equipment. I didn’t buy a 6000-plus pound vehicle, either. No income this year except social security retirement, going to refinance in 2023. What do you think is the best option?”

Jeff: Okay, let’s start off with the basic question of, do I want to wait till next year? If you want to start running this out as a short-term rental, that’s fine, and then you go ahead and establish that it’s a short-term rental. But I feel like what he’s getting at is the cold cost segregation question.

Eliot: Because we always get that question. Yeah. That’s the hint I got. “Hey, Anderson, should I be doing this major deduction getting that loss this year or should I just push it off to next year?” And what’s that going to depend on?

Jeff: That’s going to depend on your other income. You basically said all you have is social security income right now. I’m assuming you got lots of other assets, because you bought this beautiful property with what floors?

Eliot: Terrazzo.

Jeff: You don’t need to do cost segregation. It’s not going to help you, unless you’re running this property out for a lot of money, like it’s a beachfront property and a primary or something like that, and you’re getting $10,000 a week for it. But otherwise, I don’t do segregation on it this year and maybe not next year, depending on what my income looks like for next year. That decision for 2023 doesn’t have to be made until 2024.

Eliot: Yup. We got some time on that. I think the major factor here is, what is your level of income in totality? You mentioned it’s just social security. I don’t know that doing a cost seg and taking bonus appreciation, we’re looking at a really big deduction for maybe not all that much income compared to $300,000–$400,000, or something like that.

That would be my biggest decision maker in how much income we have coming in. If it’s not that much, I wouldn’t go through the added cost of a cost seg or lost depreciation.

Maybe, depending on the numbers, again, Jeff brings up a good point. If this Airbnb makes a ton of money and it makes more than even your retirement that you’re getting which is plausible, then maybe yeah. Maybe we do, but it gets down to what Toby’s golden rule, calculate, calculate, calculate.

If we have an idea, I would find it hard to believe though. In two weeks of December or whatever it is, three weeks of renting in December, you’re going to get all that much income.

Jeff: I agree. Going back to, if this property is making a lot of money, the other problem that presents is it’s going to make your social security taxable.

Eliot: More of it taxable, higher percentage.

Jeff: Up to possibly 85% of your social security. At that point, I think it becomes a different beast. The other thing I might consider doing if this is me is just holding back on that cost segregation if there’s any possibility of me getting a windfall in something else.

Eliot: Yeah. In a future year, hold off on that. Don’t blow it now when we only have two weeks. I would wait till 2023 more than likely. That’s probably your conventional wisdom there. Wait till 2023. But again, you guys have a good deal of information here, but we don’t know exactly how much income you have coming in, what to expect from the Airbnb. But I would say, probably, I would conserve it or save that cost seg for potentially 2023.

Jeff: I think both, Eliot. My guts say you don’t use it in 2022.

Eliot: Very good. All right, that’s it for our questions. Again, please submit more questions. That’s what we choose, the pool of questions for. You can do that through taxtuesday@andersonadvisors.com or visit us at andersonadvisors.com. We’re happy to do that.

I don’t think right now, we have any other announcements. I just want to thank our group. Other ways to reach out to us, the YouTube. Subscribe on our YouTube at aba.link/youtube. Our podcast, andersonadvisors.com/podcasts, and our replay is on the platinum portal. I just want to thank our supporting staff behind the scenes doing all the questions.

We got Christos, Dana, Dutch, Ian, Kira, Piao, Troy. Of course, the regular staff running the show, Ander, Jennifer, Matthew. I think that’s it for our team here today. Thank you all for joining us. We appreciate it. Have a wonderful Thanksgiving.

Jeff: We went over and now Toby’s going to be so disappointed in us.

Eliot: Yeah, we were a little bit short last time, so I added another question this time. That was my fault.

Jeff: Have a wonderful and safe Thanksgiving. Just make sure you have something to be thankful about.

Eliot: Be safe. Again, thank you. Join us again in two weeks. I think we have Toby back, yes?

Jeff: Toby should be back.

Eliot: Thank goodness. Everyone, have a good day.

Jeff: Thanks, Eliot.

Eliot: Thank you.