Several of today’s tax questions are related to STRs (Short-term rentals) like Airbnb and VRBO. Toby Mathis and Jeff Webb of Anderson Advisors discuss the differences between passive or active income on these popular investment properties, and answer additional tax-related questions. Submit your tax question to taxtuesday@andersonadvisors.
- Investing in multiple family syndications – I think when you make an aggregation election, you’re electing to treat all your rental activities as one activity
- Setting up ongoing support for 501(c)(3) organizations that support the advancement of religion – Make it a private foundation. Spell out your values and then say, here are the organizations that I believe meet that at this time- but understand how wildly society and religion might change over time
- Short-term rentals/hotel syndications – active or passive income? Unless you’re an employee like the general manager of the investment property, you’re passive. This is not a rental activity, period. Hotel syndication or short-term rental, just remove the ‘rental’ and it’s a regular business
- A real estate investor pays almost no taxes, but her husband is a 1099 contractor with a huge tax burden. Should they put some properties in his name? If you’re filing jointly, it won’t matter. You could also donate a property for a community service/non profit to get the deduction of the full market value
- There are still actions you can take if you’re getting killed on 2021 taxes, the clock has not stopped on 2021yet!
Full Episode Transcript:
Toby: Welcome to Tax Tuesday. My name is Toby Mathis.... Read Full Transcript
Jeff: And I’m Jeff Webb.
Toby: We’re going to bring some tax knowledge to the masses on the September 13th edition, which is two days before a tax deadline which is why Jeff looks extremely excited. You have another tax deadline. It’s just […]. This is the season.
Everybody thinks it’s April 15th, but no. If you got to get an accountant, this is the time of the year that they’re all busy getting hammered away going through all this fun stuff. Let me just do one thing. I can see my chat. I’m going to grab my little Q&A.
Here are the rules. You can make comments via chat. You can ask questions via the Q&A feature. Be light today. We have a lot of accountants doing return prep. We still have a bunch of folks on, including Dana, Eliot, Jeff, Trisha, Troy, Patty, and Ander.
You got Jeff and I. We’re going to answer your questions as best we can. But if you’re thinking today’s the day, I brought 10 questions, just ask one of them. Try not to kill us. They’re all getting slaughtered as it is.
All right, let’s jump in. We have our simple rules. You could ask questions. We already said that. Ask questions via the Q&A. You can ask questions during the week via email at firstname.lastname@example.org.
These are general questions and answers. Some folks out there are just asking away for other people. You’ll see, one of those is one of our questions today asking for a neighbor. We want to make sure that you know that if you’re going into detail that we’re going to ask you to become a client before we answer.
We’re willing to give general Q&A and answer general questions. But if it gets a little crazy, we will put the skids on it and say, all right, hold on for a second. This is getting into the advising. We’re not just answering a simple question.
The whole intent of this, by the way, is to be fun. We want you guys to enjoy taxes and start looking around for all the things that could benefit you. We’re going to try to bring to the surface that there are a lot of tax benefits out there that you may not be aware of. Hopefully, you go away having a little bit of fun, getting a little bit of knowledge, and putting some more dollars in your pocket with that knowledge, which is what we like.
We’re going to go through all the questions that we’re going to answer today. Don’t think we’re going to answer all these right now. We’re going to go through and we’ll knock that down. Patty, you can just interrupt next time. I was looking at the chat going, hey.
Here we go. “I have numerous multifamily syndications with bonus depreciation losses on a K-1. They were obtained between 2018 and 2020 as a passive investor and owned by a multi-member LLC—me and my wife. Starting in 2021 and currently, I have real estate professional status.” It’s going to be an interesting question here, because I can already see what’s happening.
“In 2022, I have two dispositions of properties that were purchased as a passive investor. Can I use the original bonus depreciation losses to go against the gains on the sales? FYI, I have elected to group all my real estate activities and properties together.” This is going to be a good learning experience. It’ll be interesting to go through that. We’ll get to that one here in a second.
“I am an active options trader that files a Schedule C for expenses and a Schedule D for gains and losses. I’ve heard of mark-to-market tax filing. What are the benefits of one over the other?” Good question. We’ll get into it. If you guys know what traders are and what mark-to-market is, you already know the answer. If you don’t, this will be a good learning experience.
“I have a list of 10 501(c)(3) organizations that I want to support in perpetuity as long as they continue faithfully in their current missions for the advancement of religion. I am weighing the option of a C-corp private grant writing foundation versus a charitable trust.
I worry that the make-up of the board of a private foundation may drift over time after I die and grant writing will eventually shift from 501(3) organizations that align with my values to 501(c)(3) organizations that do not.” Okay, we’ll address that in specificity. There are some things there that we want to correct, and we’ll give you some ideas.
“Short-term rentals when depreciated with cost segregation allow for the depreciation to offset income without having real estate professional status if you materially participate.” That’s a mouthful. “Most real estate syndications are long-term rentals with depreciation only offsetting rental income, which is passive.
If you are involved in a hotel syndication or a short-term rental syndication, can the depreciation offset active income or would it just go to passive income? With the rental income and a hotel syndication, are short-term rentals considered active income or passive income?”
I like these types of questions because they’re good teaching. This is a little bit convoluted. But when we dive into it, actually, these are great questions for teaching a principle.
“My neighbor asked me this question.” Hey, neighbor. “He purchased his first house/home when he was in his early 20s, which resulted in his dad needing to co-sign the loan. He paid off the loan and found out his dad’s name is on the title and not his name.” Uh-oh. Dad owns the house.
“He purchased a second home and has since been renting out the first, the one titled in dad’s name. He would like to sell the row house but does not know how to proceed since it’s titled in his dad’s name.” Wow, have you seen that before?
Toby: That’s weird that you bought it and somehow, dad’s name got on the title. I wonder if maybe there are two people. Anyway, we’ll get into it.
“I’ve heard Anderson talking about Spartan Investment Group, which buys, develops, owns self storage units across the country.” Yes, we do like Spartan. We’ve been working with them for years, and they do a great job for our clients. “I’m considering using my self-directed Roth 401(k) to invest in that company.” Probably in a syndication, but whatever. “Would I be subject to UBIT or UDFI tax by using my Roth 401(k) for that investment?” Really good question, and we’ll dive into that for you.
“Is short-term rental income still considered active if I have a property management company running the short-term rental business for me?” STR stands for short-term rentals. It’s Airbnb, Vrbo. “I do not rent the property to them, they simply manage the business for me. I’m a real estate investor and pay nothing or almost nothing in taxes every year.” That’s awesome.
“My husband, on the other hand, is a 1099 contractor with a huge tax burden. Would it benefit us to put some of the properties under his name?” I immediately ask, are they filing jointly? We’ll dive into that a little bit.
“You have mentioned multiple times in your videos that borrowed money is not taxed, but you never explain it in detail.” All right, let me explain it in detail. Borrowed money is not taxed. I’m just kidding. There are some cases where it can be.
“I have multiple investment properties, each in its own single member LLCs. My CPA says if I refi, I have to take the money out as an owner draw because they are in an LLC, and it’s going to be taxed. Please help clear this up. Can I refi investment properties inside an LLC and take the money out tax free?” We always save the best for last. We’ll get to that one before we’re done.
If you guys have lots and lots of questions, you’re getting into real estate investing, you’re getting into business ownership, whatever, you’re just interested in taxes, asset protection, or just how that world operates, come to my YouTube channel. We have a lot of them. Lots and lots of videos. We’ve been doing this for years.
I was talking to somebody, but we have videos from 2014 and stuff like that not still up, but we’ve been doing that for a long time. Actually, we started doing podcasts. I actually remember I was in Seattle and that would have been in about 2003. We’re like, meh it’s a fad.
We did a whole bunch and we’re like, meh it’s a fad. Nobody’s watching, and then you look at this. Wow. It gets a little crazy. You absolutely come and join the community.
If you just click on subscribe, you don’t get inundated with anything, you’re not signing up for any marketing list. It just lets you know when videos come out. I think you have to subscribe and then click the little bell. I know where the little bell is. Turn on notifications, there we go, the little bell.
Click that bell if you want to know when new videos come out. We usually put two or three out a week. pretty consistently at least two long ones and then some short ones. I love creating content for the YouTube channel. It’s so much fun to share information with people.
Speaking of sharing information with people, Jeff, you’re going to have to help me on this because my brain exploded reading this. “I have numerous multifamily syndications with the bonus depreciation on K-1.” First off, a syndication just means I’m an investor in a group. Usually, it’s an LLC, sometimes it’s a limited partnership. I invested, and they invest in multifamily.
You can really accelerate depreciation on a multifamily. You don’t have to do the 47½ years. That’s kind of boring. What they do is they break it into its components. It’s called segregation, not bad. Segregation, but good segregation. We’re segregating the assets.
I always use the example of carpeting in the last five years. Why are you writing it off over 27½ years, right? They’re writing these things off really fast. If you’re a passive investor, you can’t use those passive losses on anything, right?
Toby: What do you do? You lose them?
Jeff: Now they’re suspended. Meaning, you can use them sometime in the future, but not for now.
Toby: That’s the important concept first. When you have these losses and they’re passive, they offset other passive income. There are only two forces of passive income, businesses in which you do not materially participate and rental. If you don’t have any other rental income, those losses just get suspended if you carry them forward.
Let’s keep going. “They were obtained between 2018 and 2020 as a passive investor and owned by a multi-member LLC—me and my wife.” That just flowed onto their return. The chances are they’re a partnership together, and those losses are being carried forward. This is where it gets interesting. “Starting in 2021 and currently, I have real estate professional status.” Why is this important?
Jeff: Once you have real estate professional status, you can deduct any current losses from your real estate. But all those suspended passive losses, they’re stuck until you sell substantially everything.
Toby: This is where it’s really important. This is where people sometimes stub their toe. They go to their accountant and they say, I heard this great thing called real estate professional, I qualify. They say, okay, we’ll make you a real estate professional. The downside of real estate professional status is if you already have losses, you have to dump all your stuff before you get to take them, or you have to have passive income that will offset, which is possible.
But again, if you’re doing these syndications and getting these big bonus depreciation, that’s not making money. That’s creating paper loss. Yes, if I’m a real estate professional, I could use my current losses, but my old losses are stuck. I can’t do anything with them.
Here’s what they ask. “In 2022, I have two dispositions of properties that were purchased as a passive investor.” This could either be multifamily, it could just be individual properties. I don’t know which one, “but passive purchases are being sold. Can I use the original bonus depreciation losses to go against the gain on the sale?
FYI, this is the most important line here. “I have elected to group all of my real estate activities, properties together.” I love grouping unless we have loss carryforward sitting on your return, in which case, now, I would say get rid of those losses before you group, because otherwise, they’re going to be trapped in the group. In order to take that loss, what do you have to do?
Jeff: Take the loss on that property once we aggregate it. You got to sell substantially all of the properties which are aggregated, which could be 75%–80% of the properties, maybe more.
Toby: Maybe more. Yeah, they would say, substantially, all of the properties would have to be sold to release that. Normally, you have a loss carryforward on a property and you sell the property. It releases that passive loss and it becomes non-passive loss.
Toby: If I had $100,000 in a syndication and I sold the syndication, the $100,000 of loss carryforward gets released and would offset the gain that I had.
Toby: Does that not happen now for these people?
Jeff: It does not happen now.
Toby: Now, those still have some capital gains. They have this loss carryforward and it just keeps carrying forward. You don’t lose it, but it doesn’t get released. You still have this passive loss until you get rid of all your properties or, substantially all your properties. It stinks.
Or if you have passive income. You have the passive loss sitting there, waiting for you to have passive income. Passive income is not just from rental real estate. It could also be businesses in which you do not materially participate.
If Jeff opens up a pizza shop. He runs the place, I’m a 50% owner, but I don’t do anything, I don’t participate in the business, and it makes me $100,000 a year. Great. My real estate loss can offset that income that I made from the pizza business, because I did not materially participate. It’s actually a really important line there. What do they do here? They’re just toast?
Jeff: Pretty much they are. There is another regulation 1.469 blah-blah-blah that says the character of an asset is the same as the character of the income or loss that it’s generating. Normally, if you sell a passive asset, a rental property, that gain is now passive and you can offset passive losses. However, when you aggregate these properties and become a real estate professional, you’ve turned your rentals into a trade or business.
Toby: Let’s do a timeout here.
Toby: If you are a trade or business. As the taxpayer, you’re no longer a passive participant in real estate. What if you didn’t aggregate? What if you never elected to aggregate the properties and you said, you know what? Treat each of my properties separately? Then are you okay?
Jeff: It’s possible that some of those properties can remain passive. If you have a number of properties, the syndications are almost definitely passive.
Toby: Yes. Here’s the big important thing. If you do not aggregate, I need to qualify as a real estate professional on each property. Only the ones that I’d materially participate in, each having to meet a separate test for material participation. Which is why we aggregate, so we don’t have to do it on each property.
Let’s say that you have two properties that you materially participate on, two that you don’t, then you could still have passive and you could still have your real estate professional status with the losses on these ones that you’re materially participating on.
Somebody says, “In this case, is it better to not group?” Chances are, it would have been better to not group, but chances are, they wouldn’t have been a real estate professional either. Chances are, they have to do both.
Jeff: I don’t know that it’s worth being a real estate professional if I can only do it for 1 or 2 properties, and I own 10. The other wonky thing that happens when you aggregate and have passive losses that are going to be suspended… Where was I going with this?
Toby: It’s okay, Jeff, it’s tax season.
Jeff: I know.
Toby: You’re thinking of six other returns. You’ve been aggregating, and all of a sudden, you make an aggregation election, you have the passive loss.
Jeff: Okay. I know where it’s going. Back to the pizza shop. It’s impossible to buy more rental property to generate passive losses, because as soon as you buy another rental property, you’re a real estate professional and it gets aggregated with these properties.
Toby: It almost seems like rental properties are no longer passive for you. You’re aggregating all your activities together, so you’re either a real estate professional or you’re not, and either all your properties or you’re per property. If you aggregate them together, it’s all one property. It’s not this property, that property, it’s all one big property. But you still have businesses in which you do not materially participate, which by the way, could be an Airbnb.
Jeff: Yes, it could.
Toby: It could be a pizza shop.
Jeff: I think that’s a great idea.
Toby: You could sit there and go, you know what I shouldn’t do? I should not materially participate on my Airbnb, so I have a bunch of income that I can offset. Now I have these passive loss carryforwards, I’ll never pay tax on it. I’ll just be wiping it out. That’s what you do.
Can you aggregate the properties separately? I think when you make an aggregation election, you’re electing to treat all your rental activities as one activity. Unfortunately, Jeff, great idea. You’re thinking right, but I don’t think it’s possible.
All right. That was a good one. I’m going to go back to it and just look at it for a second. The FYI was the secret sauce. That’s why when I see FYI, sometimes I’m like, huh, all right.
Jeff: That’s all the information to have.
Toby: I like to know that you aggregate it, because that’s the whole calling of the question. Otherwise, we’d be sitting here saying, did you aggregate? Almost all real estate professionals aggregate.
In fact, the way that the IRS wins all those cases against the real estate professionals, isn’t that they’re not a real estate professional. They meet the first prong, but they did not materially participate on their rental activities individually. They have to combine them. You’re almost always electing to treat them all.
What qualifies as a real estate professional? It’s under 469(c)(7), and it’s a two-prong test. I have to spend 750 hours in a real estate trade or business, and that’s an annual test, 750 hours, and it has to be more than 50% of my personal services. If you’re filing a joint return, one spouse has to meet that test.
Number two, you have to materially participate on your rental activities. You do that, a material participation is a seven-prong. There are seven tests that you could qualify. (1) All you have to do, the easiest is I do everything myself. (2) If I do 100 hours and nobody else spends 100 hours. (3) If I do 500 hours.
By the way, if you file a joint return, they add your time together on the second test, not the first test. But don’t worry. I have it broken down on my videos on YouTube. If you go in there and you want to know, I always say it’s the number one real estate strategy. It’s cost seg with a real estate professional designation.
All right, here we go. I know we’re supposed to be only an hour, so I’m going to do really hard to get you out of here. “I am an active options trader that files a Schedule C for expenses and Schedule D for gains and losses.” Which means they’re a trader, by the way. There’s a term for that, it’s called trader status. “I’ve heard of mark-to-market tax filing. What are the benefits of one over the other?”
Jeff: We love mark-to-market. That was sarcasm.
Toby: We could just tell you all sorts of nasty stories. Mark-to-market is…
Jeff: Mark-to-market changes capital gains and losses into ordinary gains and losses. Why is this important? Capital losses are limited on the individual return to $3000 of losses a year.
Toby: After you offset all your capital gain. Net capital losses are limited to $3000 a year on a return.
Jeff: If you do mark-to-market—and I don’t want to go too deep into what mark-to-market is—it allows you to claim it as an ordinary loss, so unlimited.
Toby: All these stock traders go out there and say, you need to make a mark-to-market election so you can write off your losses. That statement right there should cause you pause. I hate to say this—actually, I don’t hate to say this. It doesn’t bring me joy to say this. About 5% of active stock traders make money. That’s being really generous, because they did a 15-year study in Taiwan of active stock traders, 1% had profit over that 15-year stretch.
I know a bunch of you guys are already pissed off at me. I’m sorry, but the odds are not in your favor. You’re better off being an investor. But hey, neither here nor there. If you’re going to spend the time being a trader, number one, you should get to write off your expenses. And that’s what they’re doing here.
Realistically, you need to be doing about 750 trades a year. You can’t be taking more than two and three weeks off. I say about 70% of the trading days, you need to be actively trading. If you do that, you’re a trader.
You can write off your expenses on Schedule C, you still report your income on Schedule D, which is this weird thing where you have zero income on a Schedule C, which means you’re just going to be a big loss on a sole proprietor.
And you write ‘trader’ on your return, you may as well audit yourself. You may as well just say, hey, you know what, I want to be in the highest audit rate known to man, because that’s what you’re doing. You’re basically saying, hey, IRS, I’m losing money, hahaha, but you’re reporting your income on your D, you’re taking your expenses on your C, you’re going to have to meet the test.
I’ve seen so many court cases. They always find a way to deny you what you’re looking for. Even when they say, okay, you’re a trader, then it’s the second one. You can’t write off the loss.
If I am a trader, that’s capital loss. I’m limited to capital gains or I get $3000 a year. If I have $100,000 of capital losses as a trader, guess what? I can’t use it, unless you make a mark-to-market election.
The thing about mark-to-market that I hate is a mark-to-market is saying I’m treating your investment account as though it’s liquidated on December 31st of every year. It really sucks because they always have the Christmas rally, and then all of a sudden, it treats it as though you sold it, even though you still have the security.
If it tanks the following two or three months, which happened in 2002, it’s happening here, we just saw it happen in the pandemic, in March, we had a 20% drop, we just had a massive loss today, you see all these things. What if you’re having to sell your stock to pay the darn tax bill, even though you never sold your stock?
I saw this happen. I saw Qualcomm run up, but then it ran right back down right after the first of the year. All these people that were traders had these huge option contracts. They made all this money, but they never sold.
They had $100,000 short-term capital gain, they owe the tax on it at their rate. At that time, it was like 39.6 on some of these, and the stock wasn’t worth what the tax bill was anymore. I always looked at that and said, why would anybody willingly put themselves in that situation? That’s mark-to-market. I’m not a big fan.
Jeff: You may hear some people say, well, wash sales don’t apply to mark-to-market. That’s such a meaningless argument. It’s a fractional portion of the entire argument. I’d like to tell people who want to do mark-to-market so they can claim their losses so I can save them even more money by telling them not to invest.
Toby: I got into a big one. It was in the 90s and I’m beating the head with a CPA. I was like, if you’re planning around your clients losing money at their endeavor, tell them not to do that endeavor anymore. Your planning should really be that you’re breaking even or making profit, and then making sure that you’re getting the most tax advantages.
I said, in either case, you’re not filing as a trader. There’s not a world which I live where you’d file as a trader barring maybe the fraction of 1%, where somebody’s really doing this, they’re good at it, and they accept the risk.
There are a very few people that I’ve met over my life that would fall in that category. Maybe Mark A, and then there are a few others that are out there, where consistently, year after year, they make money. Then you don’t need the mark-to-market election. It doesn’t do anything for you. Anything else on that?
Toby: Do not do the mark-to-market, please. “Does the mark-to-market election primarily convert the capital loss to potential net operating loss?”
Jeff: Yeah, it could.
Toby: That’s it. Your capital loss is no longer capital, it’s considered ordinary loss.
Jeff: But if you’re good at investing, it’s going to turn your capital gains that are at a lower rate into ordinary gains at a much higher rate.
Toby: What’s the difference? If you’re doing short-term trading, you’re still in the ordinary income bracket, right?
Jeff: Yeah, but if I’m doing mark-to-market and I’m at the highest tax bracket, I’m paying 37% on these gains instead of what normally would have been 20% on long-term capital gains. Most of these guys are going to be short-term.
Toby: Yeah. “You would not qualify as a trader if you had long-term capital gains?” Yeah, they blow you up on that one, too. “Is it possible to set up a non-TTS business for traders who don’t need the TTS qualifications, nor do I want to meet those swinging trade options?” Yeah, you are a tailor. What you do is an LLC taxed as a partnership and then have it managed by a corporation.
It’s usually about 20% that you’d give the corporation. It’s not being paid a management fee. It’s just literally getting paid to manage the LLC. The LLC is engaged in investment activities. That’s it. It’s so simple. It saves you a lot of trouble.
Realistically, you need to have a good sized amount of money in there to make it worthwhile, I would say at least $25,000–$50,000.
“If you don’t file as a trader, then what category would you file?” You’re an investor, Gary. Trader does not exist in the tax code. You couldn’t go look it up. It’s something that somebody made up (I think) in the 80s. They said, hey, it’s not fair that you don’t get to write off expenses. I want to write off expenses, because otherwise, you’re limited to investment expenses, which is margin interest, really. You can’t even write off money managers anymore under miscellaneous itemized deductions. You can’t write off hardly anything.
He says, “Is it an investor under an LLC?” You could, but what I do is I put the corporation as a partner. The corporation, if you make $10,000 and the corporation has two of it or 20%, $2000 would flow into the corporation, expense it away. Let the corporation do everything. The corporation is not trading. It’s not a trader. It’s managing the assets in an LLC or its managing the LLC.
All right. 501(c)(3)s, let’s jump into that. “I have a list of 10 501(c)(3) organizations that I want to support in perpetuity as long as they continue faithfully in their current missions for the advancement of religion.” It was Voltaire, I believe, who said, if you have two religions in a town, they’ll cut their throats. If you have 30, they’ll all live in harmony. I can hear somebody laughing horribly. Anyway, that was Voltaire. I believe that’s Voltaire.
“I am weighing the option of a C-corp private grant writing foundation versus a charitable trust. I worry that the make-up of the board of a private foundation may drift over time after I die, and grant writing will eventually shift from 501(c)(3) organizations that align my values to ones that do not.” Let’s leave it at that. What do you say to that person?
Jeff: The thing that ran through my head the whole time I was reading this is you can’t control things forever.
Toby: No, you can’t.
Jeff: Actually, what I like in the circumstance, I don’t know how you feel about it, but I think this is perfect for a charitable remainder trust.
Toby: They want to do it in perpetuity, though.
Jeff: They want to do it in perpetuity, but when I die, the money goes to the charities, and you have to trust that they’re going to do what they said they’re going to do.
Toby: I always look at real life examples. The one that I enjoy looking at the most is the Hershey School. I think it was 1905 that Milton Hershey set up a school, which was for training orphaned boys on agriculture, so that they could grow and that they would not be a burden on society.
Now it’s the Milton Hershey School, and it’s boys and girls. It teaches high school and elementary, and takes these kids, and their parents that don’t just have to be passed away. It’s not just orphans, but it’s also children whose parents are incarcerated or their parents are unavailable. I’ve met a bunch of kids out of that school. It’s grown crazy.
I use it as an example because the Milton Hershey Trust, which is a charitable trust, is worth over $12.6 billion now. It started off with a few million in the early 1900s. Here we are 120 years later, and it’s lights out. It’s just kicking tail. It has a museum and a bunch of other stuff, too.
I look at it saying, hey, you should have a little bit of flexibility just in case because you never know what the future is. You say, here’s the advancement of religion. What type of religion? What type of parameters do you want to put?
What if somebody’s belief comes to fruition? Somebody shows up and says, by the way, I am so and so, and does a bunch of miracles. Everybody’s like, oh, my gosh, I was so wrong about my religion, this one looks way better. You want to have some flexibility no matter what you’re doing, and you’re not doing a C-corp, period.
You’re not doing private grant writing. What you’re doing is a private foundation, and then you explain in detail your values that the board should be adhering to.
For example, Milton Hershey wanted to train these children something so that they would not be a burden on society. At the time, it was men who were non-productive that were the burden on society, because women (at the time) either were not necessarily working or their norm might be that they’re married off. God knows what.
It was a different time, different day and age, and I’m not making any commentary on that. I’m just saying that the big worry was boys. Here’s how he was solving that issue. Then it morphed and now it’s no longer just a boys issue. You would have something that was set up that was just for the support of these organizations, and you had very, very clearly listed your values. Even if things shift over time, even if facts shift over time, it’s your values.
You just have to be specific and give your board direction, because in 100 years, whoever is sitting on that board needs to be able to discern what values you want to establish. It’s not just, hey, I want to support religion. You’re going to say, these are the things that are most important to me, these are the organizations that most closely align, and I want their successor or an organization that closely resembles their values to be the successor. And if you do that, you’re going to be fine.
Things might shift, but realistically, it aligns with the values that you list out. I think that’s the most thing, because I see the organizations that align with my values, spell out your values and then say, here are the organizations that I believe meet that at this time. But you’re right, 50 years from now, they might not. You want them to be swapped for something that does meet with your values.
Jeff: It’s really important when you’re doing this to determine what your flexibility is. I’ll give you an example. For the past several 100 years, the Episcopal Church has been all male-led, and then they decided to ordain women. That virtually tore the church apart. That’s the kind of thing you have to consider may change in the future. Is this a deal breaker or not?
Toby: Which is why you spell out your values.
Toby: And be specific. There are certain things that I’ve been asked to draft that I refused. I said, here you go. Off with you.
Jeff: Are these sometimes challenged, though, in court or no?
Toby: No, not unless you’re trying to do something illegal. If you’re doing something reprehensible, then, again, like we had something that was pretty evil and we’re not going to touch it, but it doesn’t mean somebody’s not going to. You have the Church of Satan and a bunch of these other things, and they’re nonprofit. The Church of Weed and all this weird stuff. It’s like, cool for you. I’m not really going to touch it, but somebody might.
Your values might be something that, yeah 501(c)(3) could probably support that. It’s bizarre what actually qualifies as a religion these days. Marc Gershow used to have some really good examples of stuff that he saw. I’m sure that Kareem could tell you some ones, too, because he worked at the IRS.
At the end of the day, your values, list them, and make sure that somebody understands, the organizations at the time of your passing that had those values, and then give them the ability to replace them if somebody does not continue to walk those values.
Jeff: Yeah, that is important.
Toby: It would not be a charitable trust, it would not be a C-corporation, private grant writing foundation. It would be a private foundation, period. They’re perpetual. All you have to do is have a convention for putting the board, and it has to give away 5% of its assets every year to those organizations.
You can list more. But if you want it to continue on in perpetuity, you probably want to give them the flexibility to go probably 5%–10% if you want it to continue on forever. Otherwise, it would eventually deplete itself.
All right. By the way, I think the national average for gifts from private foundations was about 11%, just so you guys know. Everybody thinks private foundations just sit there and get big, but they do help a lot of people. The stock market sometimes goes crazy and does great things, sometimes they get more gifts, and they actually do a lot of good.
They’re not just rich people vehicles where they park their stuff. Although, yes, rich people park their stuff in private foundations. It does not die. You don’t have to worry about your kids’ spouses and making weird decisions. It’s actually a pretty good estate planning vehicle.
“Short-term rentals, when depreciated with cost segregation, allow the depreciation to offset active income without having real estate professional status if you materially participate.” In English, it’s a business and it’s an ordinary loss. As long as you are materially participating in it, no different than a pizza shop.
“If I materially participate in the pizza shop, I get to write off ordinary losses against anything I make. If I do not materially participate, then I’m a passive participant, and its passive activity loss rules. I can use the loss against other passive income. Why is that important?”
As we keep reading on, “Most real estate syndications or long-term rentals with depreciation only offsetting rental income, which is passive. If you’re involved in a wholesale syndication or a short-term rental syndication, can the depreciation offset income, or would it just go to passive income?”
The hotel syndication. Short-term rentals, it’s a regular business. That’s your pizza shop. Are you materially participating? If yes and you’re involved in the day to day operations or you’re meeting the hourly requirements of running the hotel, then that would be an active loss. If you’re not, then it would be passive. Would the rental income in a hotel syndication that is short-term rentals be considered active income or passive income?
Jeff: Most investors, unless you’re the GP or you’re running the hotel, like you said, you’re going to be a passive investor. You’re not working in the business.
Toby: You’re designed to be passive. The whole syndication, if you’re not in the management team, you’re a passive investor.
Jeff: You’re likely a limited partner in this syndication.
Toby: This is where it gets weird. If I am in a rental real estate syndication that’s kicking me passive loss and I’m a real estate professional, that can become ordinary.
If I am in a syndication, so long as I’m ungrouping all my activities—we go back to the very first question we had—if I am in a syndication that is not rental—this is hotel, it’s ordinary business, seven days or less so it’s not rental activity anymore, this is a regular business—then the only question is, am I a material participant or not?
If I am, it’s ordinary active loss or non-passive loss. If I am not, then it’s passive loss. It’d be passive income or passive loss. If it’s income that I could use my other rental losses against it, if it’s loss, then it’s just passive loss that I would use against my other passive income.
Jeff: And you probably heard us talk about active participation in real estate for long-term rentals. This would not fall into that because it’s considered trade or business. It is not considered a real estate activity.
Toby: This is not a rental activity, period. Hotel syndication or short-term rental, just remove the rental and just call it pizza. Anytime you see short-term rental, just pizza business, because that’s the way you should be looking at it. It’s not a rental activity anymore.
“My neighbor asked me this question. He purchased his first home when he was in his early 20s. His dad co-signed on the loan. He paid off the loan, but then he found out that his dad’s name is on the title, not his.
Then he purchased a second house and has been renting out the first house. He still has that first house that’s all paid off, and it’s in his dad’s name. He wants to sell it now, but he doesn’t know what the heck to do.” Dad’s on my title. This is horrible.
Jeff: Actually, I might be wrong about this, but I think this has an incredibly easy fix to it. Couldn’t the dad just quitclaim it to the son?
Toby: Let’s say dad quitclaims his interest over. He says, here’s my interest, you get it now. What’s his basis?
Jeff: I would transfer his old basis over just the way that dad had.
Toby: I think gifts carry the gift towards basis. It’d still be the same deal if the kid sold it. Would it be a gift?
Jeff: Now that’s the part I question. I’m not sure it would be if the son has paid for everything.
Toby: Except the dad could sell it. It’s the dad’s asset. If his name’s on it.
Jeff: Yes, the dad could.
Toby: The kid may be misremembering. They may have said, hey, your dad has to be on title. You’re going to have to sign these documents. Once you pay off the loan, you could transfer it to your name. You don’t remember any of that, because all you remember was, I’m buying the house, and then who wrote off the interest on the loan? Did dad write it off? Did he write it off?
I’m with you. I’m like, hey, you know what? Gift it and it’s a rental, then 1031 exchange it. I don’t know what your holding period would be. I think that you would get the dad’s holding period when you gift, when you get their basis in their holding period.
Jeff: If both their names are on the title—
Toby: I think you said it’s only his dad’s.
Jeff: I thought he did, too.
Toby: And not his name. He says not his name.
Jeff: What happens is Section 121 exclusion.
Toby: I thought the exact same thing, because you have to own it, and you have to have lived in it as your primary residence two of the last five years under 121. But they’re not asking for it, so what I would say is, you would not meet the requirement to have your name on it.
Jeff: I don’t think so, either.
Toby: The IRS would say, you did not own it and reside in it. You need to. The only exception to that is if it’s a married couple.
Jeff: One of the things we’re talking about with having your name on title, we see this a lot with timeshares. You don’t actually own the property, so you can’t deduct the mortgage interest on it.
Toby: I would be curious to see who is writing off the loan. If it’s an error and you said, hey, we mistakenly had my dad, you just did a let’s just change it now, then we say it was an honest mistake, and we never intended it, I still think the IRS looks at it.
You’re not going to go under the exam, so let’s just say you just said, all right, let’s just transfer it and treat it as though I’ve owned it all those years. But if you get under audit, I think the IRS is going to have some pointed questions, because a lot of people say this stuff, then transfer things. They play little shenanigans, and the IRS blows it up.
Jeff: Yeah, it would have worked out better if you had fixed this while you were still living in the house.
Toby: Yeah, and better off while you’re still paying for the loan. I understand dad needed to co-sign, but you would not have needed the loan at all. If you’re not on title, you don’t need to be on the loan. They didn’t need you. They needed your dad, which just tells me something may have shifted.
Again, I have a feeling there was probably a misinterpreted conversation that took place with the lender, where they said, hey, you can’t be on it. We don’t want to risk you, but you could be on the loan to gain experience. As you pay that, eventually, then you can refinance the house and put it in your name. My guess is that the bank knew exactly what it was doing when it put that on the title. Dad probably knew, too.
Jeff: The only other reason I can see not putting him on title was if was a minor and couldn’t contract.
Toby: He was in his early 20s, so he has the capacity to execute contracts. It was one of those things, where usually, just get a co-signer on a loan. You’re on the house and the dad’s not. But in this case, they had it on dad. It could have just been a mistake.
Jeff: What I don’t understand is if I’m the bank, I want the son on as a primary and the dad on there as backup, because then I got two people to go after if this deal goes south.
Toby: You have a co-sign. You still got it. It’s dad’s house, but you got both on the hook. It’s weird.
Jeff: It is weird.
Toby: But it’s secured by the property, so the bank probably didn’t care. They’re like, I don’t care whose name’s on it. We can go after you guys, but really we’re just going to sell the house if you guys don’t pay.
Jeff: Just don’t burn it down.
Toby: Yeah, don’t burn it down. You could transfer it and it’s a gift. You have $12,550,000 or some ridiculous number right now. It’s $12 million something. I forget the amount for the federal gift tax exclusion. It’s a huge amount. $12 million you can give without having to worry about it.
File your gift tax return on this one, though, and say, hey, this is the gift, this is the value of it, the value of the house. The IRS overlooks. I’m sure there’s no tax owed, so they’ll be fine.
All right. “I’ve heard Anderson talking about Spartan Investment Group which buys, develops, and owns self-storage units cross country.” They do syndications and self-storage. They have one that has an ongoing syndication where they buy lots of deals and sell them inside the fund, and then they have individual projects where they’re going in and buying.
Here, we’re going to buy these four units, and then they exit them after they fix them up. Get them operating more efficiently and then sell. “I’m considering using my self-directed Roth 401(k) to invest in that company.” You’re not investing in the company, you’re investing in a syndication that’s owning the property. “Would I be subject to UBIT or UDFI by using my Roth 401(k) for that investment? Jeff, what do you say?
Jeff: The UDFI, possibly. Not in the 401(k) because 401(k) is not subject to UDFI, IRAs are.
Toby: What Jeff’s saying is UDFI is unrelated debt finance income. If I have a property, a house, or we’ll use anything, self-storage unit, that’s in a syndication, and they lever 80% of it, so they come in with 20% cash, they levered up, and then borrow 80%, 80% of your income is considered financed income.
It’s unrelated debt financing. It’s unrelated to the investment because we use debt. We use money that we borrowed. If it’s in an IRA, that’s taxable. If it’s in a 401(k), it’s not. If you’re doing a Spartan investment, they use debt. They’re going in with cash and debt to acquire these properties, and then they fix the management.
They use their software, they use the free storage, they have a bunch of sophisticated software that they use on all their facilities, and it makes it much less expensive from an operating standpoint. That increases the net income, which increases the value and then they exit. You’re not going to have any UBIT, which is unrelated business income tax or UDFI if you’re using a Roth 401(k). But if you used a Roth IRA or a traditional IRA, you would.
Jeff: The rental self-storage units are considered rental commercial real estate. Where you might see a tiny bit of UBIT is a lot of these places sell boxes, locks, and stuff like that. That could generate a little bit of UBIT, but they would specify on there that this much is…
Toby: It’s crazy. Ryan in that group has been awesome over the years. We don’t get anything for recommending them either. There’s not a relationship there like that where we say, give us $1 for every person we send. No. We just like the fact that they make our clients money, so they do a good job.
Jeff: Yeah. If you’d like the investment, I wouldn’t worry about the UBIT portion of it. It’s going to be insubstantial.
Toby: Speaking of good investments, here’s a good investment. This is my partner Clint Coons’ new book, Next Level Real Estate Asset Protection. I did make fun of the cover two weeks ago because I’m a juvenile. For whatever reason, I think it’s funny that it has a goofy picture, and I made fun of it.
It’s actually a really good book. You should go to Amazon and buy it if you haven’t already because it’s a really good value. I think it’s only $22 for a hard cover. It’s well-put together. Also, you can do the Kindle version. In the Kindle, it’s like $10.
If you want to learn about how to protect the things that you’re investing in and make sure that you don’t leave them for somebody to take away from you, that’s a great place to start.
The other place you can go, and Patty, I’m going to surprise you with this one, is you can always come to our Tax and Asset Protection events. I think we have one on Saturday coming up. You can certainly come in and spend the day on Saturday learning about trusts, corporations, LLCs, how they all work together. Absolutely free on Saturday.
We do them every other week for the most part, and they’re very well-attended. There’s a big group, we have a lot of fun. You’ll learn just a lot about how to make sure that people can’t take your stuff.
I always say lawyers, snoops, and Uncle Sam. They’re the ones that like to take your stuff away. You work so hard. Please don’t leave it just lying there for somebody to pick up and take.
All right. Jeff, “Is STR income,” which is short-term rental income—Vrbo, Airbnb—”still considered active if I have a property management company running the business for me? I do not rent the property to them, they simply manage the business for me.”
Jeff: Short answer for the short-term rental is this is probably a passive investment if you’re not managing the rental at all. One of the tests we talk about substantially all the time is I do myself. Second test is that I do at least 100 hours more than anybody else.
Toby: You’d have a tough time with the property management company. The court cases never really believe that one.
Jeff: So then you have to fall back to the 500-hour test, which becomes really difficult if you have a property manager.
Toby: Between you and a spouse, you could hit that 500 hours. If you had enough real estate, short-term is not rental income, so you can’t aggregate it with your other real estate. It has to be, are you materially participating on this property? Not any other rentals on the properties that are the short-term rentals.
You could probably group the short-term rental. You can say this is a business. I’m engaged in these businesses together. Otherwise, it’s not going to happen for you. It’s going to be considered a regular business.
Again, remember what I said about short-term rental? Pizza shop. Is pizza shop income still considered active if I have a pizza management company running the pizza shop for me? Imagine you have a pizza shop and you hire Pizza Management LLC to come in and manage it for you. Is that active business for you anymore? No. You are a passive investor, somebody else is doing all the work.
Jeff: I have invested in Toby’s pizza business.
Toby: I want a pizza.
All right. “I am a real estate investor and pay nothing or almost nothing in taxes every year. My husband is a 1099 contractor with a huge tax burden. Would it benefit us to put some properties in his name?”
Jeff: I had this very same question you did. Aren’t you filing jointly? If you’re not filing jointly, you’re making the situation way worse.
Toby: I’m killing it, and I got no tax. This knucklehead is just killing us with taxes. Should I give them some of my properties? If you’re jointly, it doesn’t matter, does it?
Jeff: If you’re jointly, yeah, it’s all going on the same return. If you’re filing separately and you put some rental properties in his name, and I’m thinking long-term, it’s not going to change anything, because he’s not going to be able to deduct any of those losses.
Toby: No. If you’re a real estate investor and you’re paying almost nothing in taxes every year, it sounds like you’re probably a real estate professional. If your husband has contractor income and you’re getting killed with taxes, then no. You don’t have to put any properties in his name. You just need to make an election to say, hey, you know what? I’m a real estate professional. All of my losses that are wiping out my income, we’re going to allow those extra losses to come over and wipe out his income too.
It might be that you’re just not doing that. I would be curious to see if there’s any passive loss carryforward towards somebody. A lot of times, they just have no idea that real estate professional status exists. They meet it, it’s obvious, but the accountant just has no idea it’s even out there.
Jeff: There are a couple reasons you may file separately. One is if your husband’s name is John Gotti or Whitey Bulger.
Toby: You can watch me sitting on the hill. Bulger keeps popping up in that one. Oh, my gosh.
Jeff: Or if your spouse has substantial back taxes that he hasn’t paid, there are times where you want to make sure that you keep them separate. Or if you think your spouse—this goes back to the Whitey Bulger thing—is maybe doing things not on the up and up.
Toby: I don’t see any of that here. I think you’re just sitting there going, hey, my income gets offset, my husband’s doesn’t, what can we do? You could do the properties. The other thing you do is set up a charity and donate some of your property.
If you’re doing low- to moderate-income housing, if you’re in recovery housing, if you’re doing housing for disadvantaged group, it could be veterans, it could be elderly, residential-assisted living, it could be any of those categories, anything that’s helping society, here’s the rub, I can donate a house and write off its full fair market value, not what I paid for.
I’m just doing this right now. I have a gal. I’m not going to get you into all the specifics, but she was going to be dehoused. Let’s just put it that way. We are in a position to say, we’ll get you that house, you never have to worry about it, ma’am, you’ll always have a place to live.
We bought the house. We bought it for about $120,000. I’m looking at it going, I think I’m going to give it to one of the charities. We just had it appraised. It was $300,000 something. It’s gone way up. I get the deduction for $300,000 something.
Will it save me more than my original investment? Absolutely. That’s why it’s there. Yay, everybody wins. It lowers my tax bracket a little bit, it gives me some tax relief, and I didn’t have to come out of pocket other than the original investment. Yeah, it’s for a good cause. I like stuff like that.
You could look at doing that too, because you might be surprised. As you’re doing this depreciation, as you’re writing things off, you haven’t been having to pay tax, you may look at it and go, whoa, I would love to get some extra benefit on some of these homes that I’ve had for 10–20 years, whatever.
I may have even depreciated them completely and you’re like, I don’t even know what to do with it now. I get no tax benefit. It’s just churning out rentals. Okay, great. Give that to charity. Take the full fair market value. It’s fun.
All right. “You have mentioned multiple times in your videos that borrowed money is not taxed, but you never explained it in detail.” I’m sorry. We’ll get into this. There is a way that it could be taxed.
“I have multiple investment properties, each in its own single member LLC.” Except in your situation, there’s no way it’s taxable. “My CPA says if I refi, I have to take the money out as an owner draw because they are an LLC, and it’s going to be taxed. Please help clear this up.” Your CPA is wrong. Jeff?
Jeff: I was going to go harsher, but you told me I couldn’t.
Toby: You could go as harsh as you want. All the CPAs out there, you guys all just going like, what?
Jeff: Feel free to put in chat what I want to say.
Toby: Yeah. Feel free to chew up the other CPAs. Usually, we have a few on here.
Jeff: It’s actually fairly common for a bank to have you take a property out of an LLC to refinance it. If it’s disregarded to you or if it’s in a partnership, you do that, you refinance it, and you put it right back in. There are no tax consequences.
Toby: Somebody says get a new CPA. Yes. No, they may be well-intentioned. Here’s when it can be taxed. I put $100,000 in a syndication. The syndication levers that money. Let’s say that it raises a million dollars, borrows $9 million, and gets an asset that’s now $10 million. It goes up to $20 million, and they refi it again. But this time, they refi it for $15 million, they pay off the previous loan, and they distribute to the shareholders a whole bunch of money.
The first $100,000 that you get back, tax free. You don’t have to worry about it. But what if they give you more than what you put in? You’re not at risk on that loan. You’re not a guarantor, there is no risk to you. That could be taxed as long-term capital gains or as a distribution in excess of your basis.
That cannot happen in this situation because you’re a single member LLC. It’s you. You’re on the hook for these. You’re not a passive investor in this thing. You’re not on the loan. Even if they had a non-recourse loan, you don’t have to worry about this. But yes, the proceeds of borrowing is not income, unless somebody forgives it.
Jeff: Yes. Good point.
Toby: I can loan Jeff a million dollars tomorrow, he pays no tax on it because it’s not income. They always say, but you never explained it in detail, because it’s not income. There isn’t a detail.
When I borrow money, that is not income to me. It’s not my money. I still owe it back. The day that somebody says, you don’t have to pay it back, is the day I have a tax event.
Jeff: Normally, you can take a property in a partnership or a disregarded entity to you. You take it out at cost, you put it in at cost, you can take it out at cost. You can do this all day long.
If you have an S-corporation or a C-corporation, you have a whole different problem, because property has to come out at fair market value. In those cases, you could possibly have taxable consequences of removing property out of an S-corporation or C-corporation.
Toby: Easy peasy. If you want the best strategy that we see works year after year no matter what, it’s buy assets, allow them to appreciate. By the way, there are two factors for appreciation. We’re experiencing one of them right now, which is high inflation. Inflation and growth will drive your asset up and then you can borrow against it.
We use Elon Musk as an example. If Elon could just lever his stock portfolio if he wants to—he probably does—we use what are called security backed lines of credit, which means you can borrow at any time. They’re really cheap, by the way. We just did one with Morgan Stanley. It was 2.5%. Wow. You can go as high as 70% of the value of your stock portfolio, which after today, we’re not going to talk—
Jeff: You may be looking at an equity call.
Toby: Yeah. We would never go above 50%. I always say 50% is your magic line on borrowing. Don’t go about 50% of anything, because you could have something that dips down. You rarely do see it go worse, but it does happen, so you just have to be smart about it.
If you’re borrowing against a blue chip portfolio that could have bonds in it, for all we care, there are bonds right now paying over 9%, guys. You just have to get a bond that’s tied to inflation, and it’s like 9.6% last year. Some stupid numbers, right? And then you could borrow against it at 2.5%, you’re making money and you actually have the cash to go out and invest it again. That’s how the wealthy do it.
That’s how you see it over and over again. They always lever their assets. When there’s an opportunity, they lever it. They don’t go crazy. They usually are in a position to be liquid, where they needed to pay it off, they could. If I’m borrowing money against stock, I have the stock. That’s not too bad.
Look at that. We just hit all answered questions. Our guys, for Jeff, Eliot, Dana, Troy, Patty, and Andrew, you guys kicked butt today. You just saved our tax team from having to come on. They did a great job. Six minutes over? Shoot. I was supposed to stop at 4:00. Bad Jeff.
Jeff: I know.
Tobu: All right, guys. Thank you, Sherry. Anyway, pop onto the YouTube channel. We do put these up in recorded format after. If you came late or if you’re one of those people that you missed one or two and you want to see what was on them, you can listen to them a little bit faster in the podcast channels. You can go on to YouTube, listen to them there, and watch.
If you have questions, this is where we grab the questions that we answer. Just shoot them to email@example.com. We’re still going to answer your questions. We do it as a courtesy, because there’s so much crud out there and there’s so much bad information. If it’s in our wheelhouse, chances are, we answer it 20 times a day anyway. We’re just going to answer yours too.
There are some good questions that just popped up. As soon as I said they’re all answered, it was like everybody asked a question. These guys did a great job. Happy tax season. Hopefully, you guys realize that there are still some things you can do even on your 2021 taxes. It’s not too late to do cost segregation, for example.
It’s not too late if you’re getting killed with taxes on your 2021 to do some strategies, maybe look around. Even when we were talking about that first question in the aggregation election, part of me is always like, did you aggregate for 2021? Is there a time to amend that, to maybe not aggregate? I don’t know. There are things that we can look at to maybe get yourself out of that pickle. The clock is not stopped for 2021.
Jeff: You got 32 days to fix things.
Toby: You got it. Reach out if you have any questions. If not, gosh, I hope you guys have a great next two weeks. It’ll be exciting to see where everybody’s at in two weeks. In the middle of the tax season, we’re going to go easy on Jeff here.
We’ll have Jeff on for at least one more. Maybe you need to take a break at tax season. Maybe we’ll have Eliot or somebody step in so that you don’t have to get squoosh mooshed. I think that’s the term for it. Have a great two weeks. We’ll see you guys in two weeks.