Today’s Tax Tuesday episode is your 2022 send-off with a series of rapid-fire questions around year-end tax situations. Toby Mathis hosts with a few staff available to answer online.
In this episode, you’ll hear our advice on combining multiple businesses and making sure they are incorporated and isolated from you personally which protects you from liability, opening a 401(k) by the end of the year vs. before the tax deadline, purchasing cars under a business umbrella to make income with Turo, and various other valuable end-of-the-year tips on tax strategies that you should do before January 1st, and a few that you can still take care of in early 2023 before the tax deadline. Submit your tax question to taxtuesday@andersonadvisors.
- “Last year was the first time I wasn’t able to take investment real estate depreciation or deduction due to AGI over 150. I don’t have too many necessary losses or even losses that I don’t know or don’t think will get back up, but it seems like a way to reduce my AGI. How do multiple-unit landlords do it? I’m thinking five houses without stock could get you up over the limit.” – You’ve probably been phasing out, you just didn’t realize it. Maybe your loss was small enough.You could do certain things to lower your AGI. Harvesting capital losses is one of them.
- “My husband and I have full-time corporate jobs, but also have small side businesses—remodeling, party rentals, and online sales—which are really diverse, that are in different categories. How is it best to structure everything for easy accounting and tracking of funds from all of these? – The general rule is you want to isolate any business that’s doing business with somebody else. You probably want to isolate them from each other. Keep your structure simple and have one set of books, just have one business. I would have it as an LLC. Isolate it from YOU.
- “Do I have to open a 401(k) by the end of the year to make contributions?” – If its your salary deferral, yes, if its employer, you can do it after the next year starts.
- “My CPA has suggested I take the late election of an S-corp. C-corp was formed on June of 22. I’ve had plenty of expenses building the foundation of a wholesaling business, but no deals yet. With tax filing, I assume I do a late election of an S-corp. Will my taxes be filed as an S-corp or as a C-corp? And how does that impact the business startup expenses I’ve had since March of 2022?” – My suggestion is that C-corps are a trade or business the day that they started.
- “How can I make sure our Utah-based kids pay minimal tax on the sale of our property in California when we die? We know it will be stepped up in value. When I sold my own dad’s property in California when he died recently, we paid a big tax on it to California as non residents. Should we sell it and do a 1099 exchange?” – California doesn’t have an inheritance tax, period. They haven’t had one since the 80s, so I’m trying to think of how they taxed you. Send us an email I would like to find out more and answer this!
- “I lived in a condo for nine years and bought a house last year with a 5% down payment. The condo was rented out. If I sell it now, will I have to pay capital gains tax? If so, how can I avoid paying capital gains tax?” 26 USC 121 – It says that if you lived in a property as your primary residence for two of the last five years, if you’re single, you get a $250,000 capital gain exclusion. If you’re married, you get a $500,000 capital gain exclusion.
- “Looking for the best ways to protect net profits. I’ve seen 401(k) contributions, IRA contributions, investment and materials equipment, owner distributions, We are uncertain of future events and would like to keep what we’ve earned without paying it all to the government.” – If it’s net profit from the business- use all the business expenses. Look at a defined benefit plan, charity, accelerated depreciation…a lot of things you can be doing.
- “If I’m using a private lender to buy a property and borrow $10,000 more than my purchase price, is the additional $10,000 taxed as income?” The answer is no. You can always borrow money, and it’s not taxable to you.
- “This year, we made a little more money and wanted to know if your service will help us offset anything with my somewhat new business before the end of the year is over. I currently have a massage, esthetician business that I opened in October 2018. Then the pandemic hit in March of 2019, in which my state licensing demanded we stop all services or we’d get our license taken away causing me to go in the red for 2019, 2020, and 2021. Moving forward, my business has been slowly coming back but still struggling. During the pandemic, I went back to school getting certified to work in the holistic health care setting. I’m in the process of adding that business to my existing, so I wanted to get advice on the best way to set things up if I have multiple businesses.” That’s a question I cannot answer for you. But make sure they are isolated from YOU like my previous question.
- “My husband and I are wanting to take advantage of the equity in our home and would like to invest into some rental properties to start to dabble in real estate investing and Airbnb. I also wanted to know if your company will be there for us on any financial advising and legal advising in our planning on this new venture.” This is exactly what we do. Rental properties are different from Airbnb. As it is all real estate – probably want to isolate A, B, and C from each other, and we want a structure that allows us to get the maximum tax benefit in isolating that liability.
- “We are dabbling in Turo. So far, it’s been doing well. We’re interested in expanding it with more cars to add in. However, we now would like any new cars we added to be purchased under the business name.” – Depending on the type of car, it could be a deductible in one year. If you’re doing this in your name, you’re exposed. You have a ton of exposure. You need a business name on it.
- There are a lot of things that are not time-ish critical before the end of the calendar year, but the big ones are salaries, reimbursements, charitable giving.
- Check our YouTube channel for more on end of the year tax strategies.
- We hope you have a great start to the new year!
Tax and Asset Protection Events
Full Episode Transcript:
Hey, guys. This is Toby Mathis, and you’re watching Tax Tuesday. This Tax Tuesday is going to be a little bit different since it’s the holidays. A lot of my staff is out. What I wanted to do is put together a recording, because I’m out, too, and make sure that you get something for the year end. We’re just going to do rapid fire.... Read Full Transcript
We did this last year, too, where I just did a rapid fire Q&A off of questions that have come in. You can still ask questions. You can still ask questions via the Q&A feature and in chat. We will have limited staff handling it, but you can also send in your questions to Tax Tuesday, so let’s jump in.
First off, yes, I am teaching Tax Tuesday. Clint the cat, we’ll see where he ran off to. He’s probably making a mess somewhere because he is pretty good at making messes. Anyway, we are your pilots today. We’re going to jump in.
Typical rule is you can ask questions via the Q&A feature. Again, I have limited staff due to the holidays. I’m not sure how many people are going to be on for you, but you can still ask. And I would say email in your questions to email@example.com. If you need a detailed response, you’re going to need to be a client. What does that mean, by the way? Some people ask that, and I’ll just give you an answer.
If you say something like, hey, if I have a business, can I reimburse myself for business miles, we’ll respond back whether your client or not, yes, you can. You can reimburse at the mileage rate that the IRS prescribes right now. It’s 62½ cents a mile, and you have to track your miles. You’re responsible for keeping track of both your business and personal uses on a vehicle.
If you write and say, I have three cars, and I use two of them in one business and another one in both businesses, and I pay the gas at a business one, and I want to reimburse certain expenses at business two for the third vehicle, but a business with the car one and two, really, is being used equally between two businesses. If it starts going down that path, you need to be a client.
Here we go. This is supposed to be fast, fun, and educational. Hopefully, we’re going to give you the fast, fun, and educational all in one pack. Let’s go through this.
“Last year was the first time I wasn’t able to take investment real estate depreciation or deduction due to AGI over 150. I found it hard to believe. I would think that many real estate investors go over that. As such, I’ve limited myself this year in wondering almost too late if I should pare down my gains with tax losses. It’s hard for me to do.
I don’t have too many necessary losses or even losses that I don’t know or don’t think will get back up, but it seems like a way to reduce my AGI. How do multiple unit landlords do it? I’m thinking five houses without stock could get you up over the limit.”
What’s being described here is actually 469, which is passive loss activity rules. Whenever you have rental properties, it’s generally going to be passive income. Businesses, in which you don’t materially participate are passive. The rule is passive losses offset passive income only. And then they’re carried forward until you either get rid of the business to get rid of the investment, or you have capital passive income to offset to you that you can use those losses against.
This person is running up against something called active participation. There are really two exceptions to the rental passive loss, and that’s active participation where you’re managing the manager, and it has an AGI phase out between $100,000 and $150,000. The second one is real estate professional status, which we’ve talked about ad nauseum on Tax Tuesdays, in which you can go to my YouTube channel and read all about, but it’s a much higher threshold.
A lot of people hit that active participation, but then they phase out, and you’re absolutely right. It phases out for a reason because once you have a bunch of houses, the IRS is trying to keep you from using your real estate losses from offsetting your other income and depriving them in their minds of income or Congress who broke the law, who says, hey, we need our money.
This is where you get into that phase out. The phase out is really $100,000–$150,000. You’ve probably been phasing out, you just didn’t realize it. Maybe your loss was small enough. We didn’t notice it, because it’s up to $25,000. Maybe you got a $5000 loss. You made $125,000. You could write off up to $12,500, because you’re halfway through the phase out of $25,000, and you didn’t even notice. So now you notice, and that AGI becomes important.
You could do certain things to lower your AGI. Harvesting capital losses is one of them. Also, HSAs—depending on whether you have a family or just you—could be $3600 if you have a high deductible health insurance plan. IRAs are another methodology for lowering AGI. If you have a side business and you have self-employment taxes, those can be used. There are certain educational expenses. If you’re an educator, there are some other expenses.
There are some little quirks out there that lower your AGI, but those are the big ones. Yes, you got to be cognizant of it. That’s why you do some tax planning, but it’s a really good question. Congratulations on your success.
I think that what’s going to end up happening is if you have five houses, eventually, you’re going to start seeing those rents become a little bit annoying. You’re not going to have to pay tax on the rents because you’re going to have these carry forward losses.
There are going to be years where all of a sudden, you start having more and more money coming in. You’re not paying tax on it. Otherwise, you can write off the loss up to that phase out of $100,000–$150,000. Once you hit the $150,000, you’re right. You’ve lost your ability to take passive losses against your wages or your other income. You don’t lose them, they carry forward. If nothing else, at least keep that in mind.
Number two, “My husband and I have full-time corporate jobs, but also have small side businesses—remodeling, party rentals, and online sales—which are really diverse, that are in different categories. How is it best to structure everything for easy accounting and tracking of funds from all of these? Thank you.”
The general rule is you want to isolate any business that’s doing business with somebody else. You probably want to isolate them from each other, unless you don’t really care about any of them. If it’s all your effort, and there’s no value in those businesses, then you could actually put it in one business. Mix it up.
Depends on what the revenue is to what type of structure. If you have losses, for example, and you just kick it down, and it’s offsetting your other income, you might want to be an LLC, and you can even be disregarded as long as you’re not making a lot of money.
I’m not too worried about people being sole proprietors. Sole proprietors pay a lot more in tax on their net profit. If they’re profitable, it can get bad. And their audit rate is significantly higher when they make money. Especially if they’re making up to $100,000, your audit rate literally goes 800% higher than something like an S-corp.
What I would say to keep your structure simple and have one set of books, just have one business. I would have it as more than likely as an LLC. Either ignore it if it’s going to create losses, or set it up as an S-corp if sometimes it’s losses, sometimes you have good years. Until one of those businesses matures, you can operate it that way.
If one of those businesses starts to take off, then we just spit it out and set up another business and another structure for it. You could even have a parent structure, then you could have multiple.
Anyway, I’m not going to get into too much detail. This is one of those things where, hey, if it’s like a $3000 or $4000 side business, and each one of those is $2000 or $3000, and really what it’s doing is breaking even and creating some losses, then I’m probably going to lump it together disregarded.
If it’s making money, I’m maybe lumping it together and making an S-corp or a C-corp depending on what your situation is, and whether we could possibly get a lot of tax-free reimbursements out of a C-corp, and some of the plays that you look at.
Eventually, look at isolating them once they mature because we don’t want to contaminate them from each other. What’s the most important thing, and this is just the asset protection attorney sitting in me, is isolate it from you.
Make sure that, hey, I do a party rental, the chair breaks and somebody has spinal injury that you’re not looking at it, it’s something that’s going to impact you for the rest of your life as somebody comes after you with judgments or things like that.
Or if you do an online sale and somebody has products liability of some sort or something that you created, and they say you got them sick or whatever, just fill in your blank, remodeling.
Hey, I was working, and I forgot to put some glue on a pipe, and it flooded out the whole house. I’ve actually seen that. The damage was over $1½ million, and you got a $300,000 policy. You’re looking at some serious liability, and it’s personal. We want to isolate that, for sure. Put it in its own box. Keep it separate.
All right. “The difference between investor and developer protects purposes.” I really don’t know what that means. I love questions like this because it’s not a question. It was just a statement. But I saw it, and I was like, wow, this will give us a chance to talk about the difference between what an investor is and a developer is, because for at least purposes of the passive activity loss rules in real estate professional status, an investor is a passive activity and a developer is a trade or business.
If you are a developer, and you are doing things to develop properties, personally, that can be it. That is a trade or business. That means that it’s ordinary income. You can be looking at self-employment tax. But more importantly, you could qualify as a real estate professional and unlock all of your passive activities losses to offset all your other income.
It could wipe out a good chunk of your W-2. It could wipe out other income that you have coming in from another business. It can really do great things for you.
I wanted to point that out, that when you say what’s the difference between an investor and a developer, okay, there are two. I would still isolate them for asset protection purposes even from each other because a developer sounds like you’re doing something on property before you sell it or you’re working with third parties.
An investor is somebody who’s buying things for the long haul. Generally, an investor in real estate is somebody who’s selecting the property and somebody else is managing it. Those are two very different activities. You’d isolate them, so that they don’t contaminate each other. Even on the investor side, the real estate, we’re going to say the same thing over and over again here at Anderson, which is isolate risk assets.
If you’re just starting out, isolate each one because if you have three properties, the loss of two of the three or three of the three could be absolutely devastating. If you have 30 properties, you could be isolating it in groups of 5 for all I care, 10. Because if you lose 10, you still got 20. You’re not going to care. It’s going to be hurtful, but it’s not going to be catastrophic. Whereas you’re just getting started. If you put all your properties in one LLC, for example, and you lose them all, that’s pretty devastating.
Next one, “Do I have to open a 401(k) by the end of the year to make contributions?” Really good question. Here’s the thing. It used to be that you had to. Now, you have to have a 401(k) open if you’re going to make employee deferral contributions. If you’re going to defer your salary, you have to have that salary run before the end of the year.
But the employer contributions, the 25% contributions, for example, of a solo 401(k), you could actually set up the 401(k) after the end of the year. You can make those contributions all the way up until the business files its taxes, which can be September of next year if it’s an S-corp.
“Do I have to open a 401(k) by the end of the year to make contributions?” If it’s your deferral, the answer is yes. If it’s the employer that wants to make a match towards 25% of your wages up to the $60,000-some, $62,000, it’s then no. You can actually do that after the year starts.
“My CPA has suggested I take the late election of an S-corp. C-corp was formed on June of 22.” This is interesting. “I’ve had plenty of expenses building the foundation of a wholesaling business, but no deals yet.” It sounds like there’s a business that was incorporated in June. Here we are six months later, and they’re saying, hey, we should take this as an S-corp, but no deals yet. “With tax filing, I assume I do a late election of an S-corp. Will my taxes be filed as an S-corp or as a C-corp? And how does that impact the business startup expenses I’ve had since March of 2022?”
There are a couple of big questions here. Whenever we look at a flow-through entity, they always look at you. If you make the late S election, which, generally speaking, you can. I know that some people are, hey, what is this thing? It’s I did not make an S election, and there’s a revenue procedure, where you can file an S-corp return and say, hey, to excusable neglect or something along those lines that I did not make the election in time, but I’ve treated it as an S-corp, but I’m filing my taxes as an S-corp.
I assume that they’re doing that. The CPA is doing that, because they want to take losses, because they want to take these expenses. The trade or business that you set up, but you haven’t had any deals yet, the IRS could take a position that you’re not in business yet. They’ve done it in the past. There’s actually a court case, where somebody was not entitled to their expenses until they actually did a deal. Once they did the deal, then they could write off the expenses.
They had written off the expenses in a tax year. Let’s just pretend that it was 2021, but they didn’t do any deals until 2022. And the IRS said, hey, you owe taxes in that year, we’re not going to allow you to take those losses. I think it was the Woodward case.
Anyway, you could do that. You’re still entitled under either case. Do you have the startup expenses? Generally speaking, my suggestion is that C-corps are a trade or business the day that they started. It’s a lot less of, hey, I’m messing around with this thing, then I have my first deal, and you’re not trying to take the loss. The loss is staying in the C-corp, but the IRS is much more forgiving of that than, hey, I took it, and I wiped out some of my W-2 income, especially if you’re in a higher tax bracket.
Just food for thought. Is the business started if you have done no deals? There’s a good argument that you have, because wholesaling, you’re probably doing a bunch of mailing out and everything else. You could say, hey, the day that I started doing that is the day that I started this business, in which case if you had losses, yeah you could absolutely take it, which I think is a great argument.
I don’t know how the IRS would form on it. Otherwise, it’s grabbing the C-corp. You still grab all those expenses as startup expenses or as business losses because if you haven’t made any income and you’ve been incurring expenses, you’re going to have losses. Either way, I think you’re probably going to be in a similar situation. I don’t know if it really matters.
If you have a good CPA, they’re looking at it, and they are aware of the ability to make a late election. They’re probably thinking on your behalf. I don’t get in between people and their good CPAs. I’d just say listen to the CPA. You may just want to say, hey, is there any issue that they could think of about when they started that business? They’ll probably say, no, it’s the date you had shareholders, and it’s the date you started your business.
In a corporation, that’s generally the case. Just do the math and say, is this something that I need to take right now? Or, hey, maybe we just wait till next year, or maybe we wait till after the first tax year, and then we make an S election another year. It all depends on what you’re doing. My experience with wholesaling is that if you put the energy into it, it’ll start to pay off pretty quick, and you’re going to use up those losses anyway.
“How can I make sure our Utah-based kids pay minimal tax on the sale of our property in California when we die? We know it will be stepped up in value. When I sold my own dad’s property in California when he died recently, we paid a big tax on it to California as non residents. Should we sell it and do a 1099 exchange?” You could probably think of a 1031 exchange before that.
Let’s answer the first one. I’m just going to put a line through this guy. Here’s the deal. I’m not certain about Utah, but I am certain that it’s really odd because California doesn’t have an inheritance tax, period. They haven’t had one since the 80s, so I’m trying to think of how they taxed you.
When your dad passed, there was a step up in value, so I’m trying to think of what you paid on the big tax hit. My thought is you must have been in a state that has an estate tax. I know there are 12, and I know most of them. Maybe you lived in a state that had an estate tax. And because you live there, the state charged you the estate tax, because California sure has that. I’m trying to figure out where the tax came from.
It’s very curious. The premise here is, wow, I just don’t see it. I’ll tell you something that actually did occur. Somebody actually came up to me today and told me about this. They quitclaimed a property that parents did to the kids, because they were concerned about taxes when they passed away. What they did is they ensured that their kids would pay a tax when they passed away. Because if they had done nothing, there would have been no tax, because you have a step up basis.
They were well below the federal exclusion in the state exclusions of federal estate taxes, which are right now, it’s $12 million+ per individual, over $24 million as a married couple. Then there are states like Oregon and Massachusetts, I think their state tax exclusion is down. Oregon’s in a million. I think they’re the only ones along with Massachusetts. I think Massachusetts is pretty low, too.
Most states, the vast majority as in almost 40 of the states, follow the federal, so there would be no tax. Again, I’m trying to figure this out. The 1031 exchange or I think what they’re saying it’s a 1099, maybe we could sell it, not have any tax, and keep the basis low. Maybe you could sell it to the kids. Maybe that’s what you’re thinking. But again, you’re recognizing tax that you wouldn’t otherwise have to.
I’m a little bit confused. I don’t understand why you got hit. I would love to see it. If you’re out there, send that into firstname.lastname@example.org, and maybe I’ll do a follow up on it, because it doesn’t make much sense to me, unless there was what would cause somebody who passed away for you to have a tax hit when you sold the property, because you had a step up and basis. There’s just something that’s weird there.
Unless your state has an estate tax, in which case you got hit with that, which means your kid shouldn’t live in a state that has an estate tax if they’re concerned about this.
Here’s one. “I lived in a condo for nine years and bought a house last year with a 5% down payment. The condo was rented out. If I sell it now, will I have to pay capital gains tax? If so, how can I avoid paying capital gains tax?” This is actually a really good question and pretty straightforward.
You live in a condo for nine years, and then you move out. The rule that exists that allows you to avoid capital gains on the sale of a primary residence is Section 121. It’s 26 USC 121. It says that if you lived in a property as your primary residence for two of the last five years, if you’re single, you get a $250,000 capital gain exclusion. If you’re married, you get a $500,000 capital gain exclusion.
In here, you moved out of a property, and it sounds like last year. You would just sell it within three years, so three years of moving out. Once you left, now you have a five-year look back. All right, in the last five years, did I live in that property for at least 24 months? The answer is going to be yes all the way until you get to month 37 of where you’re renting it out.
Just make sure you sell it before it’s three years gone, and you don’t have to worry about it. You would have no capital gains or the capital gains would be offset with the 121 exclusion, which is pretty potent stuff. If you’re single, you’re going to avoid 250,000.
Now, let’s assume just because I’m being annoying, that the gain is actually more than $250,000 and you’re single. You still don’t want to pay tax, and you’re like, gosh, darn it, Toby, how do I do this? You could actually put a 121 exclusion together with a 1031 exchange.
What would happen is, let’s say that your house went up $1 million, and you have a $250,000 exchange, and you want to avoid it, once you rent it out, it becomes investment property. Let’s say that you sell it, and you do a 1031 exchange and buy more real estate, you would get the 121 exclusion to its full extent, and then you would 1031 the rest. What it does is it adjusts your basis up from not only your sales price or the purchase price when you bought it, but then you add the $250,000 exclusion on top of it. If you’re married, it’s 500,000.
You’re avoiding tax and depreciation recapture. Because you’ve been renting it out, you’re going to have to recapture the depreciation. Whether you took it or not, believe it or not, you’re required if you could have taken depreciation. That is not part of 121 exclusion. A 121 exclusion avoids capital gains and capital gains only. A 1031 exchange avoids capital gains and recapture. It just moves the basis over to another property.
What does that mean for you? In English, it means if you have lots and lots of gain, and you’re exceeding the 121 exclusion, the way you’re doing it right now is I made it into a rental, great, sell it under a 1031 exchange, and get both the advantage under 121, and get to avoid capital gains and recapture.
All right, “Looking for the best ways to protect net profits. I’ve seen 401(k) contributions, IRA contributions, investment and materials equipment, owner distributions,” which will not protect your net profit bonus, et cetera. “We are uncertain of future events and would like to keep what we’ve earned without paying it all to the government.” It sounds like it’s some sort of either a business or you’re incurring some sort of capital gains. Maybe you’re selling stock or whatnot. Maybe it’s real estate.
First off is to determine exactly what the taxable event is. If it’s net profit from the business, and you’re saying, boy, I’m getting hit with it, yeah, you use all the business expenses. You may also want to look at, are there ways to get money back out to myself in a tax-free manner? You’re looking at reimbursing with an accountable plan of anything that you’re incurring personally that is benefiting that business, the administrative office for the home, the 280A, your cell phone, your data, a good chunk of the expenses of your home, depending on whether you have a home office or an administrative office in the home.
Owner distributions aren’t going to do it. It’s going to be salaries, and you’re going to pay tax on that, unless you defer it in your 401(k). If you don’t defer it into your 401(k), you could even, theoretically, if you have a 401(k) like we’ve set up and allows in service distributions, you could actually get that into a Roth. But you’re much happier paying the tax if you know you’re never going to pay tax ever again.
Other things you could do is take advantage of all the deductions that aren’t nailed down. You might be looking at an HSA, which is always great, a defined benefit plan. If you have profits and you have owner distributions, a defined benefit plan is a fancy way of saying, let’s figure out how much you’re making and make sure you’re receiving that from your retirement plan. We have folks putting hundreds or thousands of dollars into there and deferring it.
You can also take advantage of things like real estate. You’re already sitting equipment, but maybe you’re looking at real estate, self rental of real estates, so you don’t have to worry whether you can group that with your business. You can take large amounts of depreciation, accelerate that depreciation, and avoid tax on your business. Yes, you can group the business and a passive activity together. It makes it basically non-passive, but treats it as one economic unit.
Other things you could do is look at getting charitable with your own charity. You could do conservation easements. You can do a lot of different things. You can even do captive insurance. If you say hey, you know what, I want to make sure that I’m getting huge deductions now, and I’m capping how much I’m going to pay tax on it, you can cap it at long-term capital gains in the future.
There are so many things out there that you could be doing. I’m just throwing a few out at you. It really just depends on what type of business you have, whether you’re trying to show profit for either angel investors, bank purposes, or whatever. Sometimes you just make the business a C-corp and pay a flat 21%. Take out bonuses and salaries. When you need it, pay tax on those.
If you have a whole bunch of profit left over, make sure you have a reason for it. And if you don’t, make sure you’re giving yourself a dividend. Dividends are taxed as long-term capital gains in this type of situation, so depending on what your income is. It could be 0% that you’re paying on those, 15% that you paid on those. I doubt I’d ever issue a dividend if I was paying 20%. I think I threw some ideas out there for you.
“If I’m using a private lender to buy a property and borrow $10,000 more than my purchase price, is the additional $10,000 taxed as income?” The answer is no. You can always borrow money, and it’s not taxable to you. You just have to be at risk for it. You’re not in a syndication, where you have nothing to do with the loan in excess of basis. This is just you borrowing money from somebody.
All you’re doing when you’re borrowing money is, hey, I owe money to somebody, and it’s secured with something that I own. Sometimes it’s real estate. Sometimes if it’s equipment, it could even be shares. It could be income streams, it could be artwork, it could be your car, anything like that, but that’s besides the point. Loan proceeds aren’t taxable. If you’re using a private lender, and you borrow more money because you’re probably going to rehab it or something, or they just think it’s a great property and maybe bought it right, I wouldn’t worry about it. It’s not taxable.
“This year, we made a little more money and wanted to know if your service will help us offset anything with my somewhat new business before the end of the year is over. I currently have a massage, esthetician business that I opened in October 2018. Then the pandemic hit in March of 2019, in which my state licensing demanded we stop all services or we’d get our license taken away causing me to go in the red for 2019, 2020, and 2021.”
It sounds like the pandemic caused you to lose money. Hopefully, you’re using the employee retention credit. Hopefully, there’s some payroll there or something there that you get some money back. Maybe you got some of that money there.
“Moving forward, my business has been slowly coming back but still struggling. During the pandemic, I went back to school getting certified to work in the holistic health care setting. I’m in the process of adding that business to my existing, so I wanted to get advice on the best way to set things up if I have multiple businesses.”
First and foremost, let me just get this. I have a massage, esthetician. The question is, if you were making that business better by going to school on the holistic health care, was it a whole new other business, in which case like education expenses, costs, and things like that are not deductible, or was it bettering the existing business, and is that why you’re going there?
That’s a question I cannot answer for you. You could obviously make arguments. I don’t know how the IRS would look at it. They may take the position, hey, this is a whole other line of business. If that’s the case, a lot of those expenses, it’s not going to be something you’re going to be able to grab unless you could grab it as a startup expense.
But again, it sounds like you were getting certified for a new line of business, in which case it wouldn’t be deductible. It doesn’t mean that there aren’t expenses there that could be a startup expense that you might be able to take advantage of.
If you combine these two businesses—remember my first question today was really about when we bring businesses together and how we bring them together—you could absolutely have two lines of business in one business. I would make sure that they’re isolated away from you. It sounds like there’s been some losses. That makes me think that we want to flow through structure, either disregarded or depending on the licensing.
You may even have requirements as to what type of entity you can be. Maybe it’s an S, maybe it’s not. Maybe it’s just an LLC, and it’s disregarded to you, and you want to take those losses. If you’re going to be making money and you know you’re making good money at this, then you probably want to be looking at an S-corp.
The numbers usually really start to turn around $25,000 a year of net profit. At that number, you’re probably around $1500 net savings. If you go to an S-corp, there’s a little bit of cost, maybe depending on who the accountant is, because the numbers are pretty much identical, but maybe they’re doing an extra tax return in their mind instead of just Schedule C for a 1040.
Maybe there’s a little extra cost there, but the bookkeeping is going to be the same. You might have a salary requirement, which might cost you doing payroll once a year for a couple of hundred dollars. When it’s all said and done, you’re going to come out pretty well ahead or pretty darn close right around $25,000. It really depends on that business, as to how big it is.
I really would look at your licensing to make sure that they allow this in the first place, because there may be requirements depending on who your board is to say that you can’t have two types of businesses combined or you can’t be in this type of business in this type of business.
There might be rules that prevent that. You want to make sure that you’re not doing something that would offend a local rule depending on your state, possibly, your county. But from a structuring standpoint, I would say, hey, the two businesses, something bad happens in a massage or doing a holistic healthcare, and somebody sues you.
Let’s just say it’s, hey, I had a contractor who decided that, really, they were an employee. Now you discriminate against them, and you wrongfully discharged them, and they sue you for $500,000. Both businesses get brought in unless you keep them separate. By keeping them separate, in separate entities. That’s generally the way you do it. I have enough to be dangerous off of this, but I would say it’s worth a further exploration.
“My husband and I are wanting to take advantage of the equity in our home and would like to invest into some rental properties to start to dabble in real estate investing and Airbnb. I also wanted to know if your company will be there for us on any financial advising and legal advising in our planning on this new venture.” This is exactly what we do.
For example, you say real estate investing and Airbnb. There are rental properties and there’s Airbnb. Sometimes you want those to be treated similarly, because Airbnb almost always is a trade or business. It’s not a rental activity. Sometimes you need to have those properties treated as a rental activity if you’re going for something like real estate professional status.
Otherwise, sometimes you want the Airbnb to be isolated on its own because you want to create big fat losses that can offset your W-2 income, because Airbnb is a trade or business. You want to make sure that you’re not poisoning that well and that you’re able to take all those losses.
Yeah, there are absolutely issues that come here. And it’s all real estate, which means property A affects property B, affects property C. We probably want to isolate A, B, and C from each other, and we want a structure that allows us to get the maximum tax benefit in isolating that liability.
If A and B are rental activities, and C is Airbnb, then the question is, do we want to add D to be the Airbnb and let C be a rental, because we need A, B, and C to qualify for real estate professional? Or can C just be its own activity as a trade or business? We don’t isolate the real estate in it, and you meet the material or participation test, and you can create some pretty fantastic losses. All those are things that get explored in a consultation. I would encourage you to actually take advantage of a consultation.
All right. “We are dabbling in Turo.” It sounds like they’re dabbling in Turo. Guys, I usually just grab these and throw them right on end. I’m not one for sitting here messing around with it. “It’s like Airbnb for your personal car.” I’m familiar with Turo. “So far, it’s been doing well. We’re interested in expanding it with more cars to add in. However, we now would like any new cars we added to be purchased under the business name.” Most likely, you’re going to have to anyway.
You should be letting your insurance know because insurance won’t cover Turo. Turo has separate insurance, but you could find yourself in a situation where your insurance says, sayonara. You want to make sure that they know what you’re doing here. It’s really easy if you start using them just solely for business, and you buy them in the business name.
Now, depending on the type of car, it could be a deductible in one year. It could be deductible over five years, and there might be limitations on how much per year you can actually deduct. Most passenger vehicles, it’s around $19,000. That’s problematic because if it’s an expensive car, you’re like, I really would like to write off more, but you might be limited.
Yes, you can absolutely isolate them. You’re going to want someone to get a pad of paper and pencil and figure this thing out. If you’re using them for your business in something like a corporation, I would much prefer that, because if you’re doing this in your name, you’re exposed. You have a ton of exposure.
Just imagine somebody comes into town and they say hey, you denied them access to your vehicle, and they alleged it was some insidious reason. It was race-based or something like that, or because they had a name you didn’t like, a disability or something, or they were too old, whatever. You start just filling in certain blanks and seeing whether you open yourself up to any potential exposure. You want to make sure that we’re isolating these activities out there.
You want to minimize that coming into your personal realm as much as humanly possible. We want to have a business name on it. Plus, if you start doing this en masse, a bunch of people are going to be driving your cars. The more people that are driving your cars, the more likely that your car’s going to be involved in something. You want to make sure your name is not in that.
You want to just keep it separate. Here’s the business. This is the vehicle provider. This is the, I don’t know what they call it, like a Turo host. I know that, again, Turo has its insurance. Make sure you have yours. Make sure they know it’s commercial, so you can get commercial insurance, and then make sure you get an umbrella.
We just knocked out a whole bunch. There’s end-of-year stuff, too, that I’ll throw out there to make sure you’re looking at your realized capital gains and looking at your unrealized capital gains. Maybe it’s time to harvest some of those unrealized losses to avoid tax on the capital gains.
Also, look at things like crypto that have had a really bad year. With crypto, you can take the loss. You can sell it, take the loss, and then immediately buy it back. You don’t lose the loss, even in the wash sale rule that affects securities. Even in securities, there’s a workaround with buying an option immediately after selling to cover what the rule covers, which is just to attach the next purchase and add the loss into that basis.
You could do that with an option and then buy the shares secondarily again, and then sell the option and grab a much bigger loss. It’s still a capital loss. If you wanted to harvest some of that, you certainly could do it.
There are other things that are really important, like if you have an S-corp taking a salary for the end of the year. If you have expenses, just know that there’s no such thing as miscellaneous itemized expenses since the Tax Cut Jobs Act, so make sure you’re reimbursing. If you have a 401(k), make sure you’re doing the employee contributions. If you’re going to use a DB plan, make sure it’s in service before the end of the year.
If you’re going to make charitable donations, make sure that those are written. If it’s a check by December 31st, the contribution has to be made before the end of the year. There are little things like that. Just be aware of a lot of stuff you can punt on, like IRA, the employer side of the 401(k), the employer contributions and a DB, and doing a cost seg on a property. You can wait until next year. You can actually do it all up until you file the tax return to make a change of accounting and take advantage of a cost seg on a property. There are a lot of things that are not time-ish critical, but the big ones are salaries, reimbursements, charitable giving.
If you have some bills or some things that you can prepay because you need to wipe off, like you’ve had a really good year and you have some money, let’s say you had $10,000 falling into the highest tax bracket, you have a lot of incentive to look at equipment purchases that may be coming up and doing them now.
You may have incentive to pay some bills that are going to be in the near future and cover them now. That’s lowering it. Maybe you’re making two or three years of charitable giving and this year, you take a couple of years off so that you can offset more income. There are lots of things like that at the end of the year that are worth it.
Speaking of the end of the year, there’s the link. If you want to come to my YouTube page. We are coming towards the end of the year, and there are other tax strategies. I put them up on the YouTube channel. I think I did that one, it was 14 year-end strategies, things like that.
Also if you’re a client, and especially if you have the tax toolbox, you did the business essentials package I encourage you. I redid. I did 45 tax strategies in one day, and we recorded it. It was the tax-wise workshop. It should be sitting in there right now freshly uploaded, sitting there in your tax toolbox. Make sure you take advantage of that, too, and that you are looking at that information to get as much tax knowledge.
I do everything from cost segregation to conservation easements, 121, 168, 1031s, tons of different types of deductions, income shifting, hiring your kids, paying those kids before the end of the year, for example, to make sure that that stuff’s done. There’s a ton in there along with a lot of the philosophy that we see from having worked with so many clients of what actually works for wealth building.
Feel free to go to the YouTube channel. It’s absolutely free. There are lots of good ideas, and subscribe. By the way, if you like this type of information, if you get something out of these Tax Tuesdays, please share it with others. The more the merrier. It’s like an easy saying, but we actually love working with people. We love the emails.
Speaking of the emails, email us at email@example.com. Any questions you have, just shoot them over. Those are tax related, right? I don’t want to hear a bunch of other weird stuff. Sometimes people go in there and they’ll just pontificate political stuff. Please, don’t send it to me. We want tax questions.
Visit us at Anderson Advisors. If you haven’t been to our Tax and Asset Protection Workshop, make sure you do. It’s free. We do it at least once a month. It’s a hoot. You’re going to learn about land trust, living trust, LLCs, corporations, S and C, real estate investing, real estate taxation, and a bunch of the nuances. By all means, please join us.
We do them, again, at least once a month. They’re pretty educational. They’re a lot of fun. There are always a bunch of attorneys on there answering questions, and accountants and other people. We bring a lot of staff there because we usually have somewhere in the thousand range watching live and it’s a pretty good-sized group. It’s lively, so it keeps us moving along.
By all means, jump into that. I’m going to throw a lot at you, and this is one of those things. I tell this when I teach at advanced classes. You’re really looking for three things when you’re doing some of the more advanced courses. Don’t try to remember everything. Just try to pick three things that you can apply now. When I say now, the next 90 days.
With all things, as you get to the end of the year, you’re starting to think about next year, and you start to think about the first quarter, think. What three things could I use that are going to make me a more effective business owner, a more effective tax planner? How can I positively impact my situation?
Maybe I’m deferring taxes longer. Maybe I’m getting more deductions, so I’m keeping more of the money that I make. Whatever the case, just look for three things, and then do it again. Every quarter, maybe you just make that your goal. Hey, I want to learn three things that I can actually implement and apply. Do that quarterly and after two years, you’re going to be pretty potent.
All right, guys. I hope that this was a little bit enlightening and that you got something out of it. Again, hopefully if you had questions, somebody was able to answer them. If not, email us with firstname.lastname@example.org, and we’ll get to it as quickly as we can.
Have a very merry Christmas and a wonderful new year with the ones that you care about. Whatever you may be celebrating, have a wonderful holiday season. If you’re not celebrating much or it’s been a rough one, just know that 2023 is right around the corner. I’m hoping and praying that you have a fantastic new year. If you have had a tough 2022, just remember you’re going to kick butt in 2023. Keep telling yourself that. Guys, have a great one.