Happy Thanksgiving! What are you thankful for? Toby Mathis and Jeff Webb of Anderson Advisors talk about how to use LLCs for your wholesale real estate, retirement plans, and other tax questions. They relate seasoning and cooking the turkey as well as words of wisdom from Bobby Boucher in Waterboy to tax topics. Submit your tax question to taxtuesday@andersonadvisors.
- Roth Account: I’m not 59 ½ yet. I know I can withdraw my contribution/conversion amounts without paying taxes, but will I be penalized? If you withdraw your contributions from a Roth IRA, there’s no taxes or penalties, but if you take out earnings from a Roth IRA held for less than 5 years and you’re under 59 ½, you’re subject to taxes, penalties
- Wholesaling: Should that be an LLC by itself? One LLC per deal or just use the same one? Depends on whether your state has a series LLC because it’s easy to create a series but it’s difficult to open bank accounts for them
- I’m thinking about delivering packages for a delivery service to supplement my income. My current car is paid off. Should I buy or lease a vehicle for business use? Should my earnings fall under the protection of an LLC and Employer Identification Number (EIN)? Do not lease a vehicle for something like this because you will quickly exceed the mileage limitations, but do set up an active entity (S/C Corp, LLC) for liability protection
- If I purchased a course or educational support not in my LLC’s name, can I still deduct it for my business? Yes, if it is directly related to your business, but get reimbursed
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Full Episode Transcript:
Toby: All right. Hopefully you guys are out there alive and kicking. It’s two days before Turkey Day, and welcome to Tax Tuesday. My name is Toby Mathis.... Read Full Transcript
Jeff: And I’m Jeff Webb.
Toby: You’ve come to the right place. If you want to have dry humor and tax, this is it. You’re here to experience it. Let’s just jump right on in. We have a lot to go over. We always shoot for an hour. We almost hit it once.
Tax Tuesday rules. If you ask live in the question and answer, in Zoom, you’re going to see that there’s a chat feature where you can just say anything you feel like. Right now, if you’re out there in chat, you’ll see Patti says, welcome everyone. Go in there and just let me know what city and state you’re in. We love to see where everybody’s at. And then the question and answers where you can type in specific questions for you that you want us to answer.
Let’s see. Oh, shoot. Now they’re rolling in. They always do that. New York, Quincy, Cuero, Richardson, Texas, Charlotte, North Carolina. We see some Hawaii, Lawrenceville, Georgia, Milwaukee. Gosh, blessed Chico, California. They’re flying through.
Hey, somebody is in Gig Harbor. So you’re up there by Clint. There’s Polar Bluff, Missouri, there’s another Hawaii. Somebody loves your dry humor. Somebody told me to be quiet. Randallstown, Maryland, Tomahawk, Wisconsin, San Jose, Minnesota, Houston, San Diego, Falls Church. I know that well. Head of the headquarters of American Red Cross.
San Diego, Houston, Arizona. We got people from all over the place, so welcome. Guys are in the right place for some tax stuff. We love the tax stuff. We love seeing what’s going on in the tax world.
Obviously, there’s no greater time than right now. We have a lot going on. Let’s just jump right in to the questions. After this one thing, you can always send in your question. If you’re not going to put it in the question and answer, you can absolutely send it in at firstname.lastname@example.org.
We also have folks on right now that are here to help you. I know I have Elliot, let’s just take a peek. We have Ander who’s not going to answer questions. He’s doing the technology. Thank goodness, we have the tech people, Elliot E and O. We got Elliot who’s an attorney, Ian, CPA. Matthew, who’s doing some tech. Patti who will answer anything you ask her. Piao is even on.
My gosh, I thought these guys were all going to be chilling out, but it sounds like they all got on, Trisha. You have an army of tax professionals there to answer your questions. Since it’s a holiday week, I don’t expect that we’re going to have a gajillion people on. So if you have tax questions, today’s the day. This is the best day to be doing it. You’re really lucky and we’re really glad to have on all those tax pros. My goodness.
Somebody says, Albuquerque. What did they say? Quito, Ecuador, nice. Gosh, we got people everywhere. We’ll get to it anyway. Okay, there’s some funny stuff always going on in chat, which we’ll not always repeat. All right, let’s go over some of this.
By the way, somebody was yelling at me about the editing and saying you guys can’t write questions. It’s not us. We literally take your questions. Sometimes we fix a misspelling, but we don’t really mess around with it much.
So, “Roth account, not 59½ yet. I know I can withdraw my contribution/conversion amounts without paying taxes, but will I be penalized?” Good question.
“We received unexpectedly large proceeds from the sale of shares/dividends earlier this year over $100,000. Some of it we’ve already invested. Looking to reduce tax liabilities on this and thinking of investing into a syndication deal of $50,000 or so before year end. What kind of depreciation can we expect? Any other real estate investing strategies you might suggest as far as tax reduction goes? We already purchased one short-term rental property mid 2021.” Good questions thus far, and we’ll answer those.
Let’s keep going. “Wholesaling. Should that be an LLC by itself? One LLC per deal or just use the same one?” We’ll get through that.
“I’m thinking about delivering packages for delivery service. Should I buy or lease a vehicle? My current car is paid off. Should my earnings fall under the protection of an LLC and EIN?” which is the employer identification number. We’ll get into all that.
“If I have purchased a course or educational support not in my LLC’s name, can I still deduct it from my business?” We’ll go over that.
“How best to purchase a vacation rental property from a parent and avoid paying high capital gains taxes as the property has appreciated significantly from when the parent purchased it?” Good questions today.
“If I use a self-directed IRA money to remodel a property, is that deductible?”
What else we got? Oh, we still got some more. “How many rental properties do I need to own and manage to meet the criteria as active participation and thus apply real estate losses to active W-2 income?”
“I run a short term rental (STR) in my home. How do I set up my STR to take advantage of home expenses?” We’ll answer that one.
“My LLC has mark-to-market trader status and will have substantial losses this year. We want to take an IRA or 401(k) distribution to pay off our house and take advantage of the LLC loss to offset the distribution tax. Any pitfalls to this?” Already, really great questions. You ready to dive in?
Jeff: Let’s dive in.
Toby: Do you have any favorites by the way?
Jeff: I do.
Toby: Okay, is this one of your favorites?
Jeff: This was […], so I kind of liked it.
Toby: Okay, you can answer this. “Roth account. I’m not 59½ yet,” but you’ll have to explain why that’s relevant. “I know I can withdraw my contribution/conversion amounts without paying taxes, but will I be penalized?” What say you, Jeff?
Jeff: I’ll answer the question first. If you withdraw your contributions from a Roth IRA, there is never taxes or penalties. If you take out gains or income out of that Roth, earnings, and you are under 59½ and have held this account for less than five years, you’re going to be subject to penalties.
Toby: Five years and you have to be over 59½.
Jeff: You wouldn’t and still be subject to tax on the gain as long as you’ve held it for the five years.
Toby: Five years, you get taxed even when you’re under. You have to hold it for the five years because you never pay tax on that. You have to be 59½, unless there are a few exceptions.
Jeff: Yeah. I think you can do the substantially equal payments, which means you start collecting retirement out of it and it has to be a regular amount, like $300 a month.
Toby: Do you think it is 72(t) within a Roth?
Jeff: I think so.
Toby: I don’t know. I didn’t look at that. I honestly don’t know if 72(t) applies to Roth. Any accountants out there that are willing to jump into chat, I do not believe that a 72(t)… I know that if you do…
Jeff: So you don’t think substantially equal is one of the choices?
Toby: Because it’s taxable amount that they’re receiving, so they’re going to pay tax over a period of time with the Roth, and never going to pay tax as long as they meet the exception. You always get your contribution back. I put $6000 in a Roth, and I don’t make it to the 5-year period, and I’m not 59½½, or either or. I need to have both if I’m not going to pay anything on it.
I can always take out my $6000, so I can put out the money that I put in. Let’s say it grows to $10,000. So there’s $4000 of growth. You would have to either be a first-time homebuyer, you’d have to have substantial medical expenses, or some other need in order to get that money out without meeting the 5 in 59½ year test. I’m not sure if there’s another way around it.
If you take it out early, you’re going to get penalized and you’re going to be taxed on the gain because otherwise, what’s the point? They’re going to say it’s all taxable now, to see if anybody’s out there that’s in there. Where are our accountants today? Usually we get rescued by one or two of you guys.
Jeff: They took the week off.
Toby: They probably been pre-Turkey-ing and they’re already like, drooling somewhere. Let’s go over one more thing on the Roth just because it’s fun. You do meet the five-year test. It’s your first contribution. Let’s say that I’m putting in $6000 a year, then as long as that Roth has been around from the earliest contribution, I think you get 5 years for that entire period, right?
Jeff: Yes, the clock starts running for your very first contribution. If they go out and open up a second Roth IRA, it’s still the original clock.
Toby: All we care about is that they know that you are putting money into a Roth for at least five years. It’s seasoned, and then you’re 59½, you can take the money out tax free, but you’re not required to take the money out. If you want to let it cook a little longer, it’s like a crock pot. You just want to let those investments continue to escalate, you’re Peter Thiel and not the guy with $5 billion in his account, you could absolutely do that.
Just for kicks, our YouTube channel, I did a tax-free crypto, where we are showing you how to actually create crypto using a mining machine and not have to pay tax using a Roth account. You have to pay a little, but you pay a corporate tax to 21% only on the amount mined, and then all the appreciation is never taxed. So if you’re one of those crypto folks and you like to do the mining, check out our YouTube channel.
All right. I like this one. Anytime somebody gets free money. “I received unexpectedly large proceeds from the sale of shares/dividends earlier this year” It actually makes a difference to which one it is. Let’s just say that, hey, we got extra money. “Some of it we’ve already invested. Looking to reduce tax liabilities on this and thinking of investing into a syndication deal before year end. What kind of depreciation can we expect? Any other real estate investing strategies you might suggest as far as tax reduction goes? We already purchased one short-term rental property in 2021.” What do you think?
Jeff: I can’t really answer the depreciation question for the syndication, primarily because we need to know what the syndication has planned. Are they going to do a cost segregation? To clarify, if you invest into any type of housing, near the end of the year you’re going to get very little depreciation, unless you’re doing that cost segregation.
Toby: Even then, syndication, $50,000. You’re not going to be at risk, so if it does generate a bunch of loss, it’s not going to get to be yours.
Jeff: Right, and that’s a good point because that $50,000 is your investment.
Toby: And that’s not deductible, so it’s like buying Microsoft shares.
Jeff: What about conservation easement?
Toby: You could potentially do it. It’s still on the chopping block with ways and means for 2½ times. The syndications that I’ve seen are usually 4½–5 times. Meaning that you put a dollar, you’ll get a $4 or $5 deduction. Congress is talking about limiting that to 2½, which isn’t horrible.
You save as much as you put in, but where you really get the juice is when you get up to four and five times. There are abusers out there that are doing 10 times, 15 times, which is stupid, but they’re doing it anyway. They’re giving the whole industry a bad name. You could do that, but here’s the one, the short-term rental. That’s the secret sauce for getting deductions before the end of the year.
What a short-term rental is anything that’s leased on a nonspecific longer basis. A typical lease is generally going to be month-to-month. Short-term rental just means less than that. Specifically, if you have average guests stays, so each individual booking and the number of stays, we divide each individual booking, you add those up. So let’s say you have 10 individual bookings, then you divide that into the number of days total rent.
If you had Airbnb of 50 days and 10 individual people, your average days would be 5. The IRS says that’s not rental income. That is an ordinary business. Then the only question is, if you can create loss by doing, what Jeff just said, a cost seg and accelerated depreciation, that would offset all of your other income.
When I look at this question, immediately I think dividends, are they qualified because that’s taxed as long-term gains? The sale of the shares, is that qualified? Is that long-term hold? We would be looking at 23.8% highest tax bracket, 20% capital gains and 3.8% net investment income tax.
Now we say, all right, let’s take a look at our whole income. That total amount there could be $23,800 without looking at the state. Now I’m looking at what could I get as a deduction that would offset that tax?
It’s not going to be $100,000, because if I can get an ordinary gain and I could offset $90,000, 37%, what would that be? I’m going to have to do math in my head. We’re getting pretty darn close, though. We’re getting around $32,000 of tax savings. That’s actually more right there.
You just got way more of a deduction than what that $100,000 is causing you. The way you do it again is short-term rental. You have to materially participate in your short-term rental to get to take that as an active loss. A lot of people that put properties into service—we just did a class on this with our tax clients—I had five people during that class that were closing on properties during this month.
I said, all of you guys should make those short-term rentals. Just put it into service before the end of the year, accelerate the depreciation, which will get you about 20%–30% of the improvement value as a deduction. Probably the property value is closer to 20% of the total value. If I bought a piece of real estate for $500,000, I’d probably get about $100,000 deduction, and it becomes ordinary active loss if you do this, which means I could take this big $100,000 loss and offset my W-2 income with it if I want to.
Jeff: You do have to materially participate. Is there any issue with that this closely?
Toby: Not as long as you’re the only one handling the management, so you have to manage it yourself. Do not hire another manager until 2022. It’s like this. You always hear at the end of the year, buy a car. Accountants are known for this. They always go, oh, buy a big car.
I always say, timeout. If you’re going to use it in your business, yes. If it’s 100% business use, okay. If you’re just buying a car and you’re just using it for personal, you’re not going to get any business deduction, but they always say, buy it, we’ll take a big write-off in your business. I’m like, oh, okay.
That’s because the type of depreciation when you’re doing that—you’re 179—you’re getting a bonus depreciation. It’s under another section, it’s 168 or 179. But we get to write off personal property. As long as it’s put in service, we get 100% of the deduction. Whereas with real estate, they typically make you spread it out and they use this half month convention.
If we bought it and we put it into service before the end of the year, we’d get like a half month. We’d literally get a half month of depreciation. Not even a year, not even a month, we get a half month. It’s like, yay.
But if you accelerate it, you get to take all of the acceleration on the 5-, 7-, and 15-year property. The carpet, the fixtures, cabinets in the house, specialized electric, the shrubs, the sidewalk, all that stuff, we’re writing off, boom, this year. Even if we only put it into service for two weeks, it doesn’t matter.
Jeff: And you do need a cost segregation to do that, but it does not have to be done by the end of the year.
Toby: You can actually do the cost seg by when?
Jeff: Up to the time you file your tax return.
Toby: So it could be October of next year?
Jeff: One other thing I want to talk about with a short-term rental being so close to the end of the year, to have it actually be a short-term rental, I would think you would actually had to rent that property out to get it classified that way.
Toby: You’d have to rent it out. You have to put it in service and make it available.
Jeff: Right, because we talked about the long-term rentals as long as you’re at least attempting to rent it out.
Toby: Yeah. I’ve seen the case on long-term rentals where somebody bought a house, made it available, couldn’t get a renter. They were trying to lease it when we had the great recession. They were trying to lease out a house and they couldn’t. They never rented it. They literally sat on it for a year.
They couldn’t find a tenant, so they sold it off. They wanted the depreciation. The IRS was contesting and they were giving it by the tax court saying yeah, you’ve made it available, your fair market. You’re not required to go under, like beat yourself up, although, I would have told them, cut to rent and just get somebody in there. I guess you could say as long as you have it available, even if somebody doesn’t use it, you have an argument at least. I’d feel 50/50 on the argument.
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Somebody says free is good. It depends on what it is, like I get a rash and it’s free. It’s not so good. That’s why I keep my distance from Jeff here. He’s like, you’re way over across the room today.
All right. “Wholesaling, should it be an LLC by itself? One LLC per deal or just use the same one?” What do you think?
Jeff: I like putting this in a corp. But one thing I thought about what’s this, if I’m wholesaling, I’m doing a lot of it. If my state allows a series LLC, I think that would work well for this. What do you think?
Toby: I think it really depends. My first thought is it’s an active business. I’m not too worried about shutting it down periodically, unless I have a lot of transactions, then I might. If you do have a state that has a series LLC that’s easy to create the series, you don’t have a lot of costs with it. It’s really hard to bank those.
Series are really tough to open up bank accounts in. It lends itself to real estate more where you have a property manager or something, and you have a one entity or one individual owning all those, and having one account.
Jeff: Have you heard of much litigations with wholesaling?
Toby: You know what? I have. It’s rare, but we’ve seen a lot of it. Where it really came in is when wholesalers make a lot of money. When the economy was contracting in 7, 8, and 9, then when it was started to recover, and you’re within a statute of limitations period, you’d see people rearing their ugly head being mad that you made money while they were bailing out of their property.
Clint had a really good one, which is there was no basis for the lawsuit. They were just threatening. The lawyer was just out now and said, but your client has quite a bit of money. He was like, what does that have to do with anything? He was like, sometimes they try to…
Jeff: He likes some of it.
Toby: Yeah, they just get mad. A lot of times, the wholesalers are coming in helping somebody keep their credit from tanking, they’re putting somebody in a position, and then they realize, wait, that’s usually a greed thing. Somebody ends up winning, you’ve done everything you’ve told them that you would do, and they just can’t stand that somebody made money out of their situation.
You’re looking at it saying, you have been immensely benefited by not having your credit completely destroyed, but they don’t see it that way. I’ve seen it a couple times, but I’ve never been involved in a suit from a wholesaler, and I buy from wholesalers all the time. I would say, one entity, as Jeff said, taxed as an S-corp or C-corp, you’re probably better off. I’m not too worried. If you want to go LLC, you certainly can manage on how many transactions you have.
All right, “I’m thinking about delivering packages for delivery service to supplement my income.” It sounds like they’re going to make them use their own car. So they said, “Should I buy or lease a vehicle for business use? My current car is paid off and should my earnings fall under protection of an LLC and EIN?”
Jeff: First thing about the car, I would not lease a vehicle for something like this. You’re going to quickly go over the mileage limitations. What I do see when people do this is they don’t use their primary vehicle, they purchase something for cash even if it’s a beater or something. If you’re just making deliveries, when they wear the car out, they replace it.
I could see doing that inside an LLC. You definitely want an LLC because there’s a lot of potential liability from vehicular activities. All you need to do is cause a wreck, and they find that you’re in business, and they’re going to go at you with a vengeance.
Toby: Yeah, I would set up an LLC, I’d make it an active entity, probably an S-corp or a C-corp. LLC, sometimes we forget that new people aren’t. LLCs only exists to the state for the federal government. We have to tell what it is from a tax standpoint. So you can have an LLC and say it’s an S-Corp for tax purposes, but it’s an LLC.
Jeff: You’re not setting up the LLC to protect your delivery earnings. You’re setting up an LLC to protect everything else you have.
Toby: Correct, and you’re trying to isolate it. So if you have a bad accident, you’re out delivering packages for Amazon driving, or UPS or one of these others, and you have a delivery schedule, you got so many you have to deliver, and you’re whipping around the city, and you inadvertently look away and caused an accident, the more time you’re on the road.
Jeff: I used to do delivery. I know how we drive.
Toby: He’s bad. He always drove with his eyes closed.You’re not supposed to do yoga while you’re driving. Actually, I know somebody who does this. Terry, I won’t say his last name, but he’s a friend. He does this every year. He loves doing it. He’s rolling around in his Cadillac, actually.
Usually, the delivery service is giving you a reimbursement on the mileage. So either they’re paying you for the miles, and they’re having you track your miles, and they’re just reimbursing in which case that’s not taxable income to you. Or they’re including it in whatever they’re paying you if they’re doing a flat rate, and they’re 1099-ing in which case, you should be reimbursing you for mileage.
What is it, 57½ right now or something like that? 56½? I can’t remember what it is for 2021. It fluctuates around. Hopefully it goes up even higher because energy costs are going up. Gas is just crazy right now.
Jeff: One thing I would suggest you watch is some of these companies, I work for one. They charge you for everything they charge you for vehicle, radio, uniforms, and you quickly realize that you’re not getting paid anything. Just be cautious, be diligent.
Toby: There it is. I know, again, I think he’s UPS. He’s picking up to a specialized delivery, but everyone is a little different. Here’s the rub. A lot of people say, well, I’ll just write off my car, then. Don’t do that because this is temporary.
Unless you’re going to do it year round and this is the vehicle that you use to do your deliveries where it’s more than 50% business use, don’t even think about doing depreciation and actual expense method. I would go straight, just do reimbursement, get the mileage reimbursement, and not mess around with that. If this is something you’re going to do over a long period of time, then we might want to consider doing actual expense method and doing depreciation, but only if more than 50% of the use is business use.
Jeff: If you’re going to do this long-term and you buy an expensive vehicle, the mileage rate may do better than the actual expenses.
Toby: You buy a little $5000 car that has a decent motor that’s not going to break down, an old Toyota or something. In theory, let’s say you put 20,000 miles on it over a short period of time, like you’re driving every day, you’re putting in 400 miles a day. I can’t imagine that’s a lot of miles, but you’re just putting on the miles, you’re getting 57, whatever it is, cents a mile, high 50s, you could receive more than what you paid for the vehicle.
It’s not tied to the value of the vehicle, versus, if you do the actual expense method, you’re depreciating the car, which has limitations, depending on the weight of the car and which section you fall under. It can be $18,000 limit for the year, $18,100 for a car. Then you’re writing off the actual cost of the gas, maybe an oil change. Realistically, you’re crazy not to do the reimbursement in my mind, unless this is something you’re going to do and you’re only using this vehicle for business use, in which case, then we might look over.
Jeff: It doesn’t have to be pretty, just reliable.
Toby: Absolutely. For delivery, you’re probably better off.
“If I have purchased a course or educational support, not in my LLC’s name, can I still deduct it from my business?” Sir?
Jeff: Yes, you can if it is directly related to your business. You can certainly do that. If you’ve been in business for a while, even say a year, that makes it even easier to do. You’re not going to be able to deduct college classes or things like that, but if you take a seminar or something, that has to do. My father was a pipefitter. He takes a continuing education for sensors and stuff like that.
Toby: If it’s something that improves your skill or is necessary for your license, then you can write it off. But I don’t think that’s what they’re asking, that they did it in their personal name. Let’s say you’re a CPA, and you go out, and you buy a CPA course for continuing education in Jeff Webb, how do I write it off? You personally can’t because you’re an employee of your organization.
The organization needs to reimburse you and you write it off for the LLC or the company, unless you are your company. If you’re a sole proprietor then it doesn’t matter. So if you’re an LLC that’s disregarded and it’s an act of business, then technically, you wouldn’t have to do the reimbursement because you’re not an employee. Or if you’re in a partnership, and you and another partner are both actively participating, then you wouldn’t have to do it. Where you have to do the reimbursement is if it’s an S-corp, or C-corp, or an LLC taxed as an S-corp or C-corp.
Jeff: And then all that other stuff I said before.
Toby: And all the other stuff that Jeff said before. What is that? I can’t remember the educational statute.
Jeff: The one for necessary?
Toby: Ordinary and necessary of 162. Is there a code for this?
Jeff: Is it 132 or 137?
Toby: I cannot remember.
Jeff: For our working fringe benefits? Basically saying that I have to do this in order to keep working here.
Toby: Yup. Anyway, we’ll look at it. For that one, yes, you can write it off, but you need to reimburse yourself if it’s an S or a C-corp. Otherwise, you can just write it off as a sole proprietor. You pay higher tax, though, your audit rate is about 500% higher than the S-corp, and you lose all your audits. But other than that, keeping a sole proprietor. You know they got rid of the table?
Jeff: Audit table?
Toby: Yeah, they got rid of the audit table. We just recently had a look at 17B, was with the data book every year, and the IRS would give us the data book, and they would say who they’re auditing. You could actually see, depending on the schedule on the 1040 whether you got audited. They discontinued it. Cool. Little turds.
Jeff: I’ve heard they’re hiring more auditors. I prefer they’re hiring somebody just to answer the phones.
Toby: Yeah, an auditor. Where are they finding the people? That’s what I want to know. We live in a city right now. We live in Vegas. Half the restaurants are closing a path of them or they’re not opening on certain days because they can’t find people. The IRS is apparently going to find a whole bunch of people. I figured that they should look in Del Rio.
All right, “How to best purchase a vacation rental property from a parent and avoid paying high capital gains? Taxes as a property is appreciated significantly when the parent purchased it.”
Jeff: I read this and the first thing I thought is, wow, what a balancing act, because a lot of this is going to depend on the parents, what the parents want. It sounds to me like they’re wanting to cash out of this business.
Toby: It’s a vacation rental property. That means it’s a rental property that they use for vacations, like a condo on the beach.
Jeff: I wasn’t sure if it was that or if they just meant it’s a short-term rental.
Toby: I think it’s probably the other one because it’s highly appreciated from when they purchased it, so you have a property that they’ve held for a while. It could be Airbnb or something like that, but you’re saying, hey, I want to buy it. I balance the, just wait for your parents to pass away.
Jeff: I didn’t think about that.
Toby: Yeah, that’s the first thing. It’s like, let them die. I hate to say it, because then you get a step up in basis.
Jeff: Yeah, especially since they’re saying it’s significantly appreciated, but it may be a case that they…
Toby: They should refi. If they want the cash, refi it, you take over the house. This is where it gets sticky. If you let somebody rent your property from you at less than fair market value, if they’re relative, then it’s considered personal use case, and you can’t depreciate or anything like that.
What you really want to do is rent it at fair market value from the parents. Let the parents refi it and get their cash. You pay enough rent and make sure you figure out what the fair market rent is. Then now it’s yours. When they pass away, no tax is due.
In theory, they’ve taken cash. The property is appreciated longer. You still have control of it and all that good stuff, maybe even put an option to buy as part of the lease, but that way, you don’t lose that step up and basis.
Jeff: Let’s say it’s not about cash. They just don’t want to deal with that anymore. Could they assign him to actually do it and take the income? Could they move without giving up the property?
Toby: Yeah, you can rent it to them. Otherwise, if you’re letting them use it, it’s considered personal property. Again, there’s no depreciation we have to worry about. You could sit there and say, hey, Jeff’s letting me use it. It’s no different, it’s just a zero transaction.
Jeff: And then he can turn around and rent short-term if he wanted to.
Toby: Yeah, I would do a fair market rental and say, hey, I’ll just take it over from you. The parents take out the money, pull it out the HELOC or something. Otherwise, there’s one other way you could do it without completely messing things up. You’re going to lose the step up if they sell it.
The other way you do it is you do an installment note and you buy it from them over a long period of time. It’s just going to sound horrible, but it depends on your life expectancy of your parents as to whether the IRS would buy it. If they’re 95, they’re not going to buy it. If they’re 75, the IRS would buy it.
Jeff: One thing I would not suggest, it doesn’t even come up at the question, but you don’t want to put this in an irrevocable trust. That’s probably the worst of all worlds in this case with a significantly appreciated property.
Toby: If you don’t want to pay tax at all and the parents want to sell it, they wouldn’t get the money out of it. Let me think about this for a second. You could possibly do a mature remainder trust where you’re going to give the remainder interest to charity. The parents would get a deduction, you could sell it, they could get an income stream out of it if they wanted to for the rest of their lives, and then you could lease it from the CRT, but that’s, again, probably two moving pieces.
Jeff: Yeah, but this sounds more like they want to do some kind of legacy to pass on.
Toby: They want to keep the rental property, that’s for sure. So you’re saying, hey, how do I do it without paying capital gains? There is one of the thing I didn’t even mention when we’re talking about capital gains. You can always do qualified opportunity zones. I tend to think that they’re […].
Jeff: Is this the last year for it?
Toby: It’s still around. I think it’s 2026 that it’s gone completely.
Jeff: Okay. Obviously, again, just thinking that it was less effective.
Toby: I don’t like it. Everything I’ve seen, it’s much ado about nothing.
Jeff: Have you all noticed that we really don’t discuss these questions before we get together?
Toby: It’s kind of fun.
Jeff: No, it is fun. I think it’s better format than coming in with a […] statement.
Toby: Here’s the answer. I’d rather be able to spit ball at it too. I’ll give you guys a real life example of what could happen and why you don’t do this. Let’s say the parent also just gifts it. Let’s say that Jeff is my dad and he has his highly appreciated property. He doesn’t want to pay capital gains.
So I say, but Jeff, I really want to keep it or hey, dad, I want to keep it. Jeff gifts it to me. Not only do I not get a step up and basis, my basis is his basis, which is like, if there’s already significantly appreciated property and it keeps appreciating, if I ever sell that thing, I’m paying a ton in tax, unless I make it into an investment property and 1031.
But if I’m, this is my vacation as a second home, I don’t get a 121 exclusion, I don’t get a 1031 exclusion when I sell, and I lost my step up. So again, best bet is, parents keep it. If they need the money, then refi it and keep it in the family. If you really, really, really want it, then you could rent it from your family enough that it will cover the cost of them cashing it out.
“If I use self-directed IRA money to remodel a property, is that deductible?”
Jeff: Wow, what an interesting question. I’m assuming that this property is not owned by the IRA.
Toby: If the IRA owns it, there would be nothing to deduct.
Jeff: Yup, the IRA just pays for repairs and improvements.
Toby: If it’s a self-directed IRA, which is what it says, and you have a property, and you remodel it. There’s no tax, there’s no deduction, there’s no nothing.
Jeff: Not exactly true. If I want to use my self-directed IRA to remodel one of my homes, I’m going to have to take a distribution out of that IRA, which is taxable income to me.
Toby: I’m talking if the IRA owns it.
Jeff: Oh, no, no, there’s nothing. I agree.
Toby: Right. If the IRA self-directed, and owns the property, and you remodel it, there’s nothing to worry about deduction-wise because there’s no income, it’s exempt. But you guys go to what Jeff said. The property is outside of the IRA, and you use the IRA model, now is it deductible?
Jeff: You’re going to take the distribution, you’re going to pay tax on that distribution. If you’re under 59½, you’re going to pay penalties on it, too. That’s not the best source of income. The other side of that is, are you doing repairs or redoing remodeling? Remodeling typically means it’s going to have to depreciate over the life of those assets and that could be 27½ years. So quick answer is, yes, it’s deductible, but maybe not in the fashion that you like.
Toby: Yeah, you’re going to be depreciating it over the useful life of the asset. If it’s residential real estate, then it’s 27½ years. If it’s non residential, it’s 39 years. It’s like you’re spreading that period out. Unless you do a cost seg, if you do a cost segregation, then you’re probably going to get a bunch of it now.
I’ll just say there are two ways to get this money out tax free if the property is outside of it. Number one, you can do a 60-day rollover. Let’s say I need money, you could roll it out to yourself. As long as you put that money back in by day 60, you don’t have to pay anything on it, you’d have to remodel pretty quickly. Yes, you can write-off to remodel.
If you’re flipping a house or doing like that, or pull the money back out, put it back into the IRA, you cannot borrow money from an IRA. But you can roll your IRA into a 401(k) and borrow up half the money up to $50,000 per participant. So if it’s husband and wife, you guys get up to $100,000. If it’s one person depending how much the remodel is, let’s just say, if it’s 25,000, you can get that money pretty easily out of a 401(k). You cannot borrow out of an IRA, you can borrow out of a 401(k).
Jeff: One other thing. If you’re improving or remodeling personal real estate that is not business real estate, it’s not going to be deductible. It will add to your basis in that property. Should you sit one day, sell that property. Otherwise, that’s not going to be deductible.
Toby: What Jeff is basically saying is if it’s your house and you remodel your house, you don’t get a deduction. It’s only if it’s investment property. Let me just summarize. If it’s in the IRA, we’re not really worried about anything. If the property is outside the IRA and we’re using IRA money, that it’s either going to be a distribution in taxable penalties, if it’s under 59½, or you need to put it back in there within 60 days, or ignore the IRA by rolling it into a 401(k) and borrow the money. There we go. See? Clear as mud.
Jeff: I like that last solution.
Toby: What? By rolling it?
Jeff: Rolling it to your 401(k) if you have one, and then borrowing against it.
Toby: We need a side gig if you don’t have a 401(k). You can put 100% of your side gig and come into a 401(k). I always see these people and they’re making, you run across them all the time, Jeff. Jeff and his crew do about 10,000 returns a year. It’s crazy.
So you’re sitting there, and you’re doing a return, and we see them all the time. They have this business, that business. I see $5000, $6000 being generated and they’re like, yeah, I just did it myself. 401(k) put the whole thing in. I already did my IRA. You can do the 401(k) and an IRA, and you could put 100% of your money in there. Let’s jump that in there.
Anyway, “How many rental properties do I need to own to meet the criteria active participation, and thus apply real estate losses to active W-2 income?” What is that active participation?
Jeff: That means you own at least 10% of the property and you substantially participate in the management.
Toby: Active participation, you only have to substantially do nothing. As long as you pick the property manager, you meet the test.
Jeff: If you actively participate, you could deduct up to $25,000 of losses.
Toby: Yeah. Is it 469(c)(7) that has a active participation? I know that has the real estate professional, but there are two ways you can make passive rental losses, ordinary non-passive losses. Two ways. Number one is active participation, but it phases out. So you have active participation up to $25,000 and it phases out between $100,000 and $150,000.
Jeff: Of AGI?
Toby: Yup. For every $2, you lose $1 of the $25,000. If you make $120,000 of adjusted gross income, you would lose $10,000 of the $25,000. So you get a $15,000 with it. Then the other route is to be a real estate professional, where you can just write off 100%, but that’s a two prong test.
Jeff: Yup. The answer is still one house, though.
Toby: So you can do it.
All right, “I run a short-term rental in my home. How do I set up my short-term rental to take advantage of home expenses?” That means Airbnb VRBO. They have a room that they’re leasing out, what would you do?
Jeff: I’ll be honest, I am not a fan of short-term rentals within the home. There’s a lot of complications that come from it. If you’re also living there, you could run into the 14-day rule, which means if you live in that more than 14 days and use the same space, then deductions are limited to your income.
Toby: Your deductions are limited to your income, but you could take the proportionate amount. So if it’s 14 days or more, or 10% of the rental days. It depends on how accurate it is, but you’re going to be putting a portion of that property as your deductible amount.
Jeff: Correct. It’s hard to take losses unless it’s almost constantly rented out.
Toby: Don’t worry about that. You’re still going to get advantage. You may not be able to write them off, but you’ll carry them forward.
Jeff: Yeah, that’s true. You’re going to be making money by renting out.
Toby: You’re going to be offsetting the money you rent out. Let’s say you have a two-storey house. I’m renting out one storey, and I’m living in the bottom storey. You’re going to get a deduction for about half of the expenses of that home. But if I’m getting a $1000 net a month after Airbnb and everything, I get to take those expenses and offset that $1000 that I’m netting a month. So you’re not going to have much taxable income.
How do I set it up? Realistically, when you’re doing short term rentals, it’s an ordinary activity, but seven days or less. We start looking at the tax standpoint, I’m probably just putting the whole house in an LLC to make sure that I don’t cause liabilities for myself for the rest of my life.
Again, I’m not going to be able to hide from liability on that property. If I own a house and I’m renting out half of it to other people, short-term rental-wise, I have two things. Is it ordinary activity? Is it because I could be subject to self-employment tax? Is it still a passive activity as an investment? But I’m worried about somebody coming onto that property falling down the stairs, and suing me, and garnishing me for the rest of my life. I’ll put an LLC around it just to make sure that I’ll do it like this. I’ll put an LLC around it so that if anything happens inside that property, then it’s isolated inside that box.
Jeff: Now to be clear, that LLC, as long as it’s disregarded back to you, is not going to have any effect on any of your 121 exclusion or anything like that.
Toby: No, 121 deals, that’s the capital gain exclusion, and they deal with it in the regs, and they say an LLC as long as it’s disregarded will not cause an issue for it. It’s treated as the owner plus grantor trust. Treated as the owner. So you don’t have to worry about your living trust, land trust, LLC for your capital gain exclusion. Your homestead, you may want to look at and make sure… I don’t own homestead myself, but—
Jeff: Do you feel that’s more of a state by state issue?
Toby: That’s just the ability to take that. You’re making your homestead into an investment property, so I’d still put the LLC. You’re going to get the home expense because it’s a business activity period. It’s just what portion of all the expenses of the home that you’re going to get.
All right, Jeff’s favorite thing ever. “My LLC has mark-to-market trader tax status”
Jeff: And we’re going to get to why that’s my favorite here.
Toby: Yes. Whenever I see mark-to-market after I vomit, then I go to Jeff. “We want to take an IRA or 401(k) distribution to pay off our house and take advantage of the LLC loss to offset the distribution tax. Any advice or pitfalls to this?”
Jeff: As much as I just like mark-the-market, I think what you’re suggesting is a great idea. As a matter of fact, if I have substantially appreciated IRAs and all, I might even throw in a Roth conversion or something like that.
Toby: What Jeff’s saying is, mark-to-market with trader tax status allows you to take losses that would normally be capital losses and they become ordinary business loss. Trader status does not exist in the Internal Revenue Code. It’s been a moving target for 24 years that I’ve been following it. It was moving target before that.
It’s substantial, regular, and continuous activity in the stock market, taking advantage of short-term trends, and what I know is you got to trade on 75% of the trading days, and you got to have 750 trades a year at minimum or you’re not going to get considered. I’ve seen people lose trader status when they had $15 million a year in trades, where they had sizeable accounts. I’ve seen people who made money in the market, lose trader tax status simply because they would only trade six months out of the year, and they would go on vacation the other six months.
I hate trader status, but if you’re going to do it, that mark-to-market allows you to unlock the losses and become ordinary loss, which is good for you for this year, like hey, I have a substantial loss. Normally, you would just carry it forward. You’d get 3000, you get your ordinary income, and you carry forward the rest of the loss until you make it back.
In this particular case, what you are when you see mark-to-market with trader status, really what you’re saying is I am a business and I have business loss. It’s ordinary, active business loss. What should I do about my IRA and 401(k) distribution?
Jeff: And you can easily rely on the court cases. No, you can’t.
Tony: No, it’s an absolute minefield.
Jeff: There are lots of court cases out there and none of them say the same thing.
Toby: What they do is you gave them three ways to hose you. The judges are really good about saying, oh, I guess a business would really be doing this. I’m like, are you kidding me? I know a lot of businesses that are in business three months out of the year. We just got through Halloween. You got a bunch of the Halloween mazes, and the Halloween haunted houses, and the Halloween pop ups, and they’re selling things. You tell me that’s not a normal business?
But if you’re a trader, and you do that, and you only trade three months out of the year that you’re really comfortable in, they say you’re not a business. So I’ll just say, let’s get around that. We’ve used a multi entity structure to avoid that. We’ve been very successful of the 20-something years, and guess how many audits? None. Guess how many audits for trader status? Just about everyone of you guys gets to deal with it because they just automatically say, win for IRS. They can push it.
Anyway, the IRA or 401(k) distribution, here’s the only thing, penalties. Are you worried about penalties?
Jeff: If I’m under 59½, yes.
Toby: Okay. So if you’re under 59½, you got to worry about that extra 10%. You could offset the tax hit with that ordinary loss from your trading. But what Jeff said, which is actually genius, in my opinion, is to avoid the penalty by just converting it into a Roth.
Say I have a traditional IRA or I have a 401(k), and I know you want to pay off your house, and I get it, I wouldn’t. The reason I wouldn’t is because you’re going to save so much flipping money depending on how much the loss is. Let’s say it’s $200,000. I’m going to save $20,000 by just converting it because I’m not going to have the penalty.
Generally speaking, the home loans are 3%. It would take a long time to catch up on that. If it’s $200,000, 3%, that’s $6000 a year. It would take you about three or four years of interest. So I would convert it.
Jeff: The mortgage interest is still deductible if you can itemize.
Toby: And If I can wait five years and I can hit 59½, and then I could take the Roth money out anyway, and don’t have to worry about tax. So my five year plan would be, I’d maybe mapping this thing out saying, we are going to be better off more than likely not just paying off your home, but keeping the home debt, and putting it into a Roth, and then getting access to the Roth later.
Jeff: If I’m able to do that, I would rather do the Roth conversion and pay off the home.
Toby: Here’s one other thing you could do. It depends on whether you’re single or married and how much the loss is. If it really comes down to it, I wouldn’t take a distribution out of the 401(k), I may borrow out of the 401(k). Depending on the debt, if you’re a single person, you can take $50,000 to half the money.
Married couple, you could take up to $100,000 up to half the money, or you do a combination of the two if you want to pay off your house and still use that loss. Again, we’d get our pencils out and we would say, here’s what’s in your best interest, I’m mapping it out. Usually, it becomes pretty obvious what’s in your best interest.
Jeff: Yeah, because you would end your scenario. You could use your mortgage payments to repay that loan from the 401(k). While you may be paying interest, you’re paying interest to yourself. You’re paying your own self back with mortgage payments. I like the idea, too.
Toby: We like it. What’s fun is, end of the year stuff, we always deal with this. You can always borrow money out of something and then pay off a whole bunch of expenses ahead of time. I’m always like, your 401(k) is the vehicle. If you’re a solo 401(k), you’re nuts not to. Because hey, I have expenses that are going to be incurred in the next 12 months.
If I want to knock down my 2021 taxes, let’s say I’m in the 32% getting up there at 35% tax bracket plus my state, knock that off. Let’s prepay some things for the year. If we have to borrow it from our own 401(k), so be it. Use it to pay off some of those expenses or prepay a bunch of your mortgage interest, whatever you have to do.
Sometimes we’re looking at these things going, you’re right at the standard deduction, push it over the edge, prepay your charitable contributions. Prepay some of your other expenses, prepay your mortgage, whatever you have to. Actually the mortgage might be an issue because it would say it has to be incurred in the year, but prepay some of your expenses in e th business.
Anyway, we can do that. Let’s see. They’ve answered almost 100 questions. This was the day to join, but now we have lots and lots of people on again. In the beginning we had about half this many. But if you have a tax question by me, all means, go into that question and answer and post it. They will continue to answer your questions. I can see one here, “Are the $6000 backdoor Roth IRAs gone for next year?” Not yet. It’s on the chopping block, but we’ll see.
There’s a lot of it. There’s a lot of misinformation because the ways and means had a number of proposals come out and they were all different. Some of them had the elimination of the step up and basis, some had the wealth tax on billionaires, some of them, you get rid of the ability to have mega Roths, and then they try to get rid of the backdoor Roth, which we’re not familiar.
There’s supposedly a limit on how much you can contribute to a Roth based off your income level, like married filing jointly, what is it, 140 or something like that? But you could put it in a traditional, not take a deduction, and then roll a traditional into the Roth. You never took a deduction so there’s no tax. So that is a backdoor. You could still do the mega backdoor too if you have a 401(k). All those are still on the table right now, you could still do them.
Jeff: Even though the Build Back Better bill has been passed by the House and it’s gone to the Senate, we can’t rely on it. The Senate can totally…
Toby: They’re going to get it. There’s no way. The SALT deduction is really ticking off all the people because literally you’re giving a deduction to the top percents. Not that I like it. I don’t like SALT anyway, but…
Jeff: But I’m really confused by the SALT deduction, which party is supporting that, and which party is against it.
Toby: I know, it’s weird.
Jeff: It’s weird.
Toby: It seems like it’s backwards.
Toby: The Dems are like, hey, we really want this and it’s only benefiting the top 4%. Like 96% of taxpayers don’t even care.
Hey, guys. Speaking of Congress and speaking of changing tax laws, subscribe to our YouTube channel. As soon as something comes out, we’re posting on it. We’ll probably do a webinar too. But if you want to go to that aba.link/youtube, sign up, just go ahead and subscribe, go there, click on it, subscribe.
Just follow us. You’ll get notified. I think that’s how you do it, subscribe, then click that little bell, and it will send you stuff out. We’ll be joining on the spot for it, plus, we’ll talk about it here. By all means, you can just come in here and ask us tax questions. As you can see, we charge an awful lot for the tax advice we give.
I.e., it’s free. People say, is it really free? Yeah, we just like to give out information and share information. Usually there’s some really cool questions, and we take your questions, and we we pattern our practice, and we teach on those questions. So we take the same information. The things you’re giving is great feedback for us. We like to share it.
Jeff: To let you know how up-to-date these videos are that we put out, I usually send something to you, Clint, and Michael about, hey, did you see this and I get back, we already got a video out on it.
Toby: All right guys, Happy, happy Thanksgiving. We will answer your questions. It looks like there’s still about 25 pending, so do not worry. Have a great Thanksgiving. Be thankful for all the good stuff. We are really lucky in this country as much as we beat on each other. We are really lucky in this country. Hopefully, you guys realize that.
Anyway, we are really, really lucky. We’re really thankful to be able to teach this. We’re going back to when Jeff started and they were still using abacus. When I started was when the Internet was just coming out. The ability to teach and give out information is just awesome, so we’re so thankful that we get to share with you guys. We don’t get to say it enough, but we are. I am thankful for that. Jeff?
Jeff: Yeah, absolutely.
Toby: I’m thankful that we can eat a lot of turkey and go into a turkey coma. Anyway, see you guys next time.
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