Simple Ways to Reduce Capital Gains Taxes When Selling Stocks

Jeff: And I’m Jeff Webb.

Toby: We’re here today to answer a bunch of questions that we have that you guys emailed in. We’re going to dive in today. We’re from our Summerlin location. If you don’t recognize the backdrop, it’s because there is none. It’s just a big, white sheet of paper, but it gets the job done.

Simple rules of Tax Tuesday. There’s chat and there’s Q&A. We have folks on to help you. I heard Ian, Troy, and Eliot. I know we have others that are there to answer your question. You could put that into the Q&A. If you have a specific question about your scenario, put it into the Q&A. Otherwise, just ask us and comment via chat.

Somebody says, “Only one minute late.” We were not late. Maybe one minute.

Anyway, if you need a detailed response that’s really specific to your situation that is not going to be answered in a simple Q&A, you need to be a Platinum client, and then you ask via your Platinum portal where somebody will respond to you in writing. We like our accountants to answer those questions in writing because you’ll ask the same question next year more than likely. We want to make sure that there’s no question that we answered it and you know what the answer is. Sometimes, memories or interpretations get foggy, so we like to put those things in writing. You can absolutely do that if you’re Platinum.

This is supposed to be fast and fun. Jeff, are you ready?

Jeff: I’m ready. The reason we were a minute late was we were letting the excitement build for your return to Tax Tuesday.

Toby: It’s all anticipation. Have I been gone for a while? Let me think about it. Maybe. You’ve been gone.

Jeff: I don’t think we’ve done it together in quite a while.

Toby: I was looking. It’s been six weeks. I’ve done a couple with Eliot. I think you have too.

Jeff: I’ve done a couple with Eliot.

Toby: Anyway, we get it done. Hey, Jeff and I are back together again. Let’s talk about the opening questions.

“What is the best strategy for hiring your kids?” Just don’t do it. I’m just kidding. “I heard create a management solo proprietor.”

“How was a ‘dynasty’ set up so it is not taxed at the estate rate after the death of the creator? Are both the trust and the beneficiary taxed in any year funds are distributed?” We will answer those. Those are good ones.

I didn’t even ask you guys where you’re from. Why don’t you guys put that in the chat? Just give us an idea of where you’re from.

Anacortes. I was just in Anacortes last week. Santa Monica, DC, Kansas City, Rowley, Claremont, Miami Florida, Summerville, and Round Rock. How many people do we have on? A lot of you all.

New York, Kapolei, Hawaii, California, Newport Coast, Clinton, North Carolina, and Virginia. We got both coasts covered. Ventura, California, PA. I grew up just outside of Philly.

Vancouver, Canada. I was there as well about a week or two ago. Nashville, Baltimore, Maryland, and Sunny Miami Beach. Virginia Beach, Texas. We got people all over the place. We have a good group.

Somebody says, “Where outside of Philly?” In Media, if you guys know where that is. We have a good segment of society here. We have a good sampling is the way to put it. We got a lot of folks. I didn’t see any foreign countries this time. If you’re in a foreign country, put it in the chat.

All right, let’s keep going over our questions that we will answer one at a time. Here’s what the questions are.

“I have substantial credit card debt and private debt amounting to $120,000. I own a few rental properties. Currently own six long-term incomes and two Airbnbs. Two properties are mortgage free, and one of the current long-term tenants wishes to buy the property.” They’re asking for an opinion here. “Should I sell and pay off consumer debt? Should I owner-finance? If I sell and owner-finance, can I avoid capital gains?” We’ll get into that one too.

“We want to sell some stocks to pay off some debts, but we know that if we do, we’re looking at a huge capital gain. What can we do to lessen the tax that we have to pay on the capital gains?” We’ll go over some of your options on that one for sure.

“Is Anderson Advisors training recommending to have an operating agreement that allows the non-pro-rata and discretionary authority to make distribution on a regular timeframe or amount? For a multi-member LLC, how do we deal with yearly taxes in this case?” Good questions.

“What options are there to save money on taxes if you own an LLC? Can passive income be used to fund a retirement account such as a solo 401(k)?” Again, good question. We’ll answer that.

“I’d like to take advantage of Section 179 before the end of the year and buy a business vehicle. Can you talk in more depth about Section 179 and how depreciation and bonus depreciation work? Also, what kind of vehicles qualify for this?”

A few more, and then we’ll dive in.

“What is the best way to get money from my entity, a C-corp, while limiting the amount paid in taxes personally and as a corporation?” We should ask the Trump organization because apparently, they were just convicted of 17 charges. They were doing some stuff, but we’ll see what happens.

“If my bill would be over $500,000, what can I do before the end of the year to reduce this?” I’m assuming it’s my tax bill. Just get in mind that that’s somebody who didn’t make $500,000, but they’re going to pay $500,000. First-world problems.

“I’m looking to attain two or more rental properties within the next year or so. Is it better to create an LLC for each property or take title under my current S-corp? I have an S-corp retail classification that I am considering dissolving. Should I just reclassify my S-corp as a real estate investment and take title in the name of the S-corp?”

We have some really good questions today. Those are a couple of little advanced ones. That’s the bread and butter, but if you want to dig in and find specific answers to your tax questions, one of the best places you can go is my YouTube channel. Anderson has a wonderful YouTube channel that you can go check out. Take a look at all the different videos on different topics. I think I publish two a week.

While you’re at it, visit my partner, Clint Coons. He does a great job going over asset protection and a lot of strategies as well. While you’re here, sign up for a couple of YouTube channels for free, and you’ll get lots of tax knowledge into your inbox.

Here’s the really cool part. We record all of our Tax Tuesdays and put them on YouTube. If you want to see what we’ve been up to or if this is your first time, welcome. You can always go into some of the old episodes, listen to them however you want to do it—podcast or on YouTube—and see the type of stuff that we do.

Here’s the sampling. “What is the best strategy for hiring your kids? I heard create a family management solo proprietor.”

Jeff: The best strategy for hiring your kids is to have gainful employment for them. You got to have something that they’re doing and what you’re paying them for. To just create a family membership sole proprietor is not really doing a whole lot. It isn’t going to work.

Now, if you’re running a real estate brokerage or something like that or any number of things that would be if they’re a sole proprietor and there are tasks that you can give the kids to do depending on their age, then you could certainly hire them at that time and pay them an equitable wage.

Toby: Here’s the deal. If your kids are under 18, you do not have to pay withholding taxes, old age, disability, survivors, and Medicare. You don’t have to do the withholdings or Social Security, which means I can pay my kids. If I’m paying them less than $12,950, it doesn’t matter whether they’re my dependents or not. They don’t have to file a tax return, and I can deduct that payment so long as it’s payment for actual work that they do.

Jeff: That’s generally true of sole proprietorships and partnerships but not S-corps and C-corps.

Toby: Because S-corps and C-corps don’t have kids. The reason that you see a sole proprietorship being used is that quite often, let’s say, mom has a business that’s an S-corp or a C-corp. Dad and whoever the kids are are on the outside. Sometimes, dad will set up a sole proprietorship and say, you know what, we’re going to be the marketing company for mom’s corporation. You enter into a regular agreement and pay that sole proprietorship. That money is being used to pay the kids.

Let’s say you have two kids and that business is making $24,000 a year. The business, if it pays it all out to the kids, obviously would have zero net income, so there’d be no taxes owed. If the $24,000 was paid equally amongst the two kids, neither one would have a tax return that they would have to file and neither one would have a tax liability. But both kids would have to be under the age of 18.

You have one of the parents basically being the business. You could set that up as an LLC disregarded to the parent, or in theory, you could also have that be a partnership between the mom and the dad even in that situation where you have the mom having the corporation. That’s why I think that’s popping up.

Now, what Jeff said is 100% correct. If you pay them directly from an S-corp or a C-corp, then you just have to pay them through payroll. You will have withholding, which isn’t a bad thing in my opinion because you’re paying into Social Security. They’re going to get their benefits than at some point.

You have to meet so many quarters. Do you remember how many quarters you have to pay into Social Security before you qualify for benefits?

Jeff: I want to say 10, but I’m not sure that’s correct.

Toby: I think it’s a lot more than that. I’m not 100% certain. Maybe we have some Internet sleuths out there. Forty, there we go, so it’s 10 years. But if you’re not paying into Social Security, then in theory, you haven’t paid and you don’t qualify. There is some benefit there.

The other benefit there is let’s say you want to put the entire $12,000 into a Roth 401(k) or a Roth vehicle. You can’t do the IRA. You’re limited to $6000 a year. If you want to take the entire amount that you’re paying your child, you want to get it entirely into a Roth 401(k). You could if you’re using a corporation. You can’t if you’re using a sole proprietorship or a partnership under those circumstances.

If your kids are over 18 or you’re hiring a parent or another relative and they’re over the age of 18, then all bets are off. They have to pay Social Security even if you pay them. You can pay them as an independent contractor if they’re doing certain types of work, or you can pay them as an employee and run it through payroll, but you lose the ability to pay them without paying into Social Security if they’re 18 or over.

Jeff: I think you’re correct.

Toby: It’s 17, 16, 15, 14, 13, or 12. There are court cases where even nine-year-olds were getting paid. As long as they’re able to do something worthwhile, you can pay them.

Maybe you have a plumbing company and you have your kids posing with a plunger and a wrench. They have to be able to do something or you could pay a third party to do it. If you could pay actors, models, or whatever it is, you can certainly pay your own kids as well. The nine-year-old case got paid Screen Actors Guild’s rates.

“Any advantages to hiring grandkids?” Same thing, Sam. If you had your grandkids, it’s the same scenario. I believe that if they’re related to you and they’re under the age of 18, you don’t have withholding. Do you have to do Social Security if it’s grandkids?

Jeff: I’m not sure about that. I can see the logic behind it. I just haven’t run into that.

Toby: But the same scenario. There’s a way to get it over to a company that then pays the kids. There’s a way to get it over there. If it’s your business, then you just pay the parent sole proprietorship. Have the parent pay it all out to the kids, the sole proprietorship zeroes out, and the kids don’t have to report the income or pay to file a tax return. Very good tool, especially if you’re paying for somebody’s tuition.

Fun stuff. This is one of my favorite ones, by the way. “How was a dynasty set up so it is not taxed at the estate rate after the death of the creator? Are both the trust and the beneficiaries taxed in any year funds are distributed?” What do you think?

Jeff: I have no idea.

Toby: Really? This is the fun stuff. When you say dynasty, this means something that’s going to be for the benefit of the family for a long period of time. If I have assets and I pass away, I have to worry about the federal estate tax. I have to worry about state estate taxes too. In the state of Oregon, yours is only $1 million. Anything over the estate exclusion is taxable, and then the exclusion in the federal world is over $12 million. Do you know the exact?

Jeff: It’s $12.2 million, $12.4 million, or something like that.

Toby: It’s a big chunk of money. If your estate is over $12 million, you got to pay attention. You can always give a spouse unlimited amounts, by the way. You don’t have to worry about that. But if you want to benefit your kids, your grandkids, et cetera, it’s going to go into one of two vehicles.

One of those vehicles is a revocable trust which can become irrevocable when you die. It can be a living trust that then becomes irrevocable. It is not going to be taxed at the estate level again unless all of the assets are distributed to a child or one of your beneficiaries, in which case, then it’s part of their estate.

Otherwise, if it’s just sitting in trust for health, education, maintenance, support, or specific things like, hey, I want you to travel internationally, or the money is there to help you invest and do matching funds on properties that you buy, then any income is going to either be taxed at the corporate level or at the beneficiaries level if it’s distributed to them.

When you say are both the trust and beneficiaries are taxed in any year funds are distributed, the answer is probably not if you’re distributing all the funds. If I just own a bunch of stock and I don’t sell any, there’s no income. There’s no tax.

Jeff: A dynasty trust, is that normally an irrevocable trust?

Toby: Yes, it’s going to be an irrevocable trust and it’s going to fall into the category of complex or simple.

Jeff: The dynasty trust then versus the living trust. Dynasty trust is going to be taxed on its income every year.

Toby: But it could start off as a revocable trust during your lifetime.

Jeff: So it ends up being an irrevocable living trust.

Toby: I like to set up my living trusts to become dynasty trusts when I die. In other words, a lot of folks die and distribute people. Hey, if I die, I want it to go to my kids. That’s great but probably not the best thing, especially if you have sizable assets because statistically speaking, there’s about a 16% chance of that making it through. There’s not much money that actually gets maintained when somebody gets a windfall. They usually get bad habits too.

Let’s say we say, you know what, let’s not do that. Let’s give them some money, but let’s give them access to money if they need it instead. Then, that’s being held in trust.

There’s something called distributed net income. There are things where you can lower the trust taxation by distributing it to beneficiaries. The beneficiary pays tax as though that income was theirs.

Jeff: Would it be typical for a dynasty trust from what you’re saying that they’re paying out the income to the beneficiaries so they’re not paying trust rates, which are really high?

Toby: In the trust, you get into the highest bracket after about $12,000. It’s really, really bad.

Jeff: But the corpus or the body of the assets and all stay in the trust.

Toby: Correct. The corpus just sits there. Sometimes, you rate it. Sometimes, you’re going to distribute some of the principal under certain circumstances. It depends on what you draft. I could say, hey, Jeff, I’m going to leave you money. I’m leaving $1 million for health, education, maintenance, and support, but when you turn 50, you can take 10% of the principal. When you hit 60, you can take another 10%. When you hit 70, you can take another 10%. Something like that.

I could allow you to take distributions that are not just income, but in any case, it’s not taxable. But if you take that distribution, it’s part of your estate. If Jeff passes, it’s part of his estate. That’s why if you have large estates, you see a lot of practitioners that are like, hey, don’t distribute it because you’re just kicking the can to another generation, and now they have to mess with it too. Let’s use the dynasty trust and get those monies out. That way, we don’t have to worry about that estate tax.

In the estate tax, if you go over the $12 million or $13 million mark and you’re single, every dollar is being taxed at 40%. It’s a pretty hefty tax. If you’re a $20 million person and it’s the fair market value of your assets at the date of your passing, you’re talking about $3 million in taxes. They don’t care what you sell it for. What they care about is what its fair market value is. Even if you sell it and it’s not worth enough, you’re in deep doo-doo, my friend.

Jeff: One last quick question. I set up my dynasty trust, I’m the initial trustee, and I die. Is it usually recommended that the successor trustee is somebody that’s not directly associated with the trust and is not a beneficiary or something?

Toby: Generally speaking, you don’t want the beneficiary to be the trustee because if you have restrictions like, hey, we want to hold it in trust, that beneficiary may just ignore it and take all the money. They might get sued by a future generation which could happen.

The easier way is to say, hey, I’m going to use either a trusted party or a fiduciary like a lawyer, accountant, or wealth department of my bank that’s a professional trustee and say, hey, you guys manage this. If you have somebody that you trust, you do that.

The other thing you do is you could put a trust protector in the place where it says basically that you need the acquiescence of an attorney or firm when you’d make distributions. They’re there to enforce the trust to make sure beneficiaries don’t do something weird.

We’ve seen it. Hey, I’m going to give you our house when you hit 40. Maybe they’re 25, and they’re like, I think I’ll just take the house. Who’s going to stop them? You got to make sure that you’re being intelligent about it.

Somebody says, “If the living trust owned a holding LLC which in turn owns several subsidiary LLCs in different states, can our trust successors get a step-up in basis for the LLC properties when we pass away?” Yes. See how I make that easy?

There was another good one. “My mom had a living trust which I am the executor of. My mom gets taxed on the note we carry.” You probably did a sale of a business or something like that. It’s an irrevocable trust that you set up, transfer, and sell. Mom or Dad sells the business or highly appreciated asset to the trust and takes back an installment note. Trust sells the asset, and they have no recognition of gain because their basis is now reset when they did the installment note.

Jeff: That’s not a deferred sales trust.

Toby: That’s what I was thinking of, thank you. Deferred sales trust.

“Mom gets taxed on the note we carry when the siblings get taxed as ordinary income on the disbursement. Is there a legal way to reduce the tax?” Honestly, no if you’re getting interest payments on a note.

Jeff: Somebody’s got to have to get taxed on it. It’s either the trust or the beneficiaries.

Toby: Yup. I said there are two ways to avoid all the estate tax and to create a dynasty. Number one is an irrevocable trust. Number two is charitable organizations, either a public charity or a foundation that then your heirs can work for.

Let’s say I was in Oregon and I had a $5 million estate. I’m going to get killed in taxes because Oregon only gives me an exclusion on $1 million.

What if I wanted to avoid getting hit with a bigger tax? I could actually have my trust fund, a foundation, or a charitable organization. If my kids work for that charitable organization, they can continue to work for it. My grandkids, great-grandkids, and everybody could work for that organization and draw a salary. They don’t have a right to distributions outside of that organization, but I could avoid a big tax bite on that if I wanted to. It works great. I didn’t want to leave that out.

“I have substantial credit card debt and private debt amounting to $120,000. I own a few rental properties. Currently own six long-term incomes and two Airbnbs.” That sounds like eight properties in total. “Two properties are mortgage free, and one of the current long-term tenants wishes to buy a property. Should I sell and pay off the consumer debt? Should I owner-finance? If I sell and owner-finance, can I avoid capital gains?” What say you, Jeff?

Jeff: I think it is actually a good idea to pay off some of the credit card and personal debt because it typically comes with very high-interest rates, probably more than your ROI on your rental properties.

Toby: You’d want to know that though.

Jeff: Yes, you definitely want to know that. Picking which house you sell actually comes into play too. Does it make more sense to sell a mortgaged property or a pay-it-off property? I agree that I would sell and pay off the consumer debt. It’s probably costing a lot of money.

Toby: Number one, we need to look and see what the rate of their debt is. If you have credit card debt that is interest-free for another six months and you have private debt that’s at 4%, we may say, hey, hold on. You want to look at that.

I have no idea of the terms of the private debt. There might be a prepayment. Hey, it’s a four-year note and you have to pay all the interest for the term of that note if you prepay it. We have to know certain facts, but I’m with Jeff. Generally speaking, credit card debt and private debt are more expensive than debt on properties.

Here’s what I would say. Yes, you have the option to sell a property, but the other thing is you have two properties mortgage free. I might just refi it and pay off my consumer debt. It doesn’t really matter.

Jeff: If you got credit cards in the 20% range that you owe, HELOC one of those properties.

Toby: Home equity line of credit. Take credit against them.

Jeff: And use that money to pay down that credit card debt. Even now, it might be a 7% interest rate on the mortgaged one. Maybe a little bit higher with a HELOC, but it’s far better than the high usury rates on credit cards.

Toby: There are a bunch of people already saying that. Consider refinancing a rental, reducing the rate, and paying off the consumer debt. What about mortgaging the property to pay off the debt? Yes, they’re all saying the same thing. You could do a HELOC if it’s a mortgaged property. If it’s a mortgage on investment property, you get to write off the mortgage interest against the rental income.

You could owner-finance if you decided to sell. Let’s say you said, you know what, Toby, Jeff, and folks online, I don’t want to refi. I just want to sell it. I like my tenants. They’re really great. What are the tax ramifications?

Technically, you could 1031 that, but you’d have to have all the money go to a QI. You’d have to identify a replacement property, and it’s going to be a bit of a dumpster fire. You’re going to have to buy another property.

Let’s just say 1031 is off the table. What you’re going to do is you’re going to recognize four types of income when you sell and do the owner-finance. You’re going to have the return of basis which is taxed at zero, depreciation recapture which is going to be 0%–25% depending on your tax bracket, long-term capital gains which are going to be 0%, 15%, or 20% depending on your tax bracket—it could be as high as 23.8% plus your state tax if you make too much money—and interest.

You could spread it out. Let’s say you do that for over 10 years. You’re spreading out the tax hit over a 10-year period. You’re getting a nice little income stream. Not necessarily a bad situation. Can you avoid the capital gains on that? No.

Let’s say that I sell again and I owner-finance. I could opt out of the installment sale, take the entire amount of the gain, go into a qualified opportunity zone, and defer my gain until 2026.

Jeff: I’m not a big fan of this particular scenario of owner financing because I think it kind of defeats the whole purpose of paying off the personal lines of credit and credit card debt.

Toby: Yeah. Because your debt doesn’t go anywhere unless the down payment is $120,000 and you carry the rest. You want to get rid of that $120,000.

One more, we have more tricks up our sleeves. How can we avoid capital gains? This happens to be a great year to harvest capital losses because we’ve been getting the crap kicked out of us in the stock market and crypto. What you might want to do is sell some of your losers and say, I have unrealized capital losses. Maybe now is the time to take those to offset the capital gains on the property. Just a thought. Maybe you’re way up.

This is fun. Somebody’s asking more questions about that. Somebody says, “Try consolidating the debt.” Somebody else says, “Credit card trading.” I get it. It gets a little nutty. Not a big fan of the credit card stuff.

“We want to sell some stocks to pay off some debts, but we know that if we do, we’re looking at a huge capital gain. What can we do to lessen the tax that we have to pay on the capital gain?”

Jeff: You’ve already given away my answer to the last question.

Toby: Go back in time and buy some crypto. Go back to January and buy a bunch of Bitcoin or something, then you’ll have plenty of capital losses to offset all that gain.

Jeff: I sell my losers left and right. Maybe their whole portfolio was nothing but gain, but I find that hard to believe.

Toby: Yeah. I’d be looking for stocks that don’t have much gain in them.

Jeff: I sold some off today that I saw wasn’t going to be going anywhere and had substantial losses in them.

Toby: This is a nice bloody day on Wall Street. You exacerbated that issue. We love that. What can you do to lessen it? I’m going to give you another one. This is the coolest one that you’ve never thought of. There’s something called a security-backed line of credit.

If you have stocks, especially stocks with big gains, there’s a good chance that your brokerage house will give you a line of credit against those stocks. They usually give you a line of credit of up to 75%. It might be 70% right now with the volatility in the market. It may be as low as 50%. But you borrow against your stocks. You’re generally paying a really low-interest rate.

The last time I looked, it was still at 3%. Mortgages are 7% and security-backed lines of credit are still in the 3% and 4%. Borrow it, pay off the debts, and do it that way instead.

I understand that you want to pay off debts and I love it, but you do need to get your pencil out and calculate how much tax I’m going to pay. Would I be better off keeping the debt? What’s the debt amount? If it’s 4%, 5%, or 6%, I might just keep it. If I have huge capital gains—and I don’t know what huge is—and it’s 23.8% that I’m having to pay on long-term capital gains or if it’s 37% because it’s short-term, I’m probably not going to do it right now just to pay off debts. But I could borrow tax-free against those same stocks and do it.

Somebody says, “Can you borrow against your IRA?”

Jeff: No.

Toby: You can’t borrow against an IRA, but do you know what you can do? Roll it into a 401(k) and then borrow against your 401(k).

Jeff: You can borrow up to $50,000 from your 401(k).

Toby: Per participant. If you’re married, you can get up to $100,000 and use that. That’s paid back over five years at the applicable federal rates (AFRs), which are currently right around 4%.

Jeff: IRAs can’t have any type of loans or anything like that connected with them. They loan money to others that you just can’t borrow yourself.

Toby: Pamela, what you do is you set up a Solo 401(k). You need to have a sponsoring entity, so you need to have a business of some sort, but you can have a Solo 401(k), roll it into the 401(k), and then borrow up to $50,000 or up to 50% of your balance. If you’re married, then you could roll both spouses’ IRAs into a Single 401(k) and borrow against that. You can do that hopefully.

Somebody says, “Borrow from an insurance policy too.” Yeah, look around for anything you can borrow against. That was used in the capital gains. Great point, Mark. I was using, hey, I see that we have stocks. I know we could borrow against that, but the other thing you look at is do you have any cash value, life insurance, whole life, indexed universal life, or variable universal life where you can do a loan against the cash value. Even a HELOC would work too. Hey, maybe I’ll borrow against some real estate.

Sometimes, we’re just looking around saying, what’s the cost of the debt? If I’m borrowing against my own 401(k), it’s not zero because I’m paying the interest to myself. If I borrow against the house, then I have to calculate the debt of that versus the debt that I’m paying off and make sure that it makes sense from an interest rate. If I borrow against my stocks, then it’s usually a wash because my stocks go up. Statistically, they go up even though this year has been different.

Statistically, they go up at the rate. If I look at the last 10 years, it’s over 14%. If I look at the last 50 years, it’s right around 10%. If I look at the inception of the market, it’s around 10%. I factor my gain on my stock against the interest rate I’m actually paying. If the interest rate is 4%, it’s going to be really tough for you to get hurt over the long term. That stuff works.

Jeff: One thing I like about borrowing from 401(k) is you do have to pay it back with interest, but that interest has been paid back to you in your account.

Toby: I’m good with that. Here’s another fun one. Somebody says, “The Schwab Pledged Asset line of credit is 3.8% plus 1.9%.” That’s a little bit higher. I know that the Morgan Stanley—I just was talking about it with Gio, one of my friends and clients—was less than 4%. It was pretty low. They were below 2% at the beginning of the year. It’s crazy.

“Is Anderson Advisors training recommending to have an operating agreement that allows the non-pro-rata and discretionary authority to make distributions on an irregular timeframe or amount?” We can. We don’t want to loop you in. From an asset protection standpoint, you don’t want to force distributions. “For a multi-member LLC, how do we deal with yearly taxes in this case?”

Jeff: The first part of the question, do we recommend, I don’t know that we say that we generally recommend that.

Toby: We recommend it. I can tell you that.

Jeff: Really? Where you can do special allocates around it?

Toby: What we do is we say you’re not required to make distributions because if somebody gets an assignee order—let’s say you get a charging order against an entity that requires distributions on a quarterly basis—you just undid the asset protection. We want to make sure that we have an operating agreement that says, I get to decide if I distribute money or not. If there are two partners, I can give more to you than I can give to this one over here.

Jeff: As you said, we’re talking about a partnership.

Toby: You’re almost always talking about an LLC that’s taxed as a partnership in that case. I can’t imagine another situation because, in an S-corp, you have to give equal distributions. You can still put restrictions on the distribution even out of an S-corp, but here, it’s a multi-member LLC which I’m going to say is a partnership.

Jeff: We’re really only talking about the distribution, so we’re not talking about I’m going to allocate this income item this way.

Toby: No, we’re not talking about non-pro-rata allocation of income. I don’t think you would actually have a thing like that. But I can do non-pro-rata distributions. You can do that for non-tax reasons. If I want to allocate losses to one party who has perhaps an appetite to do that and that’s part of the deal for them to invest, I could do that. But I think what they’re talking about here is just can I do non-pro-rata discretionary distributions where there’s not a forced compulsion?

I know Clint goes over this. He talks about all the mistakes he sees in LLC operating agreements. One of those common ones is you set something up for asset protection, but it undoes itself because it requires distributions on no less than an annual basis of the profits to the partners.

If I am a creditor of one of the partners and I can get a charging order against that partner, now I know I’m getting paid. If I get a charging order against Jeff and he’s got an operating agreement where it’s discretionary and can be non-pro-rata—which means it doesn’t have to be equal amongst the partners—now I’m in trouble because I’m like, what if I get a charging order? Am I just going to be standing there scratching my head for the next 20 years and getting nothing? That’s going to force me to become more reasonable in my settlement.

The big question here is how do I deal with the taxes?

Jeff: Distributions actually have zero to do with the taxes. If Toby and I make $100,000 in our partnership, whether or not we have any money distributed to us, we’re going to pay tax on that $100,000 individually. He’s going to pay tax on his half, and I’m going to pay tax on my half. Whether or not that money is distributed to us directly doesn’t change even how much is taxed.

Toby: Unless you distribute more.

Jeff: More than you have a basis of.

Toby: Yeah. If I distribute more than you have a basis, let’s say that you put in $50,000 and I put it in nothing. We say the non-pro-rata distribution of profits. It makes $100,000. You could get $50,000 out tax-free. If it distributes $50,000 to me, I’m paying tax on it because I have zero basis, but I’m also going to get allocated half of the income, $50,000 as well. I’m going to have $50,000 allocated to me plus I’m going to have $50,000 of long-term capital gains.

Jeff: You see this less often in partnerships. You see it a lot more often in S-corporations where they’re getting outside loans, paying that money out as distributions, and then it turns out they had no personal basis in those distributions.

Toby: We see that a lot, especially when you’re not at risk in syndication and you have somebody who put in $100,000 in syndication. The syndicator levers the hell out of that, and then they borrow against the new improved value.

Let’s say they rehab an apartment building. They pull out more cash than was needed to actually start the project, and they distribute it to everybody. Let’s say that I put $100,000 in and I get $120,000 back, $100,000 of it is tax-free and $20,000 of that is long-term capital gains regardless of whether there’s income from the actual syndication.

People screw that one up periodically and get in a little bit of a nasty surprise. The good news is a lot of accountants don’t know the rules, and sometimes they’ll just miss them. They’ll be like, oops. But if you get audited, you’ll be in for a nasty surprise.

“What options are there to save money on taxes if you own an LLC? Can passive income be used to fund a retirement account such as a Solo 401(k)?”

Jeff: I’m going to answer the second question first. Passive income cannot be used to fund a 401(k) or any other type of retirement account. Retirement accounts have to have earned income behind them.

If I’m an LLC taxed as an S-corporation, I’m paying myself a salary and that allows me to contribute to a 401(k). If I’m a partnership, the income that the partnership makes becomes my earned income if I’m a general partner. The corporations are a little different. Once again, you have to have a salary.

Toby: So I have to get wages of some sort to fund a Solo 401(k). I cannot have wages out of a sole proprietorship. If my sole proprietorship is a passive activity, there’s no way for me to convert that. If I have a partnership, same rule. I don’t even think if I was a GP of a partnership. If it’s passive, it’s passive.

Jeff: If it’s passive income, you’re sunk.

Toby: Somebody says, “My LLC is a teaching business.” If you’re teaching, Pamela, then yes, you could absolutely fund a retirement account. The question is, how are you taxed? When it says, are there options to save money on taxes if you own an LLC, it depends entirely on how that LLC is going to be taxed?

For example, the IRS doesn’t see an LLC. They go like this, I don’t see you. Tell me what you are. You’re going to say you’re either a disregarded entity, just ignore me, I am a partnership because there’s more than one of us, and we don’t know what we are. Or you’re saying, treat me as a corporation, which can be an S-corp or a C-corp.

That’s really the gamut of this case. They all come with the good, the bad, and the ugly. If you’re a sole proprietor, you’re getting no benefit really. You’re getting to write off your ordinary necessary business expenses if it’s an active business. If it’s a teaching business, then you’re going to write off the expenses that are part of that teaching business. It really comes down to it.

If I use something like a cell phone in that business, I have to figure out what’s my personal use on that cell phone and how much the business uses it, and it can reimburse me or pay for the business use, and things like that. There are some benefits.

The other option would be an S-corp. By the way, if I have profited, 100% of it is subject to old-age, disability, survivors, and Medicare, which means Social Security taxes on 100% of anything of my net profits when I’m a sole proprietorship.

If I make my LLC taxed as an S-corp, for example, then I get some other options available to me. Number one, if I have a net profit, so long as I take a reasonable salary, the profits are not subject to self-employment taxes, so I save the old-age, disability, and Medicare. That ends up being 15.3% when you actually do the math because part of it is deductible. It’s about 14.1%. For every dollar that I make up to $147,000, I know I’m saving 14% by being an S-corp. Over $147,000 is a little bit different. It’s 2.9% or 3.8% depending on how much you make that you’re going to save as an S-corp.

S-corps also get something called an accountable plan. It allows us to get a lot more deductions that are necessarily available to sole proprietors. There are lots of different things that are available to you.

I would actually suggest that you spend a bunch of time on my YouTube channel because I break down a lot of those differences, or you come to our Tax & AP class because we get into some of that too.

Jeff: Going back to your cell phone example in the sole proprietorship, if it’s an S-corp, we don’t care what part is personal.

Toby: The beautiful part about an accountable plan, which is when the employer reimburses you, is if I use this at all for business and it benefits the business, the business can reimburse me for 100% of not just the phone itself but also all the data and cell usage.

Jeff: Just an example of the consequences of the different entities.

Toby: It’s huge. I don’t understand. A lot of accountants are like, oh, there’s no difference. I’m like, what are you talking about?

Hey, my partner, Clint, who’s a fantastic asset protection attorney, really knows his stuff around taxes and legacy planning and wrote another book. It’s called Next Level Real Estate Asset Protection. He can help you take your real estate investing to the next level. It was number one on Amazon. You can go there and purchase it. Really good book, highly recommend it. It just got published right at the end of August, so just a couple of months ago.

“Way to go, Clint,” says Sherry. His mother gave it a rating of five stars. That was from a long time ago. I should update all the ratings. It’s done quite well because it’s a really good read.

Somebody says, “Good read. A great read for sure.” Clint’s mom must be on and commenting in the chat. Just teasing.

“I’d like to take advantage of Section 179 before the end of the year and buy a business vehicle. Can you talk in more depth about Section 179 and how depreciation and bonus depreciation work? Also, what kinds of vehicles qualify for this?” Jeffrey?

Jeff: For 2022, we’re not going to talk about Section 179. It’s pretty much a moot point. We don’t really talk about bonus depreciation.

Toby: Even if it’s a 6000-pound gross vehicle weight?

Jeff: Yes, bonus depreciation is still Trump’s 179.

Toby: Why would that be? I like to pepper you with questions because you’re sitting right next to me.

Jeff: If it’s under a 6000 GVWR (gross vehicular weight rating) vehicle, your limitation is $19,200 of depreciation in that first year. That includes bonus depreciation. If it is over 6000 pounds, then your bonus depreciation is pretty much unlimited.

Toby: Here I am, I’m going to buy a car, and my accountant says, oh, you should buy it in your company because we can write it off 100%. You need to buy a big vehicle like a Suburban, a G-Wagon, or a Tesla X, something that’s got a gross vehicle weight of over 6000 pounds. They tell you you can write the whole thing off. Buy it and put it into service before the end of the year. Is that true?

Jeff: We need to start talking about business use. We had one, Ian, who was answering questions. Got this from a client. They purchased a $250,000 vehicle for managing real estate, and my immediate answer was, oh, heck no.

Toby: $250,000 vehicle means it was a G-Wagon, by the way, because that’s about what they’re going for. Technically, you could write it up, but if it’s real estate, would it still be passive?

Jeff: It would still be passive unless he’s qualifying as a real estate professional. I don’t know if that’s the case.

Toby: Do you think it would be seen as an unreasonable expense? You’d have to be using it 100% to get the full deduction.

Jeff: Correct. You’d have to be using it 100%.

Toby: There’s Ian. He says, “Yeah, he’s a real estate pro.” So it’s an ordinary loss. It’s like any other business. It makes you uncomfortable.

Jeff: It makes me uncomfortable because it sounds more like I bought a personal-use car and put it in my business.

Toby: That’s the thing. It all comes down to whether are you actually using it for business. What percentage? If I buy a $250,000 car and I’m using it 100% for my business, I can do that. I can write that puppy off if 100% use is for business. But if I have personal use, it’s either going to lower that amount or it’s going to make a taxable event to me because that’s no different than the company paying me wages.

Somebody says, “What happens if you use it 50%?” That’s the magic threshold. It has to be greater than 50% usage to take the big fat bonus depreciation. If it drops below 50%, you stand to lose not just the deduction, but you might have recognition of the money that you already used or already depreciated. You may have to recognize that again.

Jeff: The depreciation rules say if you use it less than 50% in business, you can only use the straight-line method, no accelerated methods, which means if I took a bonus in that first year and used it 100% in the second year, and it went to 49%, I actually have to go back and recapture that bonus depreciation.

Toby: As ordinary income. This is where all you realtors out there say, I’m going to drive it for the end of the year and I’m only going to use it for personal. Then, you get tired of being a realtor because the market dropped. Now, I’m driving it around and you say, I’m not going to keep track of my miles. My accountant is annoying me. They keep wanting to see my mileage log and all that fun stuff. Then, you go below.

You say you did a $250,000 deduction. Guess what you’re recognizing in the following year, $250,000. I took the loss in 2022, and I’m recognizing it all back in 2023.

Somebody says, “So if my LLC does property management for my wife’s solo LLC, I could get a Ferrari, but it’s better to get a fully loaded pickup truck.” You could get a Ferrari. You only can write off $19,000. That’s it. That’s why they have these depreciation restrictions. A Ferrari is not going to meet the gross vehicle weight test, so you’d be able to write off $19,000 out of the $300,000 that you paid for a Ferrari or more, whatever it is.

Jeff: You talked about if you use it personally, it’s compensation to you. That compensation is going to be based on the value of that vehicle.

Toby: They actually give us a test. Every year, they publish a table that says, here’s the lease value of the vehicle for inclusion in your income.

Somebody’s asking a good question. “I have two cars.” It doesn’t matter how often you actually drive the business vehicle so long as it’s only driven for business. Is that a fair assessment? They have two cars, one that they drive personally and one that they only drive for business.

What if they only drive that car for business for 5000 miles a year? Yes, 100% business usage means whatever you paid for it, if it’s over the 6000 gross vehicle weight, you can write that off. If your bonus depreciates, it means you can write it off. It’s $18,000–$19,000 in the first year, and then it drops a little bit in the second year.

Jeff: I think it might actually go up a little bit in the second year.

Toby: It’s kind of a funky schedule. I was looking at it yesterday.

Jeff: No, you’re right. It would go down the second year because the bonus is gone.

Toby: Bonus is gone. It goes to 80% the next year, 60% the following year, 40% the following year, and then it’s gone.

Jeff: The other side of that coin I wanted to talk about was when you only have one vehicle and it’s your business vehicle. That almost is a failure every time. You have to have a personal use vehicle.

Toby: If you have a car and you’re saying it’s 100% business use, you better have another vehicle that’s 100% personal use or they’re not going to believe you. If you have one car, you got to track your mileage.

I’ll just tell you. I use something called MileIQ. I always show my phone. That’s my wife, so don’t get mad at me. I’m not doing anything naughty here.

You go to MileIQ. It’s just a little app. What it does is it tracks your GPS, and then it says, was that person or business? It knows when you stop. It tracks all of your trips. At the end of the day, I think personal is left and business is right. If they see that you drive in the same location over and over again between your house and an office, they’re going to say is that a business trip? You say, yup, and then forever, it’ll always track that as business mileage when you drive between your office.

We could just talk about vehicles all day long because when you buy a vehicle, you have two choices. You could do the actual expense method or the mileage reimbursement method. My recommendation for almost everybody is just to reimburse the miles. It’s $0.625 right now. It doesn’t matter the value of the vehicle or which vehicle it is.

I have three cars now, and I’m not worried. I’m using them each. I’m going to drop below 50% on this one. This one’s right at 52%. I can’t drive that one anymore. All that weird stuff just goes out the door. Even if I drive one for 10% for business, I’m just reimbursing the miles that I put on it.

Enough of that. The accountants are sitting there going, I swiped left, I swiped right. I’m like, what are you guys doing? Are you guys doing Tinder? They’re all like, oh, what’s Tinder? That’s MileIQ. I think that was Jeff.

“What is the best way to get money from my entity, my C-corp, while limiting the amount paid in taxes personally and as a corporation?

Jeff: Repay your shareholder loans. The best way to get money out of your C-corp is if it already owes you money.

Toby: I would say there’s another way. Reimburse yourself for expenses that you incur that benefit the business like cell phones, computers, medical, dental, and vision if you have a C-corp and a health reimbursement plan. Startup expenses. Anything that you do that benefits that business, even meals. I go sit with Jeff and we talk about business. It’s 100% deductible. Let the corporation reimburse you. It is not reported to you and it’s not taxable to the corp.

Jeff: And there’s always the famous corporate meetings in your home.

Toby: 280A, 14 days a year or less, I can write off. You can just pay yourself from the corporation. You don’t have to recognize that anywhere. You’re not writing it off anywhere. It’s tax-free. It’s not taxable under your adjusted gross income, so you don’t have to include it, and the corporation takes the deduction. Where would you put that, as a meeting expense?

Jeff: I usually put it in as a corporate meeting expense or something like that. Just don’t get crazy with it.

Toby: Somebody is asking about Clint’s book. “Will it be available at the Las Vegas event this weekend?” Yeah, we have a live event coming up Thursday, Friday, Saturday, and Sunday, and I’m sure that we will have some.

“Oh, sorry, but it’s not. But I can have one sent to you.” Patti, why don’t we have boxes and boxes of Clint’s book? This is insanity. We don’t have any of Clint’s because Forbes published it. I’ll see what she says. “Yes.” I cannot believe that. You should see if we can get some boxes from Forbes. They’ll give us them. We need to have Clint’s book here. They should ship us a bunch of Clint’s books because everybody will buy one.

Next one. “If my tax bill will be over $500,000 this year, what can I do before the end of the year to reduce this?”

Jeff: My first thought was with this kind of tax, you’re talking about a lot of income, maybe $1.5 million. My first thought was is this coming from an entity where you could possibly do a defined benefit plan?

Toby: That’s a good one. Defined benefit plan, what is that, Jeff?

Jeff: That is a retirement plan. It’s not like the 401(k)s, which are defined contribution plans. In a defined benefit plan, they’ll let you put anywhere from $200,000–$300,000 away into your retirement account based on your salary.

Toby: You look at what you’ve been making over the last few years. An actuary says, how much would you have to have in your retirement plan for you to continue to receive that when you retire? It’s a factor of how old you are, how much you’ve been making, and assumptions that the actuary makes on the growth of that money plus inflation. They come up with a number. Usually, it’s a range. As Jeff said, it could be $200,000–$300,000. We have a client putting in over $700,000 a year into their defined contribution plan. It’s deductible.

That’s number one. Look at retirement plans and advance retirement plans. What’s number two?

Jeff: Normally, I would go with cost segregation at this point, but if you don’t already own property, it makes it very difficult to accomplish. What else do you get?

Toby: Charitable donations. I can write off up to 60% of my adjusted gross income by making contributions to charity. If I don’t have cash on hand, I could give appreciated assets up to 30%.

If this person is making $1.5 million to get this tax bill, you could give up to $500,000 of appreciated assets away and write them off. You could also do a conservation easement. If you wanted to buy into an investment where they’re going to conserve the investment, you get to write off the fair market value.

The difference between the basis of your investment and the fair market value of what it would have been worth had you developed it is usually 4:1 to 5:1. If I donated $200,000 there, I would get an $800,000-ish deduction. I could do that. I think that’s capped at around 50% of your adjusted gross income.

Jeff: That one is capped at 30%.

Toby: Is it 30% for conservation easements? We would want to take a look at it.

Jeff: But if it goes over 30%, it carries over from year to year until you use it up.

Toby: You got five years to carry it forward for sure. The other thing you could look at is you look at your business, assets, accelerated depreciation, and oil and gas. You could do an oil and gas investment. What they do is the investment is considered intangible drilling costs, and those are treated as ordinary losses, so usually, you get about 80% of the investment as a deduction in year one. You might have time to do that this year. Let’s say you made a $500,000 dollar investment. You could get about a $400,000 tax deduction.

Jeff: Is there any sense in investing in syndication or something that may be taking large deductions?

Toby: Not unless you’re a real estate professional. If you’re a real estate professional, the old adage for us is if you’re paying taxes, you’re a real estate investor, and you don’t own enough real estate, there are limitations on some of the losses that you can take. What is that called? There’s a restriction on how much loss you can use against the other types of income.

I think that if you’re married and filing jointly, it’s around $500,000. We’d have to use a combination of those things to get your taxes down. The good news is when you’re that high at tax and you have a $500,000 tax bill, you’re at least the 37% rate, so almost everything we do is going to save you $0.37 on the dollar.

If you do an investment in oil and gas, it’s not just, hey, I have this great investment—hopefully, it’s a good investment—but I’m also getting a 37% return today because of the deduction that you’re making.

Jeff: I want to go back to the charitable donation because I think when we say charitable donations, people think we’re donating to Ronald McDonald House or something like that. But you could donate to your own charitable organization.

Toby: If you’re working with us, for example, if somebody says, hey, I want to set up a charity, we’re really close to the end of the year. We would use a donor-advised fund. Anderson has a donor-advised fund. We would dump money into the donor-advised fund that would roll eventually into your charitable organization.

Let’s say that I have a heart for affordable housing, so I’m going to set up an affordable housing nonprofit. Or I care about veterans, so I’m going to set up a veteran’s support group or veteran’s housing. For amateur sports, Aaron Adams did a volleyball league, a volleyball nonprofit that he ended up building about a $2 million structure. He donated about $2 million to it.

You get these huge deductions. It can be for something that you’re going to control. Again, it’s kind of like the right pocket left pocket thing. Sometimes, I can move money from my right pocket into my left pocket and get a deduction for it.

Now, if it’s in a charity, there’s a taxable event for me to get out of the charity. I’m going to have to work for the charity and pay myself wages. My experience is that 99% of the charities that we set up are not taking a salary. What they’re doing is something good for society, and it’s a one-way road. Money goes into charity, and people love to do charitable activities.

Jeff: It’s a great way to create a legacy for yourself.

Toby: Absolutely. A buddy of mine, Aaron Adams, will tell you. He says it all the time, so it’s not confidential. He actually took a girls’ team in Idaho Falls. He coaches a high school team that hadn’t even made the playoffs. I think they were there either number three or four in the state. He did a fantastic job, but he […] stuff, so if you like that type of activity, amateur sports is actually a nonprofit activity. Helping animals, science, education, and anything that involves feeding or housing the poor or marginalized groups can qualify. You can absolutely do it.

We don’t have a link to Anderson’s donor-advised fund because we only do it for clients that are actually doing the nonprofits, but we can park your money as long as it’s going to go to your Anderson set-up nonprofit. Otherwise, you could use a typical donor-advised fund that goes to other charities, but just know that the donor-advised fund doesn’t have to give to the charity that you designate. That’s always where it gets fun.

Here’s a good one. “I am looking to attain two or more rental properties within the next year or so. Is it better to create an LLC for each property or take title under my current S-corp?” You just made my heart skip there. “I have an S-corp retail classification that I’ve considered dissolving. Should I just reclassify my S-corp as a real estate investment and take the title in the name of the S-corp?” Jeff?

Jeff: Since this company was already in existence doing something else, I do not favor this at all. Also, it’s an S-corporation, so you would at least have to revoke that S-election.

Toby: Don’t do it. If you revoke the S-election, you’re going to be a C-corp. It’s even worse.

Jeff: I’ll dissolve this one if you really want to dissolve it and form a new LLC that’s maybe a partnership or even disregarded to yourself if it’s just there.

Toby: The recommendation is to set up an LLC for each property. Unless you’re in the state of California or Florida, then we might use trusts instead. But for the most part, the best practice is to isolate each property.

It depends on how much debt is on them, the value of the properties, and the value of your other assets, but generally speaking, it’s going to be to isolate those two rental properties. You do not want to create adverse tax consequences. You put it into an S-corp and take that puppy out to refi it, or take the property out and move it into a different LLC. That’s a taxable event to you. The appreciation is taxed as wages to you. It could be a nasty tax situation. You do not put rental properties into an S-corp unless the benefits far exceed the disadvantages.

Guess what you can do. You can always go and sign up for the YouTube channel and watch these types of videos all the time. We’ll be putting the recording of this Tax Tuesday in there as well. You could absolutely do that.

If you have questions in the meantime, send them to taxtuesday@andersonadvisors. That’s where we grab the questions that we answer every week or every other week, but you will get answers no matter what if you send those to taxtuesday@andersonadvisors.

You can also visit us on our regular website at andersonadvisors.com. Some of you guys asked about the Tax & Asset Protection events. You can absolutely get information there as well as on Tax-Wise, the nonprofit events that we hold. We do a lot during the year. I think we do about 50 events a year, so there are lots of opportunities for you to engage and learn. It’s a ton of fun.

Somebody says, “Love this, guys. Haven’t joined you in a while.” Thanks for joining us. It’s much more fun for Jeff and I when people are on and it’s not just he and I are looking at each other, although that’s not horrible either. Jeff, you’re easy on the eyes, my friend.

All right, that is it. You guys are awesome. Until next time, I’m Toby.

Jeff: And I’m Jeff.

Toby: This is Tax Tuesday.