It’s Tax Tuesday again, and today we’re mixing it up – this episode is hosted by Anderson Advisors’ Michael Bowman, Esq, who welcomes two of Anderson’s expert tax pros, Eliot Thomas, Esq., and Kurt Bergfjord, Esq. And as always we’ve got our talented and experienced tax advisors manning the chat questions in the office.
On today’s episode, the guys review all the documents and receipts that you should be gathering up in preparation for filing your taxes, and answer multiple listener questions around the pros and cons of C-Corps, S-Corps, Partnerships, and the audit magnet – Sole Proprietorships. The discussion also covers our episode title question – are there benefits to putting your primary residence in a trust – which is really only for asset protection and estate planning – there are no tax benefits to doing so.
If you have a tax-related question for us, submit it to taxtuesday@andersonadvisors.
- “Even if I show income on my tax return from rental and business activity as a sole proprietorship, and self-employed but no taxable income because I use my large net operating loss to cover all taxes, is my income still considered income or will it be a hindrance as far as getting an investment loan or home equity line?” – It depends – Some are going to look at this, it will ding you, and you won’t be able to get a loan. Others will take it into consideration and analyze the tax return.
- “I currently have two LLCs in California that I file as a partnership. Should I create another LLC as a holding for both LLCs? And should that be disregarded or filed as a partnership as well? Of course, there is the additional cost of $800 for California as well. What’s your suggestion?” – from the legal point of view, it might be a better idea to have that holding company and all those assets coming into it.
- “How can a full-time LP investor in private equity in real estate syndications as well as stock investor utilizing options for income, structure such as to offset income of these activities with expenses, syndication conferences, to vet sponsors, subscription services, travel for investment briefings, computer equipment, expenses, et cetera? Assets are held in a Wyoming LLC and property trust for the stocks. Would a management C-corp make sense having one ‘client?’ I am aware of people in my circumstances that write off expenses on their schedule C, but I recall Anderson doesn’t recommend that.” – If we could utilize that management corp, maybe we can capture some of those benefits that you otherwise wouldn’t be entitled to.
- “How is REPS applied to a tax return?” – If you are a real estate professional (REP)for all intents and purposes, then you can actually turn that otherwise passive income into non-passive income. I’s going to be on Schedule E page one or Schedule E page two if you have a K-1
- “We have seven rental properties set up with the ABA structure. My husband works full-time for the government. I manage our home and rental properties. Two properties are mortgaged, the rest are paid for. Now, both in our 50s, we’re financially comfortable with a large cushion. We got retirement funds, mutual funds, properties, kids, education funds, et cetera, but we are getting killed in taxes every year. I feel like we are working to pay taxes. We don’t live extravagantly, and still drive the same cars for 10–15 plus years. Taxes feel like a punishment for saving when we were younger.” – Ideas to save on taxes include becoming a REP, depreciation, cost-seg study, there’s even a nickname- “short-term rental loophole”
- “What are the tax benefits of putting my primary residence in a trust?” There is no asset protection, but if it’s in the right kind of revocable trust, then we still get to take advantage of our section 121 of tax exemption from gains on the sale of your primary residence—$250,000 single, $500,000 married filing joint.
- “I want to be as anonymous as possible. What is the best business structure and ways to submit taxes? I do not want the tax info to flow down to my personal taxes.” – When we talk about anonymity, anyone looking at your personal tax return is really not going to have too much of a purview into your business activities.
- “Should I do a cost seg for a condo?” It depends – Have you had it for a while? are you a REP? Are you renting it out? Have you been appreciating for a while?
- “What is the best corporate structure to have in place that can also allow for tax savings?” We’ve covered this – C-corp, S-corp, partnership, and then the worst would be sole proprietorship.
- “What tax incentives are there for real estate investors to not have to pay an absurd amount in taxes?” – REP status, short-term rentals, cost seg studies, 1031 exchange, keep good books!
- “As a real estate investor opening my first LLC, which is the best for me to use, S-corp or C-corp? – it depends – do not put appreciating property in a C-Corp, but C is good for short terms or flips.
- “I started my LLC last year to begin my search for buying a business or real estate. Currently, I am a W-2 employee while I get started. My question is, can I write off any expenses since I did not make any money in my LLC? We’ve incurred expenses, but I don’t have any income.” – was it open for business, or are you in the exploratory phase? timing on when to deduct may be more important.
Full Episode Transcript:
Michael: All right. Welcome to Tax Tuesday. We’ll let everyone come in and start joining us. I got a cool show today. You guys have seen me a couple of times. Generally, when we’re out in Hawaii, Toby grabs me and we’ll do a joint one. Today I’m taking it over for the day, and I brought a couple of excellent tax professionals.... Read Full Transcript
I’m getting hellos from people. Sherry Brody, my gosh. How long have you been a client, Sherry? Robert Goose. I remember, hey. Oh, my gosh, 12 years, yes. I still remember when we met, that was fantastic. That’s a really cool thing. We’ll get into this as people are getting in.
Just to give you guys some background information, I started with Anderson in 1999 when I did litigation and came back after doing plaintiff’s work, defense work. Being in litigation, I wanted to get on the front end, plus with taxes, all these threats against us as investors and business owners. I really wanted to get it on the front end. Another desire is to help people and prevent them from making mistakes I was making in my own investing, in my own businesses. To do that, you have to have a good understanding of the tax code.
A lot of people look at the tax code as restrictions. I look at it as gifts, a weird way to look at the tax code, but gifts. John, hey, how are you doing? It seems when we do these events, it’s like a big family reunion.
It looks like a lot of people have already joined. It slowed down. I really wanted to get started as quickly as possible. The reason why is we are going to mix it up a little bit. With me today, I’ve got Mr. Eliot Thomas. Eliot, why don’t you go and say hi to everybody?
Eliot: Hello, welcome. Eliot Thomas, Manager of the Tax Advisors. I’m coming from Las Vegas, and we have two of our team here up in Utah.
Michael: Also, Kurt works in my office. Kurt, why don’t you go and say hi to everybody?
Kurt: Hi, everyone. My name is Kurt Bergfjord. I’m a tax advisor here up in Utah with Michael.
Michael: I roped Kurt into doing this last week towards the end. The reason why is inside the office, all the attorneys here and everyone up here in the Salt Lake office, are constantly funneling in and out of Kurt’s office. I went in and I said, hey, we’re doing Tax Tuesday next week. Do you want to join in? He said, can I? I said, can you!? Yes, please do.
I really enjoy working with Kurt. I’ve appreciated his acumen. I think it will shine and show throughout this next hour that we’ll be on this. To start off, again, what we’re looking at doing is bringing tax knowledge to the masses. We’ve got a list of questions that Eliot, Kurt, and I went through.
What we did was we picked the ones that were most relevant at the time. There are different things that are relevant throughout the year. In putting this list together, we decided, hey, you know what? Tax season is coming up. One of the things that I’ve done and most of our clients have done is procrastinating. Someday I’ll get to it. Someday before April 15th, I’ll get to it. Someday I’ll get to it. Someday I’ll get to it.
I think we’ve all been in the situation that on April 14th, we are basically scrambling around trying to gather stuff up. What we want to do to start this off is we want to go through the things you guys should be collecting right now so that you guys are in a position, being April 14th and you’re going through bank records and boxes. Shoe boxes are what a lot of people do. We’ve compiled a list that we want to go through, share it with you guys, and talk about it. Basically, what we’re doing here is putting it on nowaday island that you guys will go ahead and start putting things together.
I’ve told the story. Probably some of the people on here have heard this. The worst thing that ever happened to me for the tax deadline was I had an organizational system that was pretty asinine being that I was in Arizona.
What my system was for keeping receipts was I would walk in the door and I pull out the receipts. It was a bilevel basket. I put the business receipt on the top. Anything personal would come up that I thought I could write off on the bottom of this bilevel basket. It’s probably April 13th, April 14th, I go and I say, I’ve got to start doing my taxes, I got put all this stuff together.
I can remember just like yesterday, what had happened was this basket was next to a window. If you guys know, receipts are on thermal paper. Throughout the year and being that it was Arizona, those receipts were no longer legible.
What it made me do was go through bank records, credit card statements for the entire year, and try to recreate a picture. Now there are some rules regarding keeping receipts. I never got audited that year, but I know one thing for certain is that I overpaid in taxes, and that’s a problem.
What we need to do is keep accurate books and records. That’s why we offer virtual bookkeeping, but we want you guys to start gathering information now because if you guys wait and procrastinate, you will overpay in taxes because you won’t be able to create a clear picture and you’ll forget things. What usually happens with clients is they will say, hey, I just found this receipt. Can I go ahead and do an amended return? We’ll say, well, it cost this much and it’s probably not worth it.
We put together a list. We want to go through what you guys should be gathering and collecting to prepare your taxes. The first one’s probably the easiest. I’m going to take this one, it’s your W-2 forms, and they should have already been sent out. You guys should have received them by now. These are what, if you’re working a W-2 job, you’ll get from your employer. And then any 1099 forms. Kurt and Eliot, if you guys want to discuss the 1099s and who you should be looking out for for the 1099s, go ahead and put it in.
Eliot: Kurt, I don’t know about you, but I’m thinking, probably the most common that we run into is for the independent contractors. Any thoughts about those?
Kurt: If you were an independent contractor in 2022, most likely by January 31st, those customers should have sent you a 1099 telling you exactly how much income you had so that you can report it accurately on your tax return. It is a requirement that they usually send that to you. Those should be trickling in. They should be in by now, actually. You should have already had them. They should have been in by January 31st already.
Eliot: Excellent. For those of you who maybe don’t understand you have your employee W-2 that Michael was talking about, if you’re an independent contractor, that’s where you’re going to get that 1099 that Kurt’s talking about.
There are actually probably over somewhere close to 14 different types of 1099, but that’s one of the most common. They now have it as a 1099-NEC, I believe it is. But we have the other 1099s, maybe interests and things like that that could come in if you received interest income. Also a popular form for a lot of people is their mortgage interest. I believe that’s the 1098. Is that right, Kurt?
Kurt: Yup, the 1098.
Michael: IRS is really original. If you got 1099s and then 1098s, I think all of us on here have had a 1098. Your student loan interest would be one of them that we’ve had to deal with and mortgage loan interest, for sure.
Eliot: Absolutely. Whether or not we can deduct that will depend on whether or not you’re itemizing on your return. But getting back to the facts of what we’re looking for here, one thing that we noted on our list are the receipts, various businesses and things like that. Kurt, how are you going to take deductions if you don’t have receipts?
Kurt: It’s going to be a lot harder to prepare your tax returns if we don’t have receipts. Obviously, you want to be categorizing both your income and all your deductions. If you don’t have records of that, it’s going to be very hard to substantiate those deductions in the unlikely event an audit were ever to occur.
Michael: This is going to be kind of fun. Everybody who’s ever heard me speak, every conference I’ve ever taught, I talk about an acronym for deciding whether or not an expense is deductible. In chat, let me see who knows what acronym I’m thinking about. Anybody out there? It’s a four-letter acronym, starts with a C. CORN, there we go. Listen to this, these guys are all my people right here.
People have put that in there are rising up there. When you go out and you wonder yourself, hey, is this an expense I need to keep the receipt for so I can deduct it? Follow CORN, customary, ordinary, reasonable, and necessary. I always, to this day, use it. In fact, I was at an event just this last month. A person came up to me and said, Michael, that’s corny. I’m like, hey, it is, but it works for me.
Like Eliot and Kurt said, keep those receipts. I’d prefer you guys do bookkeeping. Troy is on here. Most of you guys have virtual bookkeeping, if not, look into it because if you’re not keeping accurate books and records, you will overpay in taxes because you won’t remember everything, receipts get lost, and things like that. Some of the things you need receipts for, charitable donations, medical expenses, business expenses, that follow CORN, would be a new one.
The other thing you guys need to take a look at is your investment transactions. They’re very, very important. Your broker should send you out statements on your trades. It’ll be quite a lengthy report. Most of the online brokerages will do that for you.
Something that’s very important—Kurt, we were talking about this last week—looking at your state and local tax forms, and making sure they’re filed on time. Kurt, actually, why don’t you tell them about New York and one of the problems we had out there, or one of our clients had a problem with a past tax professional?
Kurt: That was a thing where a client came to us in prior years. We started filing their tax returns about mid last year. But before they came to us last year, they’d had their prior accountant file an extension for their tax returns for them. This individual had done some business in New York, had had to file a New York state tax return, but the prior tax professional did not file a state-level extension. The federal extension was filed, but the New York State extension was never filed.
We are spending time in February today trying to clean up the penalties and interest because when New York state didn’t see that a proper New York State extension was filed, they assessed the client a big penalty on that. It’s just something to keep your eyes out for. Certain states would require a specific state extension, where some states will just allow and follow the federal extension.
Michael: Again, if you’re doing business in other states, that’s something you don’t want to overlook. If you ever own properties in other states, you’ll have to do a return in those states also.
Here’s a great question. Actually, two people have it. Okay, I don’t have the receipts, which, that happens. I’m going to ask Kurt and Eliot what they think from a tax professional standpoint. Can credit card statements be okay?
Eliot: We typically accept them if they have enough information showing who the other party was, the amount, if it’s broken out, or if it’s just a large dollar amount without a whole lot of specificity to what exactly is making up that amount.
Eliot: Right? There we go. Yes.
Michael. We always deal with that one. It’s a running joke. Hey, a client just turned over a receipt to Costco for $1200, and they’re claiming it was paper towels for the office.
Eliot: Yeah, looking for receipts to see if there’s a breakout of all that was there or not on the statement, which usually there’s not. Ultimately, they say you have to have receipts. That’s the IRS rule. But does that mean that they won’t accept some of the credit card statements if it has enough info? I think they probably will. You wouldn’t want to rely on that if you didn’t have to, but it’s better than nothing, that’s for sure.
Michael: I think that’s a good point, Eliot. Write down even on that statement, who, why, what, where, especially if it’s business related. Who was there? Why was it important to the business? If you just outline the scenario.
It’s always my opinion in an audit. The more information you have written down, the more plausible you are. An IRS agent doesn’t want to waste their time over looking at things. If they see that you have the support, they’re going to move on to the next victim, I guess you can say.
Kurt: If you are under an audit at any time, you want to make it as easy as possible for that auditor. As much detail as you can provide them, the receipts, the QuickBooks records, and things like that, they’re going to see that all your deductions are right in line, your incomes are right in line. As Michael said, they’ll just want to move right on to the next one because they have a list of cases they want to get through. If you can make it easy for them by having good books and records, it’ll be good for everyone.
Eliot: Exactly. Just to loop back real quick to something we talked with what Kurt just brought up talking about the business records, if you have your own sole proprietorship or something like that, we often talk about clients. Maybe making sure you have a good set of books or a profit loss statement.
If anybody out there is having problems about how to categorize these expenses, you certainly can give them to your preparer. It’s going to cost you a lot more money because they have to categorize all expenses. More time, more costs.
If you ever go to just google IRS Schedule C, there, you’ll get a nice breakout of various expenses on that schedule. I often tell clients to just use that as a roadmap because that’s what your return is going to look like. That will help you organize, categorize, et cetera.
Michael: For sure. All right, Eliot, why don’t we go ahead and jump into the questions that we’ve selected? Again, we picked ones that were really pertinent to what we’re going through right now and beginning of the year and questions that have just been coming up with clients, what we’ve been working on. Here’s one. Eliot, why don’t you go and read it and then we’ll discuss it?
Eliot: All right. “Even if I show income on my tax return from rental and business activity as a sole proprietorship, and self-employed but no taxable income because I use my large net operating loss to cover all taxes, is my income still considered income or will it be a hindrance as far as getting an investment loan or home equity line?”
Michael: A lot of people are in the same situation. In fact, what’s funny is it’s a balance. Eliot and Kurt, you guys probably run into this all the time. It’s almost a badge of honor to have your clients not pay any taxes, or just balance all those expenses out. In many clients, we look at it and say, oh, my gosh, I don’t have to pay any taxes this year. I’m showing a loss. Now this is even better. A lot of accountants have that badge of honor. The problem is that we’re dealing with third-party financial institutions.
We’ve run into this. We raised our affairs from a taxwise standpoint. It showed that little or no income. We saved in taxes, but then getting a loan can be somewhat tough.
Here’s where it really comes down to. There are credit unions out there, there are some financial institutions that are pretty astute when it comes to this, and there are some that are not. Some are going to look at this, it will ding you, and you won’t be able to get a loan. Others will take it into consideration and analyze the tax return.
The answer is it depends. It’s going to depend on the lending institution that you go through. Again, the reason (I guess) to show a profit is to get loans. That’d be one reason. Or maybe even consider an alternate business structure so it doesn’t hit your personal return, so you get things like a home equity line of credit here. The other thing why you want to show a profit is that you’re able to make contributions to a retirement account.
I don’t know if you guys have anything else on that. It’s always a balance for business owners, especially when you’re running into a sole proprietorship, S-corporation, partnership, things that flow down to your personal return and offset your personal income. The answer to this question really is going to depend on the lending institution, basically.
Eliot: Kurt and I, actually, we talked quite a bit about this topic. As far as from a rental standpoint, just as Michael mentioned, depending on your lender. If your lender is more savvy, more used to the real estate business, they know.
For instance, if you did bonus depreciation, that often causes a big loss. Some of the lenders will recognize that and they take that out of the equation to understand that that’s a different kind of deduction that’s not really operational from the standpoint of cash flow. To Michael’s point, you get a lender that’s a little more wise and experienced with dealing real estate. That’s what you’re looking for.
Kurt: Just to piggyback off that, sometimes when you’re looking at preparing your tax return and you know you’re going to need a loan, maybe not this year, maybe you want to minimize your taxes this year, but in the next couple of years, you’re going to be going out to get a loan, so It might be wise to show a little bit more income in this current year and then maybe next year. Because if you know in two or three years you’re going to want to get a loan, they look at the last two years of tax returns generally, I think. Just want to keep in mind that forward-looking thinking and planning that out if you’re going to need financing in the future.
Michael: Kurt nailed it. Yeah, we should always be thinking out and planning. Obviously, we don’t want to pay that much in taxes and we want to actually pay our fair share, but we have to look at it from a business standpoint. Kurt, absolutely right. If you’ve got a need for financing that you know is going to come up in the future, you need to start preparing for that.As we’ve all found out, once you go into and you start the process, it becomes too late because everything’s historical, and we can’t go and recreate things.
All right. This next question, I thought it was a good mix between law and tax. There’s some balancing going on here. Eliot, go and read it, and we’ll dissect it from a couple of different views.
Eliot: “I currently have two LLCs in California that I file as a partnership. Should I create another LLC as a holding for both LLCs? And should that be disregarded or filed as a partnership as well? Of course, there is the additional cost of $800 for California as well. What’s your suggestion?”
Michael: I’m interested to see what the tax professionals say first and then I’ll give my two cents.
Kurt: I think you could go either way. I think a holding company generally is a good idea. Again, probably from the legal point of view, it might be a better idea to have that holding company and all those assets coming into it. It might consolidate filings, especially if that holding company is disregarded.
Those two LLCs, we might be able to change into disregarded entities. Instead of having them currently as partnerships, those would then funnel down into the holding company, which then could be just disregarded itself on your personal tax return.
When you talk about the number of tax returns to be filed, we certainly could cut down that a bit. Again, that’s going to save you money on the actual tax preparation, but there are also might be reasons to keep them as partnerships as well.
Eliot: Exactly. From the partnership standpoint, if you can consolidate, that typically might be a better solution. Obviously, for all the things Kurt just mentioned—fewer returns, little more clarity, ease of preparation, et cetera—there could be another reason depending on who the other partner is on these various LCCs that might make a difference on how we would structure. But certainly, we’d like the idea of maybe having an overarching holding company up the top, if possible. I’ll let Michael handle that.
Michael: It’s always fact and term-specific on this. But when I looked at that they have two California LLCs that they both are filing as a partnership, so there are two tax returns. Why not make them both disregarded coming down to a partnership if there is another person as opposed to just a spouse? Your accountant may not be recommending this because they like you to have more entities to have more tax returns to do, but you could consolidate it down.
I think the $800 with California, it’s just a cost of doing business. It is what it is. Don’t get hung up on the $800. If you went ahead and made both the two LLCs in California disregarded, brought them down to the holding company, and if you’re a married couple, you can make that disregarded or you can keep it as a partnership, then you’re basically having one tax preparation fee because the other ones are disregarded, the only one we’re filing one, one return that could get audited. From a taxwise standpoint, I stand by Kurt and Eliot.
One thing that I would recommend is that if these are rental property LLCs, what I would do is I would absolutely form that holding LLC. The reason why is now we’re bringing the charging order protections with Wyoming. If we go ahead and create a Wyoming holding LLC, now we’re charging more protections into the play of any litigation that goes on with you guys, personally.
If I read this and didn’t have any other facts, which I don’t, I would say, yeah, go ahead and have both of those LLCs disregarded down to a holding LLC. If there’s another partner file as a partnership, or disregarded if it’s a married couple and you don’t want to consolidate. That’s the way I would look at it.
I think there are a lot of variables that we addressed, but the bottom line without any further facts or circumstances being played into it, having both those LLCs disregarded down to a holding company makes sense from a taxwise standpoint and also from a legal protection standpoint. That’s the way that I would do it, for sure.
Eliot: Perfect. Any more thoughts there, Kurt?
Kurt: Also just stepping back to the funding, if you’re going to be going up for a loan, I’ve heard this as consideration. If we just leave all those LLCs disregarded, all that rental income, rental expense, is going to be reported right on our personal tax return. That’s going to give a lender an opportunity to really pick and nitpick at the expenses, at the revenue of the various properties.
If instead, that holding company was filed as a partnership, that’s going to go to page two of Schedule E. That’s just going to be one number. It’s very hard to tear apart one number being reported on a tax return as opposed to however many numbers would be warranted if it was all disregarded.
Michael: I think that’s awesome insight, absolutely. It’s interesting how things correlate to other parts of our businesses, and that’s what we have to look at. Like I said, working with Kurt, he’s always bringing out these points that, oh, wow, all right, I can see how that’s beneficial. Good job.
Eliot: He’s got the eagle eye for it, no doubt.
All right, next. “How can a full-time LP investor in private equity in real estate syndications as well as stock investor utilizing options for income, structure such as to offset income of these activities with expenses, syndication conferences, to vet sponsors, subscription services, travel for investment briefings, computer equipment, expenses, et cetera?
Assets are held in a Wyoming LLC and property trust for the stocks. Would a management C-corp make sense having one ‘client?’ I am aware of people in my circumstances that write off expenses on their schedule C, but I recall Anderson doesn’t recommend that.”
Michael: I’m going to throw out the low hanging fruit here and then we can dissect it. You’re doing private equity, so you’re an investor there. You’re doing syndications, stock investors, so you are doing management activities. You’re constantly doing ROI analysis. You’re looking at the best use of the money. You’re looking at the different conferences. The third party is that C-corporation and is doing services for the LLC. I think putting that management company from the facts we have would make sense.
Kurt: Yeah. Just to go off that, as an LP, you’re generally passive in nature. You might be limited on the, going back to Michael’s customary, ordinary, reasonable, and necessary. Some of those deductions that you could otherwise have, if you had a management company, might not be available to you as an LP.
Similarly, if you’re just an investor, you’re trading and things like that, some of your deductions might be limited. If we could utilize that management corp, maybe we can capture some of those benefits that you otherwise wouldn’t be entitled to. We can pay a little bit of the profits from those LP interests, from that stock trading activity, into that management C-corp and really put it to use for you.
Eliot: Kurt, we get that money into the C-corp, we’ve probably taken some money off our personal return, and now it’s in the C-corp. What might be some of those advantages in the C-corp that you can think of to help the client out?
Kurt: I always like to start at the easy ones, 280A. Rent your primary residence up to 14 days, tax free. You can rent your primary residence to your corporation to have corporate meetings. That income is tax free to you, and it’s a deduction to the corporation. We just started chipping away at that income that we’ve shifted over to the C-corp, and 280A is a great place to start.
Next place I’d look is the accountable plan, all those business expenses that you have—cell phone, internet, home office and things like that, subscription services. If you’re an investor, you’re always looking at different kinds of things and have subscriptions and things like that. That C-corp is a great way to have that C-corp reimburse you for expenses that you probably were incurring anyway but not really getting a benefit for.
Michael: What you just said, Kurt, just made me smile because I remember putting my management corporation in there and moving a lot of the expenses I was paying for personally. I think everybody on this knows there’s a difference between the personal tax code and the business tax code or the corporate tax code. Personal tax code is earned, I get taxed, and then spend what’s left over. Corporate tax code is earn, spend, and then get taxed.
When I started to put things into the corporation, they were things that I was already paying for personally, and then I moved them over to the corporate expense side of things. I was astonished about my personal accounts, how much money they had in them versus what they were before before I moved over.
It made me smile when you said, hey, you’re already paying for this stuff anyway, just you got to link it as being a business expense. Everyone should follow CORN on that.
Kurt: Another great example of something that you’re usually not getting a great benefit for that we can utilize in that C-corp is those medical expenses. With the Health Reimbursement Arrangement, most of the time, on your personal return, medical expenses only in excess of 7½ percent are going to be deductible, and that’s only if you itemize your deductions.
However, if you have a management C-corp, any medical expenses, out-of-pocket insurance premiums that you pay for you, your spouse, and your dependents, can actually be reimbursed to you, and they become deductions of that C-corp. It can become a pretty powerful tool.
Eliot: Kurt, you’re telling me then that we do these things on our C-corp. What happens if I don’t follow Anderson’s advice and I go ahead and put on my Schedule C? What happens to my 280A, my medical reimbursement, and my accountable plan?
Kurt: The reason we don’t recommend it is because the Schedule Cs have the highest audit rates. Things like 280A, I don’t even think they would be available to a Schedule C because they’re not a separate taxpayer. A C-corp is a separate taxpayer. A Schedule C, a sole proprietor, is the same taxpayer. A lot of those things that would be available to you are as easily captured if you just put them on Schedule C, plus they put you at a higher audit risk.
Michael: I like that part of it. Thinking outside the box, higher audit risk. I always think back, business expenses are big along on a business return. I think that the IRS back in the 80s started to realize that, hey, things that go on a personal return because it minimizes the personal taxes that people take liberties with. I said, hey, you know what? If we want a rich hunting ground, why don’t we look at Schedule C and we’ll just start popping people?
I even remember hearing about the crazy 80s in more ways than one, I guess we could say. Also, just from a taxwise standpoint, people forming S-corporations, writing everything off, and having no income, I guess the people in the 80s ruined it for all of us.
Eliot: Pretty much. All right, great points, Kurt. Are we good on that one, guys?
Michael: I think so. I think it always comes back to just being taxwise. I think that moving things over on a corporate return and keeping them off your schedule C is just the difference in the allotment of expenses that we can move through a corporation as opposed to us doing business underneath our own name as a sole proprietorship.
Eliot: Speaking of taxwise, a shameless plug. A week from this coming Thursday, we’re going to have our third episode of the new taxwise, and Kurt will be there with us. We’re anxious to have you guys all there. Everyone can join.
Anyway, continuing on, “How is REPS applied to a tax return?” I assume we’re talking about real estate professional status. What do you guys think?
Michael: This seems to be in the tax community as something that people will keep talking about. I think that it’s probably also been mentioned on Tax Tuesdays, probably every other event. It’s a very popular thing out there. You just have to make sure you actually hit those qualifications. There’s a proper test out there, and the IRS will audit. Let’s go ahead and look at the return and where it’s applied.
Actually, let’s go ahead and get the test. Eliot or Kurt, why don’t we break down the test? We won’t get all the nuances of it, but let’s go ahead and give the basic test.
Kurt: I think the problem with a lot of rentals, especially with generally higher income earners, is rentals are per se passive. That means any rental loss is not going to really help you offset your wages, your regular business income, interest, dividends, capital gains, things like that.
The IRS does actually have this section in the code that says if you’re meeting certain tests based on time requirements and you are a real estate professional for all intents and purposes, then you can actually turn that otherwise passive income into non-passive income.
The great thing about non-passive income and losses is that non-passive losses can actually offset active income like W-2. It can actually be a very beneficial tax mitigation technique. But there are some requirements for it for sure. First off, you’re going to need to spend at least 750 hours in real trades or businesses. You’re going to want to document that time very diligently.
Michael: Documentation is huge. And yes, they do ask for it.
Kurt: The log is going to be very important. Just like we were talking about having good records of your business expenses, documenting your time is going to be really your saving grace there, being diligent about that, so 750 hours in real trades or businesses. You’re actually going to have to also spend over 50% of your time in the real trades or businesses. If you’re a surgeon working 90 hours a week, just know that you have to spend 91 hours a week also in the real trades or businesses. This isn’t always for everyone, but certainly, there are a lot of tax benefits to that.
Those were the first two time tests. Also, what often gets overlooked is you also have to materially participate on all your rental properties. There are a couple of different ways to meet material participation, but that is also going to be a requirement to turn that passive rental income or loss into non-passive rental income or loss.
Michael: We’ve got a question here hitting that. Can a wife who is a REP use her losses to offset W-2 income from the husband? Why would you say spouses of these two?
Eliot: Yeah, absolutely they can.
Michael: Many cases and many spouses do that. I’m not sure if the REPS spouse appreciates it all that much because then they’re going to deal with tenants and toilets. But you’re getting a tax deduction. Maybe I’m going to try to prepare my wife for this in the future. But you are getting a tax deduction. Just remember that when you unclog the toilet, honey,
Eliot: Good luck with that one, okay, Michael?
Michael: I know, right? That was a really good way to explain REP status. I’ve heard it explained in so many different ways, but I love how you put the foundation in it and then built on it to the technicality of the test. Where do we account for this?
I guess the heart of the question is, where is it applied on a tax return? What forms? Where do we put it? How do we go ahead? We’ve qualified it, How do we go ahead and get it on the tax return to benefit from it?
Eliot: It’s a regular rental activity, so it’s going to be on Schedule E page one or Schedule E page two if you have a K-1, if you’re doing it through a partnership. We don’t really change the placement on the return. It just says if we have a loss instead of it being passive like Kurt was talking about at the beginning of the question, this will now be non-passive or active, and that loss will simply be a deduction against other ordinary income on your return, your W-2 income or what have you. We don’t change the placement, still Schedule E page one or two but just a very much different impact.
Michael: All right, next question.
Eliot: Okay, “We have seven rental properties set up with the ABA structure. My husband works full-time for the government. I manage our home and rental properties. Two properties are mortgaged, the rest are paid for. Now, both in our 50s, we’re financially comfortable with a large cushion.
We got retirement funds, mutual funds, properties, kids, education funds, et cetera, but we are getting killed in taxes every year. I feel like we are working to pay taxes. We don’t live extravagantly, and still drive the same cars for 10–15 plus years. Taxes feel like a punishment for saving when we were younger.” A lot of people I think can relate.
Michael: A lot of people feel that way, absolutely.
Eliot: Right, a lot of pain there. “What are some ideas to help us save on taxes? Deductions, we have a C-corp. We are having ABA or Anderson do our taxes again this year. Is there anything else that we can do in 2023 to help?
We are open to the idea of another property, possibly a vacation rental. Would this help or hurt our situation? Can I deduct medical expenses, copays, et cetera? I have a real estate license and work very, very part-time for a property management company. I’m not interested in working full-time as a real estate agent, but would be open to expanding this.
What are some of the ways I could reach the required 750 hours that Kurt was talking about in the last question, but not as seller’s or buyer’s agents? Are there any deductions for part-time real estate employment?” A lot of stuff in there.
Michael: Even here in chat, there are a lot of surgeons, doctors, who have their spouse qualify for REP status. That’s something to look at. You’ve got seven rental properties. Start keeping a log of all the time you’re spending on managing them. In seven properties, I think you’re getting to the point where you might be hitting that 750 hours. You might be surprised. If you did keep a log, you might be there.
Maybe look at using the corporation and seeing how much you’re paying that corporation for the management duties would be my two suggestions there. I don’t know what you guys think.
Eliot: Kurt, we often talk about, when it comes to rentals, having that depreciation deduction. There might be some more favorable types of depreciation than just running the mill straight line. Any thoughts there?
Kurt: It looks like we got seven rental properties, but we’d be curious how much depreciation has been taken on those and how long we’ve had those. If you’ve had those for 25 years or so, maybe a lot of that depreciation has been taken.
Maybe in the last couple of years with the markets changing, you snapped up a couple more of those rental properties, and you have a lot of depreciable base left in there. We might be looking to maybe get a cost segregation study done.
Michael: That’s what I was thinking, too.
Kurt: Seeing how much depreciation we might be able to front-load into these current years, especially you said you’re in your mid 50s, you still have a W-2. It would be good if certainly, maybe you could get REP status this year.
We’re still in February. That means you have plenty of time to start planning that out, start documenting your hours, as we march through the year. That paired with front-loading some of the depreciation. If we could get REP status and create a large active loss for a real estate professional, that might be really beneficial in 2023.
Eliot: Even if maybe they couldn’t get there, I saw them mention maybe getting a vacation rental. Maybe we do a short-term rental. Do you think that could maybe be in the mix if we can’t get that REP status?
Kurt: Definitely. If you’re not quite ready for the real estate professional high bar, maybe looking at some short-term rental Airbnb situation that we could add to the portfolio.
Michael: There’s even a nickname, short-term rental loophole. It’s actually calling all throughout the Internet. Everyone’s touting it. I don’t know if my wife would ever go for that, going over changing sheets, cleaning it up, and the work on that. Absolutely, though, I think that these are all the things we need to be taking a look at.
I love how we just put a realistic spin on this and really be honest. You got to take a look at it a little deeper. How long have you had the property or the properties? How much depreciation is left? Is it going to be cost effective to do a cost seg?
The one good thing is most of the cost seg people out there, they will do an analysis, make sure that it is worth what you pay for it, and you get about three times back.
Eliot: To that short-term rental loophole, as Michael pointed out and that Kurt was talking about, you could still go back to what Kurt was talking about with the depreciation, a cost segregation on that one unit, a short-term rental. Maybe some bonus depreciation might have a nice loss there if we can’t get that REP status. You have options here, potentially.
At the very end, are there any deductions for part-time real estate employment? If you’re the one managing your short-term rental, you won’t have to worry about all those other tests that REP status gives you for the long haul. That might give you a shortcut there.
Kurt: Just to go off that, I think in terms of the hour requirement, a short is I think 100 hours involvement in a short-term rental property. You get it in the second half of the year to get it up and running. You have a little bit of short-term rental income, and then we look at doing that cost segregation, front loading a lot of that cost into this year, producing a nice loss in 2023. Certainly, if we still have a W-2 in play, that could really lower your taxes in 2023.
Eliot: Anything else, guys?
Michael: I think we’ve covered it. Not interested in working as a full-time real estate agent, maybe expand it a little bit using those hours. Not as a buyer’s or seller’s agent, I can understand that. I think we’ve covered it pretty well.
Eliot: All right. Next, “What are the tax benefits of putting my primary residence in a trust?”
Michael: I had to get this one, I had to grab this one because a trust is a trust. There are two kinds of trusts out there. There’s revocable and there’s irrevocable. I’m assuming that this is going to be a revocable trust, like a land trust or a living trust. I grabbed this question, just because it’s a question that we get from a taxwise standpoint, but we also get it from a legal standpoint.
Hey, is there asset protection with a living trust or land trust? The answer is no. No legal protections from a revocable trust, such as land trust or a living trust, which most people put in there. Really, from my standpoint, and we might want to talk about QPRT or something, but I just wanted to share with everybody out here, no. Nothing from a tax benefit from doing a living trust. There are maybe a couple of exceptions. What do you guys think?
Eliot: I would say that nothing on the asset protection side. Generally speaking, they aren’t revocable trust, as Michael pointed out. You’re looking at basically a disregarded entity, it’s just going to flow right through. We don’t really have a tax consideration in that. But if it’s in the right kind of revocable trust, then we still get to take advantage of our section 121 of tax exemption from gains on the sale of your primary residence—$250,000 single, $500,000 married filing joint—as long as it’s the right kind of revocable grantor trust, then we can still take advantage of that.
Michael: A revocable trust is just going to flow down. It’s like the IRS doesn’t even see it. Right now, the estate exclusion for federal is about $22 million, just over. If you have a $22 million residence, we’re probably going to do some other planning with you in maybe putting in an irrevocable trust. The IRS doesn’t giveth without taking away, so we need to be careful of that for sure.
Eliot: Anything you wanted to add, Kurt?
Kurt: I think certainly, if your asset levels are getting that high, but you do get that question a lot, should I put my primary residence in a trust, generally, certainly for a lot of people, that is not really going to have any tax benefits. Certainly, if your assets are getting up to that $23-, $24-, or $25-million-level when you’re looking to pass, then we might be looking at doing something with the primary residence and the trust. But generally speaking, we’re not going to try to do that without some significant planning.
Michael: We do it for privacy reasons and for estate planning. Those would be the two reasons, not from an asset protection standpoint or from a taxwise standpoint, but from a privacy absolutely and obviously for estate planning.
Eliot: All right. Next question. “I want to be as anonymous as possible. What is the best business structure and ways to submit taxes? I do not want the tax info to flow down to my personal taxes.”
Michael: I got a kick out of this question. Because the IRS wants to know responsible taxpayers. I’ll let you guys do a taxwise standpoint on this. Privacy is really important to our client and it’s important to me as a litigation attorney keeping your name out of public record, but the IRS is going to want to know who you are.
Don’t be alarmed at it. It is what it is. We’re not cheating on our tax returns. We’re not committing fraud. There is one entity out there that I can think of that we don’t want the income or loss to flow to our return. There’ll be I think one entity out there that would do it. What do you guys think?
Kurt: We’re probably looking at some kind of corporation or partnership with that. Certainly, all that tax information off that return may be in terms of an S-corp or a partnership, the taxable income will actually still flow down to your personal tax return. But a lot of that information about the properties, the nature of your business, your expenses, your income, things like that are going to be reported on a separate tax return.
When we talk about anonymity, anyone looking at your personal tax return is really not going to have too much of a purview into your business activities. They’ll be able to see your income, but they won’t really have a good idea of what’s really going on behind the scenes, the end, to have the idea of anonymity there. As much as we can keep off your personal tax return and have that personal tax return really clean, simple, and not a lot to dig through, I think that would be best.
Michael: Someone put in the chat, a C-corp. I think C-corps are probably the best way to structure a business structure, then S-corp, and then partnership. A worse would be sole proprietorship. That’d be my opinion on that, very congruent with what Kurt just said.
Eliot: To something Kurt had pointed out in one of the previous questions, if you look at your S- and C-corporations, you have some of those reimbursements to take advantage of. You’re actually helping yourself as well from a tax standpoint. Of course, a C-corporation is a separate taxpayer, but if you get the medical reimbursement, countable plan reimbursement, 280A corporate meetings, and maybe in a C-corporation, you’ve done a lot for yourself there.
If you maybe still need to hit our personal return, we can do the S-corporation that they were talking about, still get the accountable plan and 280A, so best of both worlds there.
Michael: You guys make it sound like there are a lot of options with taxes and tax strategies. I love it.
Eliot: When you talk to the tax advisors like Kurt, you’re going to get a whole lot to think about.
Michael: Kurt’s like, no, I got enough work as it is. You’re blowing me up. I love this next question, by the way. We’ve touched on it, but sometimes we get hyped up on different strategies, think that one size fits all, and that everything is going to apply. We really have to take a look at variables, and is this strategy right for me?
One of the things I always think is important is for us to know that these strategies are out there, but just realize that they might not apply to you at that time. But always be aware of them so that you can go ahead and implement them when the timing is right. This question right here, should I do a cost seg for a condo?
I thought that was really interesting because one would think from some of the advertisements that you see on social media, some of the different programs out there that, hey, you know what, I should always do a cost seg. We started getting included from a couple of previous questions. What Kurt said is, hey, there’s a balancing test that we need to do. What was the point you made regarding the timing and depreciation, Kurt?
Kurt: When we talked about looking at this question, should I do a cost seg for a condo, it depends on what we’re using it for. Have we had this condo for a while? Have we been appreciating it for a while now? Are we real estate professionals? Are we renting this condo short-term? Various factors would go into that and weigh whether we should do the cost seg now. Should we do the cost seg? Should we hold off on the cost seg?
Also, maybe we’re planning a rehab next year or some kind of remodel, maybe waiting and holding off for that might be a good thing to keep in mind. That’s a good thing about Cost Seg Authority. You go over there and talk to them, they’re going to give you a good idea of what benefit you’ll be able to get out of it. Then we take that benefit, apply it to your personal situation, and see, hey, does it make sense to do it this year, or maybe you want to wait and apply it to next year might be a better situation for you.
Michael: I think the big takeaway on some of this is just because the strategy is out there, it doesn’t mean it’s always going to apply. You have to do that cost benefit analysis.
Eliot: As Toby says, calculate, calculate, calculate.
Eliot: All right. I think this is the last four, I believe. “What is the best corporate structure to have in place that can also allow for tax savings?”
Michael: Maybe some of the attendees are starting to realize a theme on expenses, how to go ahead and operate taxwise, how to get things off your personal tax return, how to move them over into a business structure. I don’t know. Maybe we’ll ask the audience. What’s the best corporate structure to have in place and allow for tax savings? What do you guys think? Go ahead and put it in.
Eliot: I think John’s throwing darts at everything there, except for the sole prop.
Michael: It makes sense. You know what? That actually could. I love John. John’s a fantastic individual I know. A corp, all except sole prop, like the S-corp. You’re amazing because it says, it depends. It absolutely depends, I was hoping so. Sherry would have thrown that out there because she loves it when I say that. I think there’s a hierarchy with corporations. Again, we’ve covered it, C-corp, S-corp, partnership, and then the worst would be sole proprietorship.
Eliot: “What tax incentives are there for real estate investors to not have to pay an absurd amount in taxes?” Kurt’s been down on this the whole day.
Kurt: Yes. Just to recap, management corporations, real estate professional status, also looking at maybe short-term rentals, cost segregation studies, are all very good ideas.
Also, if you’re looking to sell a property, look at those 1031 exchanges. Instead of selling, paying the capital gains because you’re just going to turn around, take that money, and invest in another property anyway, maybe go through a 1031 exchange, where you’re actually just deferring that gain, kind of kicking that can, as long as you can. Defer, defer, and defer is a pretty tried and true strategy.
Michael: And maybe not even have to pay tax. What happens if you die with those with the new properties and your kids inherit it?
Kurt: Yeah, you get to step-up in basis. That’d be a great way to do it.
Michael: Okay, that’s what I just did. Do not tell my children that. I do not want to leave this planet earlier than I have to. I could just see him like, hey, Dad, take one for the team. You know what? We could use those properties now at a stepped-up basis. In a way, it brings tears to my eyes like, my children are taxwise.
Eliot: Maybe mom would be on it because he made her do real estate professional status.
Michael: My kids would take her out too and get the stepped-up basis. They would be taxwise. Kurt, you nailed it.
Here’s the other thing I would recommend, keep your receipts. Organize your receipts, do proper bookkeeping. Without the proper bookkeeping and without keeping accurate books and records, you won’t get these tax incentives.
Eliot: Speaking of which, talk to Troy on that. He’s helping answer questions right now, as well as all the rest of our staff, Dutch, Ross, Jared, Sergei, Dana. They’re all out there pounding questions away. We’re just short of 200.
“As a real estate investor opening my first LLC, which is the best for me to use, S-corp or C-corp?
Michael: What do you think, guys? What’s the term we put here?
Eliot: It depends.
Kurt: It depends.
Michael: That’s the one. I’m going to give you guys my interpretation and then you guys can expound on it. The great thing about the two individuals I have on this is that both of them have their own opinions. I like C-corporations when we talk about a management style. I would never use a C-corporation to hold appreciating property, though.
As a real estate investor, opening my first LLC, which is best for me to use? An S-corp or a C-corp? If you’re going to invest in long-term property, you’re just going to use an LLC. Most of the time, it’s going to be a flow through down to your returns.
I’ve had to fix the situation too many times with clients who came to us, who got set up before they got to us. They put appreciating property in a C-corporation, and that’s a big no, no. Even an S-corporation can have pretty bad ramifications.
You’re going to be using a C-corporation for short-term active investing. You’re going to be doing wholesaling, you’re going to be doing flips, and management, but never put long-term holds in a C-corporation. It would be my two cents on this question. What do you guys think?
Kurt: When we talk about the S versus C, a big difference between the S versus C is those medical expenses. If you and your family have a lot of medical issues, maybe we want to really take a close look at that and see if that C-corp might be a better option for you. But on the other end, we also want to be looking at your personal tax rate. Are you in a very low tax bracket personally, or are you in a very high tax bracket personally?
What income are you going to be expecting from this corporation you’re going to be setting up? Because if we have a very high tax bracket individual versus a very low tax bracket individual, it certainly might change the analysis and what is going to be better for you not only this year, but also down the line. There could be a lot of factors and really, it really depends.
Michael: Like Kurt’s saying, do a balancing test. Maybe that C-corporation, that management entity isn’t right for you at the time. If you got one property and you’re not doing any short-term activities, maybe hold off on that corporation. But no, it’s got value once you start building out your business.
Eliot: Exactly. I would just tackle what Michael said about the first LLC. My legal side is going to go making that a disregarded LLC, put the rental property in for asset protection, and then maybe in time, get that second LLC that’s going to be your management corporation. That’s the way I would go about it, personally.
I do favor the C-corp, I am guilty of that. I like it better than S. But to be sure, Kurt’s got a very valid point. There are times, facts, and circumstances that you might go S over C.
Michael: Troy says that I’ve been finally listening to him. Yes, Troy. I always listen to you. Sometimes I forget to, but you remind me.
Eliot: All right, last question. “I started my LLC last year to begin my search for buying a business or real estate. Currently, I am a W-2 employee while I get started. My question is, can I write off any expenses since I did not make any money in my LLC? We’ve incurred expenses, but I don’t have any income.” Kurt, what do I do?
Kurt: The first thing I would say is, did you actually make it into business? Did you buy a property? Did you open doors? If you were just doing some other businesses, was that actually open for business? Those exploratory costs are one thing. Usually, we’ll be able to deduct them, but more of the timing on when we’ll be able to deduct them, is the more important thing.
We just finished 2022, maybe you just opened your doors in February just this month here. We might be holding on to those expenses. That’s where that good bookkeeping and good record keeping come into place.
If you’re in the exploratory phase of the business, you want to really hold on to those things and document them very well. Maybe you weren’t quite in business in 2022 just yet, so we can’t really necessarily deduct them, but they’re going to be very important in 2023 when we do start making money.
Michael: That’s huge. There are so many rules in place. You nailed it, Kurt. There are so many rules in place. There are so many tax court cases where people tried to get away with this. If you guys were paying attention to what he was saying, when did you start doing business?
Thinking about the business, we’ve seen tax court cases regarding that. I was thinking about the business, so that was an expense towards the business. They weren’t even in the line of business. Or they started an LLC and never made a profit. There’s a rule called the hobby loss rule that we have to contend with.
These are exactly what Kurt said that you got to be careful. Just because you thought about the business, thought about buying a business, or thought about buying real estate, doesn’t mean you’re in the business. It’s when you actually get into the business.
Eliot: Yeah, great points, both. I would just say this, though, just the mere fact that you didn’t make money, doesn’t prevent you from taking deductions if, as Kurt said, you started the business. Don’t worry about the fact that you may or didn’t make money as far as whether or not you can, that’s not the determining factor.
Michael: No. Amazon lost money for how many years before they finally…
Eliot: A lot.
Michael: Don’t be scared of that hobby loss rule I mentioned, too. It’s a rebuttable presumption that you can come back on the number of hours you spent on the business activity. Do you have experience in the business?
There’s about an eight-factor test that you can go through to rebut that presumption that the IRS comes at you that you’re doing this as a hobby or for the tax loss. Don’t be scared of that at all if you’ve got your ducks in a row.
You know what? I think we should go ahead and wrap up. I think we had a great session. I really appreciated Kurt, Eliot, and everybody else on here. We have Dutch, Troy, Ross, Jared, Dana, Tanya, and Sergei. I want to give a shout out to them. Shout out to you guys for being those who are working hard for a better future.
On behalf of the people on this Tax Tuesday, Anderson, and myself, I wish you guys the best of success in your lives and your investing in your businesses. Have a great rest of the week, everybody.