Why you should consider switching from LLC to S-Corp

Jeff: And Jeff Webb.

Toby: You’re watching Tax Tuesday. First off, welcome in. Let’s give everybody a chance to get into the room. They always flow in and it always seems to take a few minutes. We are also streaming. Andrew, where are we streaming? Are we streaming on YouTube? Let’s see if Andrew actually responds.

All right. Where is everybody from today? Somebody said the Trump International Hotel in Las Vegas. You’re right across the street from where my wife likes to do damage, Fashion Show Mall. Anacortes. Do you know Anacortes? Quincy. There’s Texas, New York, Anchorage, Manhattan Beach, Dallas, Seattle, Washington, Orange County, Bonney Lake. I know that area, too. 

Wow, a bunch of folks from Washington. Beautiful downtown Burbank. It’s pretty. Redwood City, a few Las Vegas, Tampa. Beautiful beaches. Kuala, Woodinville. We have a lot of Washington. You guys seem to be getting squeezed in or something. A lot of folks from the Pacific Northwest. There’s Georgetown, Texas, just out of Austin where Carl, one of our attorneys, grew up, so we like that area. Massachusetts, Colorado Springs, Orange, New Jersey. That’s a famous place, too. Seattle, of course.

We have a lot of folks on to help answer your questions. Some of you guys are already going into the Q&A and starting to ask the questions. The way it works is really simple. You can ask questions via chat. If it’s something that we’re hitting on immediately like, hey, where are you from and you put it in there, I can see there’s Shoreline, Washington. I lived there for a while. Charlotte, North Carolina, Napa. I can see you chatting. Jeff can pretend to see you. Can you see that?

Jeff: I see the words.

Toby: I just can’t see anything close to me, but I can read it across the room, so that’s good. We also have the Q&A where you can ask questions that are a little more detailed. If it’s going to be beyond a sentence, go to the Q&A. If you’re just commenting on something that we’re saying, or if it happens to be your question that we’re going over today and we ask you questions—we get that a lot, we go back and forth—do it via chat. 

All right, let’s jump in. I could already see the Q&A. We have Eliot, Thomas, an attorney, Troy Butler who heads up our bookkeeping department. We have Matthew, Patty, Piao’s on, and Dutch. I can’t believe Dutch and Piao are actually on. Dana, all these guys. We have a tax deadline today, so they must be taking a break. They’re probably all here until midnight last night.

We have a whole bunch of folks on. Andrew and then also Kenny. We have a bunch of people rolling around out there helping or in a support role. We’ll make sure that we get you guys taken care of.

You can email us questions during the week at taxtuesday@andersonadvisors.com. There’s never a cost. We don’t sit there and bill you for questions or anything like that. We just take your questions, and we answer them. If it’s super detailed, we say, hey, you need to become a client first, then we answer them. But for the most part, we’re just shooting you quick responses. It’s out of that grouping that we have staff that just grabs one. They seem to say, keep coming up, and they’ll grab questions, throw them over towards us, and say, here, grab 10 or 15. We will make sure that we get it.

You guys could see the rules now. That would help I suppose. It is supposed to be fast, fun, and educational. Jeff here has been a CPA just about as long as I’ve been alive. Just teasing. It’s close to 40 years. Someday, I’ll be 40 years old, too. We’ll have to give you a nickname. It’ll be something about old people.

Let’s go into the questions that we’re going to be answering today because we have a lot of them.

“If I buy an existing home inside an opportunity zone, will I be able to save tax on the capital gains of keeping the property for 10 years?” Good question.

“I sold a rental house that is in a trust. The trust sold the house. The trust is owned by my LLC.” We’ll go over all these by the way. “I did a 1031 exchange and identified a storage facility that I am purchasing. If the LLC flows to my personal social security number for the 1031 exchange, could I purchase it by creating a new LLC that also flows to my social security number, or do I need to take the title of the new property in the name of the trust or the LLC that owns the trust?” 

If you could tell that there’s funky grammar, it’s because I literally take your questions. We don’t massage them, we just bring them right on out and put them in their whole glory. But I think we get the gist of that one. We’ll go over that.

Jeff: Sometimes we don’t even get capital letters.

Toby: No. I just grab it. I try not to mess around with it or spend too much time with it. I like it to be real.

Jeff: Don’t put words in their mouth.

Toby: Yeah. I don’t want to start rewriting your questions because it’ll become easier. Let’s just put it that way. I’ll be like, oh, that’s a very good question. What if you had said this? Then it will be the same question over and over again.

“We qualified for a real estate professional in 2020. Two questions: (1) we must qualify annually, correct? (2) If we had a cost seg done on property purchased in 2021, would the entire accelerated depreciation be able to be applied toward active W-2 income when total depreciation exceeds rental income?” This one, obviously, we’re going to break down when we hit it. 

“Example cost seg for 100% of bonus depreciation is $30,000, rental income of $35,000 less ordinary and necessary expenses. $30,000 leaves net income of $5000. Can the $30,000 bonus depreciation bring the rental income to zero and the remaining $25,000 of bonus depreciation be applied towards W-2 income?” I’ll break it down for you guys. Don’t worry, we’ll get into that.

“We bought a second home in San Diego. The closing of escrow is November 4 of 2021. We were able to quickly turn it around, put it in service, and did a handful of short-term rentals.” You guys rock. Hopefully, you’re listening. We’ll also explain why that’s actually really cool. “We’d like to see if we could do a cost segregation study now in 2022 and use some of the stepped-up depreciation for our 2021 tax return.” We’ll go over that. Good question to have and a good situation to be in.

“Crypto IRA. What legal options are available to structure an IRA participating in crypto? Personal and/or trust IRAs, both traditional and Roth, positive and negatives of each option? What risks are there, regulation, changes, et cetera? What (if any) risk is there of a policy change? I have a legal crypto IRA already established then losing the IRA tax privileges.” Good question.

“Can we briefly talk about non-grantor irrevocable complex discretionary spendthrift trust?”

Jeff: Sounds like they don’t want us to go on and on.

Toby: Yeah. “Some people are saying we can contribute our rental assets to this type of trust, declare an extraordinary dividend to the corpus of the trust, and it would be tax-free.” You get an extraordinary dividend, no tax. We’ll get into this. Let me give you the eye right now. Do you want to give them the eye, Jeff? I do, too. I’m giving you the eye.

“Once you exhaust the 27 ½ years of depreciation on a rental property, is there anything that can be done to provide an additional tax write-off for a rental property? It seems my tax preparer used the purchase price of my rental property 20 years ago to do the yearly depreciation for up to 27 ½ years. The property value now is triple the cost of the purchase price. Can the depreciation amount be recalculated or am I stuck with the original calculated amount?” Good question. A question we get all the time, by the way.

“Sold a single-family residential December 2021 and are in the process of a 1031. Are expenses of sale—i.e. repairs, painting interior, replacing carpet—deducted as expenses, or can they be used to increase the cost basis of the property?” Good question. We’ll dissect that one.

“My business partner and I have an LLC for our real estate investments. Our LLC is taxed as a partnership. Would it be better to convert our LLC to an S-Corp? If so, why?” Good questions we’ve got. Somebody went a little crazy and just kept putting questions on their list.

Jeff: And picked the ones that take up the whole page.

Toby: I know. It’s because it looked like a good question. I’m like, oh, this one looks interesting. It’s just like moths to a flame. It’ll be midnight when we get to it, but let’s do it anyway.

“I have a property that was my primary residence. Our goal was to take advantage of both Section 121 and 1031 to maximize tax savings. We lived in it for 10 years and started renting in October 2020. We intend to sell it around June of 2023 so we’ll have it occupied for two years out of the last five years. We were thinking of putting it into an LLC as we have full-time tenants, but then we started to get concerned. What if we transfer ownership? We may no longer qualify for the $500,000 gains. What should we do? Purchased the house for $269,000 in 2011 and will likely sell for around $900,000.” Way to go.

Jeff: Nice return.

Toby: Who knows, it’ll probably be worth about $6 million in 3 years, 2 years, 1 year, or 1 ½ years because of inflation. What do you guys think inflation is going up at? Do you guys know that they actually changed the way we calculate inflation? I know that they did it in 1980, 1990, and I believe, 2004, something like that.

Jeff: I know we go with the core inflation where they disregard energy and housing which is what’s going up substantially.

Toby: Here’s a trick. They changed the way it was calculated. I remember it was Newt Gingrich. They kept saying, hey, Social Security is getting hammered. If we use regular inflation, it’s way too high. This will keep you from having the cost of living increase go up and having to give our seniors more money. We wouldn’t want the actual inflation because inflation is going too high. We need to recalculate it so we don’t have to give people that are in Social Security more money.

There’s been a lot of that in the news. Inflation hasn’t been this high since 1982. Actually, if we calculated it the way it was in 1982, it would be 15%. It’s huge. Just look at real estate.

How many questions did I pick? You guys should not let me drink and pick Tax Tuesday questions. You should do an intervention.

“If I have oil and gas and mineral rights in a traditional self-directed IRA and want to convert them to a Roth self-directed IRA, can I use a third party professional evaluator of mineral rights who will assess fair market value per SEC guidelines and provide well-documented paperwork that was used to determine fair market value at the time of conversion to determine fair market value to be used to do the Roth conversion? Would this increase the odds of a potential IRS audit or raise a red flag to the IRS in your opinion?” Good question. Hope you know the answer.

“My father-in-law is selling two family homes in New York and are both tenants in common. My in-laws live in one unit and rent the other unit out the whole time. My wife and I didn’t live there two years of the last five, so I know my in-laws don’t need to do 1031 exchange but I need to. My wife and I are doing 1031 for a bigger investment property. 

My question is, is there a way my in-laws can give their capital gain from this sale to my wife so we can put it in as a down payment of a 1031 property?” Good question. We’ll go over all the little implications. These are really good questions. This is why I grabbed too many. Sorry, guys. I always like watching people’s responses.

“The government wouldn’t massage the numbers, wouldn’t they?” No, they’re not masseuses, but they might mistake them.

“How do I correct my tax returns for a basis error on my vacation rental property? I incorrectly allocated too much building versus land. I understand that my depreciation expense will decrease.” Good question. You guys are going to want to stick around for that one because for any of you guys that have ever screwed up on a tax return, it may not be what you think.

All right, let’s jump into this. Just real quick, we are on YouTube. Specifically, all these Tax Tuesdays end up taking perch in one of our spots. Go to our YouTube page, do a little subscribe, and click the little bell that you can see. It’s up here somewhere. I have to use a pen now that I’ve started down that path. It’s a subscribe thing. There’s a little bell, click on subscribe. You can see we’re throwing lots of content up there. Look, there’s Tax Tuesday right there. You can actually come and watch us on the stream so you can have some fun there.

All right, let’s get into the questions. “If I buy an existing home inside an opportunity zone, will I be able to save tax on the capital gain of keeping the property for 10 years?” Jeff?

Jeff: The qualified opportunity zone had three benefits to it. There was the deferral, the step-up, and the payout. It’s a shorter deferral now, but you still get the deferral. The step-up in basis is now gone. It used to be that you’ve got a 10% step-up on the basis of your property that you put into the opportunity zone. The last part, the payout, is if you hold the property you put in there for 10 years, that’s tax-free. That still exists. The one thing that’s missing is the10% step-up in basis.

Toby: When it came out, it was 10% after five years and then 15% after seven.

Jeff: Right. The deferral on the gain that you previously had, you have until 2026 to defer that.

Toby: You just said something. If you buy an existing home in an opportunity zone and you want to be underneath these three benefits, you have to be using capital gains. You can’t just go buy a property in an opportunity zone. Step number one, you have capital gains and you put them in an opportunity zone fund, which has to be a partnership, an S-Corp, or a C-Corp. It has to be an entity that’s taxed in those three characteristics. 

Then, it has to acquire opportunity zone property that qualifies. If you buy a house even with deferred funds, you’re not out of the woods yet. Once you buy it, do you have to improve that property? They actually require that you increase the improvement value of that property and double it. If you buy a house that’s on land and the land is worth $100,000 and the house is worth $200,000, you have to put $200,000 into that house. You could actually stretch it out over a period of years.

Then, after 10 years, you step up the basis whenever you decide to. You’re going to be treated as though you stepped it up at 20, 45, or something like that, but you don’t have to pay tax, so it’s really powerful. But you have to jump through those hoops. 

The question for you is, do you want to jump through those hoops? If you just bought a house and you keep it there for 10 years, it’s not going to do you any good. If you defer capital gains, you’re going to pay tax on that capital gain. It’s treated as though you sold the property that you’re deferring.

Let’s say I sell a whole bunch of stock and I have $100,000 of deferral. I take that $100,000 and I buy a piece of property in an opportunity zone. That gets me through step number one. I now have a deferral of $100,000 that is taxable. It’s going to be treated as though I sold that asset on 12/31/2026. In 2027, I’m going to pay tax on $100,000.

Let’s say that $100,000 investment in that house, I put another $70,000 into it or whatnot, and now that house is worth $1 million after 10 years. I could sell it and pay no other tax. That’s the power of an opportunity zone. See, you thought today would be boring.

“I sold a rental house that was in a trust. The trust sold the house. The trust is owned by my LLC.” The LLC is probably the beneficiary. “I did a 1031 exchange and identified a storage facility that I am purchasing.” Perfect. “If the LLC flows to my personal social security number for the 1031 exchange, could I purchase it by creating a new LLC that flows to my social security number, or do I need to take the title of the new property in the name of the trust or the LLC that owns the trust?” Jefferey?

Jeff: That sounds like a disregarded LLC since he’s saying it’s flowing to his social security. Anyway, I am of the opinion that the LLC that sold it or the trust that sold it needs to be the one purchasing the replacement property. If it’s a disregarded entity and you form another disregarded entity, I don’t know. What are your feelings on that?

Toby: It happened. You have to take a name to name on a 1031 exchange stock exchange. After you’re done, there used to be this, oh, can I transfer it to a new entity? If the beneficiary or the true beneficial ownership has not changed, you can switch the name on it.

Jeff: I agree with that completely.

Toby: You’re going to close in the trust and then if you want to distribute the trust to a new LLC that’s in your name, you certainly can do that, or you could just leave the trust. The problem is that guys like me use the address in the name of my trust. I’ll have the 123 Main Street trust. If I go buy something else, 456 Apple Street. It’s kind of funky to have it in the 123 Main Street trust, but I wouldn’t care. I’d be like, cool. Rarely do I see 1031 exchanges in trust. Usually, it’s an LLC. If you have other partners in it, you do what’s called a drop-in swap.

There are a bunch of questions coming in. It looks like our guys are knocking them out, though. I get distracted. I see good questions and I start wanting to answer.

Let’s just leave that one at that. Close in the name of the trust to make your life so much easier. Once you’re done closing, then look at the LLC. You can close with another LLC as the beneficiary, but what really matters is what’s on that title. You might just want to keep it there.

“We qualified for real estate professionals.” This is real estate professional status, Section 469(c)(7) of the Code, very specific to real estate investors. What it means is that they don’t have passive losses. It becomes an ordinary, non-passive loss. “Two questions, we must file or qualify annually, correct?”

Jeff: That is correct.

Toby: The answer is yes on that one. It’s an annual test. “If we had a cost seg done on a property purchased in 2021, would the entire accelerated depreciation be able to be applied toward active W-2 income when total depreciation exceeds rental income?” They used the example of a cost seg, the bonus depreciation is $30,000, they have ordinary and necessary expenses of $30,000, so they have net operating income of $5000, and they have additional depreciation of $30,000. Do they get to take the $25,000 deduction?

Jeff: That goes back to whatever your answer is for question number one. Did you qualify to be a real estate professional?

Toby: This is 2021. Just because you’re a real estate professional in 2020 does not mean you automatically qualify in 2021.

Jeff: Correct. If you do qualify in 2021, you beat the test, yes, this loss from these rental activities could offset any other income you have on your tax return.

Toby: That’s why we like real estate professional status. What if they’re not a real estate professional? Is there anything else they could do?

Jeff: If it was short-term, they’d have a better chance of it. But if it’s long-term, if they’re making less than $150,000 or preferably less than $100,000, they can take up to $25,000 in loss.

Toby: When I saw the $25,000, I was going, oh, there are actually two ways you can write that off. One is active participation where you manage the manager. Number two is the real estate professional status, which is a much harder status. Active participation, you go like this: yup, I’m actively participating. I decided who the manager was. I’m in control of the property. You’re going to be an active participant. But it phases out between $100,000 and $150,000 of adjusted gross income. You might be able to get to write that off anyway.

But let’s be real. If you’re making $100,000 and you get a $25,000 deduction plus you have your standard deduction, I much prefer that deduction when you’re in the higher brackets. Toby is going to get flack for that. I apologize, guys.

“We bought a second home in San Diego in November. We’re able to quickly turn it around and put it into service,” good job; you guys might get rewarded for that, “and did a handful of short-term rentals in 2021. We would like to see if we could do a cost segregation study now in 2022 and use some of the stepped-up depreciation for our 2021 tax return.” Jeff, what do you think?

Jeff: If you are considered to have materially participated in that short-term rental, that’s actually pretty easy to do.

Toby: You get a big, fat write-off.

Jeff: And you have up until the extended due date of your return to get that cost segregation done for 2021.

Toby: You actually can do the cost segregation study right up until you file your tax return, assuming that it was something that went to your tax return. If this was a corporation, no. If this was an LLC disregarded to you, yes. If it was an LLC disregarded to an LLC that is taxed as a partnership that flows to you, yes, you could do it. Anything that flows to you, you’re going to be good. You have to materially participate.

They put it into service. The IRS doesn’t care whether you were in service for a week or 11 months. Bonus depreciation is I bought it in that tax year and put it into service. Can I take a big, huge deduction? The answer is yes. It’s an ordinary loss. The only question is, is it passive or non-passive? 

Passive just means you didn’t materially participate. Material participation is one of seven tests. There are seven tests under it. The easiest one is if you manage these yourself because there’s no way you hit 100 hours or the other tests on this property. Did you manage it yourself? If you did, you’re in luck. If you didn’t, then you’re going to have a passive carry forward.

Jeff: Using a service like Airbnb does not disqualify you from that materiality test.

Toby: Yup. What happened is you bought a second home in San Diego. That’s telling me that you probably are living there. It may not be a faulty assumption. But if I’m in Las Vegas, I buy a house in San Diego, and I’m using it as Airbnb, the court is going to say, no, you’re not materially participating because you have somebody else doing it for you. If it’s in your town, you’re going to be in luck.

If you’re out there, whoever wrote this, let me know in the chat whether that’s in your town. I love it when we give good news because Jeff’s always giving people bad news. He’s always telling them they can’t write things off. Gosh, Jeff. Bedside manner, because usually he goes, boo, you can’t write that off.

Jeff: And you’re going to prison forever.

Toby: He has one of those orange jumpsuit costumes. He always just hands them the orange jumpsuit and says, here you go. No, he never does that. Jeff’s one of the really good CPAs who’s really nice. He’s always trying to think of how we can help the client.

Let’s see if anybody out there in chat does short-term rentals that put something in service towards the end of the year? I love talking to those guys because they’re the fun ones. They’re like, hey, do you know you can write that off? And they’re like, what? What? What? Bonus depreciation is about 30% of the depreciable value of a house.

“Jeff always smiles when he says no.”

How to make money and save the world. Jeff, this is the Candelarios. This is really cool.

“Do you still have to be a real estate professional?” No. I’ll go back to that. When you’re doing short-term rentals, it’s not rentals. If it’s seven days or less average guest usage, it is ordinary income. You may as well be a plumber.

Jeff: That’s considered trader business. It’s not considered rentals.

Toby: Yeah. We have somebody, guys. A bunch of people are popping in now. “A remote condo in Boston. I live in Portland and I remote manage the two Boston condos.” You’re going to be able to do it. Lilian, are you able to do it long-term? If you’re managing those things and nobody else is providing substantial services, you could actually accelerate the depreciation and offset. 

Oh, it’s long-term rentals. If it is between 8 and 30 days and you provide substantial services, it’s not a rental. If it’s extraordinary services, then even if you go for a six months rental but it’s like a recovery clinic or something, it’s not a rental. But if you don’t provide any services other than here’s the house, then it’s a rental. Sorry to get deep on you, guys.

All right, let’s go back to saving the world, the Candelarios. I’m going to be doing an event on Saturday with the Candelarios. They’re really cool people. Years ago, I met them. They were trying to do transitional housing at the time in King County, Washington. Since that period of time, they have just exploded. They have a bunch of houses up in Seattle and they’re working all over the country now. I think they’re down in Florida.

One of the really cool things is they do transitional housing which is a shared housing idea. It’s like taking a house and instead of renting out the whole house, you break up the rooms. In King County, they get $850 a bed for a 10-bed home because they have to put 2 people per room and they have 5-bedroom homes. It is cheaper for King County to incarcerate people that way. Nonviolent offenders. In their case, it’s women, nonviolent offenders. It’s significantly less expensive than housing them in jail, and more appropriate. They get guaranteed 10 beds, so they’re making $8500 a month per house. You could just keep doing that.

The reason that we teach this is because there’s also a nonprofit component to it. If you’re trying to help people that are going through dependency, if you’re trying to help people that are doing transitional housing, there is so much opportunity there. More importantly, there’s so much unmet need and it’s just really important.

“Are they staffing these homes?” They don’t have to. The parole officer can come over and check it out. They’re non-drinking, nobody can come over after hours, they go to work, and they come back. It’s very regimented, but they can get into all that. 

It’s absolutely a very interesting area that we’re seeing more and more people getting into because let’s be real, you got Blackrock in the single-family residential zone buying up houses. How are you supposed to compete with somebody who gets their house at an interest rate that’s half of what you can get? And they’re buying it at ridiculously stupid cap rates. Either you chase them or you find a way that they can’t possibly enter into. 

In this case, it’s usually about three times what a typical rental will go for. You don’t have to do anything. You could work with organizations. I do. I rent to both autistic homes and to transitional housing. Patty has to do with it more than I do because she handles all of our rentals, but it’s really easy.

We rent to an organization and they have people that they place. You could be that too. I get about 20% higher rents and I feel good about myself because I’m trying to do something that’s meaningful. All right, that’s enough of that. If you want to come, Patty shared the link. It’s absolutely free.

Crypto IRA. “What legal options are available to structure an IRA participating in crypto?” Crypto being less is called Bitcoin, Ethereum, all the wonky coins. What is it, Shiba?

Jeff: Doge.

Toby: Doge. “Personal and/or trust IRAs, both traditional and Roth, positives and negatives for each option. What risks are there? Are there any risks of policy changes if you already have a crypto IRA established? What about losing IRA tax privileges?” What do you think?

Jeff: The first thing I thought about when I read those questions was the effects of answering each of these questions really does not depend on the crypto. It’s just a form of investment. If you’re going to put securities into an IRA and want to convert them to a Roth, it would be the same with doing crypto.

Toby: We treat them the same.

Jeff: Yeah, having crypto in there really makes absolutely no difference. But what are the risks of legislation? You may be aware that Biden recently signed an executive order about crypto. It really didn’t change much. One of the things it’s doing is having the Treasury Department look into coming up with their own coin, virtual currency, maybe more protections to avoid fraud and stuff like that.

The one policy change I know is going to happen in the future is I think there are going to be more regulations about reporting income and stuff like that. We’ve seen that a long since crypto came out, that they’re slowly building up the way the security brokers have had to do.

Jeff: They have to do this, but they think about Biden. All right, everything Jeff said is absolutely 100% correct. It’s just a capital asset right now. What are the changes? It’s not going to be a retroactive change for an IRA. If they change it to something that an IRA can’t hold, they’ll probably give you a year to relinquish those assets and get them out of there and put something else in its place.

Jeff: There has been talk of eliminating the Roth. I don’t see it happening, but if they did, that would only be going forward. You can’t create a new Roth from this point forward.

Toby: They might do that. They’ve talked about (in the Build Back Better) these large IRAs and what to do if they have too much assets in them. They just start saying, hey, you have to take required minimum distributions of 50% and stuff like that. They could say, hey, we’re going to accelerate, you need to get rid of these things, and we want everything out.

All it is is an individual retirement arrangement is what an IRA is, actually. We always mistake the account part, but whatever. Everybody does it. It’s really just saying, hey, institution, you have a custodian that allows certain types of investing.

The custodians are the ones that restrict the investing. You can literally do pretty much whatever you want inside of an IRA. If you want to collect gold, you just can’t take physical possession. You could do a lot of different things in an IRA. 401(k), the same thing in that particular case because you can potentially take physical possession of certain types of coins.

The reason I bring that up is because there’s a wallet that a lot of crypto goes into. There’s a discussion as to whether you have unfettered control of that wallet would cause a taxable event the same way it would if you had unfettered control of bullion. In an IRA, it would be a deemed distribution. In a 401(k), it wouldn’t.

If I was you and you were worried, I might be looking at a self-directed 401(k) . I don’t need a custodian that way. Or you just go get a safety deposit box in the name of the entity, put all your crypto in a cold wallet, and put it someplace or have the fiduciary hold on to it for you. As long as it’s not in your unfettered control, I think you’re never going to have an issue.

That said, there’s some precedent on changing laws retroactively. I think it’s a government taking. It hasn’t been handled in the Supreme Court. The people that say that you’re allowed to do that misread the case because the case didn’t actually involve an actual taking, but it’s been read to be that way.

Most likely, nobody wants to pick that fight. If they decide they want to target crypto, there’s going to be a phase out period, but I don’t see them targeting crypto. It’s basically a capital asset this time. Why would they change it?

“Can we briefly talk about non-grantor, irrevocable, complex, discretionary, spendthrift trust?” Somebody has been on the Internet too much.

Jeff: I was just thinking that.

Toby: “Some people are saying we can contribute our rental assets, this type of trust, declare an extraordinary dividend to the corpus of the trust, and it would be tax-free.” Do you have your orange jumpsuit somewhere? I hate those people. I know who they are, too. It’s like, yeah. Actually, go ahead.

Jeff: Yes, you can put your rental property into an irrevocable spendthrift trust. However, it’s a gift to the trust. It’s got to come out of your estate. You gift this property. That’s all well and good. Now you’re going to have stuff only 1041. It’s the trust tax return for that trust.

When we get down to the extraordinary dividend, here’s why I have an issue. Normally, when we talk about a trust receiving extraordinary dividends, and this only has to do with the calculation of DNI (distributable net income), extraordinary dividends usually come from entities that you don’t own. It’s when it’s more than 10% of the value of the stock?

Toby: Yeah, I can actually make it easier.

Jeff: Make it easier.

Toby: There are no such things as extraordinary dividends in a complex trust. It’s for subpart B. I know that provision, forget the name of the code. It’s for simple trust. In a simple trust, you’re required to distribute the asset out. But if the trustee elects an extraordinary dividend, an extraordinary dividend is something you can’t control. It’s like a cash dividend or stock dividend, and that’s what it was written for.

This is a long, long time ago statute. What companies would do is say, hey, we’re going to issue you 50 new shares of your company. And they said, oh, when you’re forced to distribute money out every year in a simple trust—that’s what a simple trust is; I’m distributing all the assets—I don’t have to distribute those shares. I can apply them to the corpus. That’s what this is about.

Whoever said you could do a rental, I know who these people are and I think that they should be investigated. It’s a bunch of crud. That’s not what it says. That’s not what an extraordinary dividend is. An extraordinary dividend can be a cash dividend. That’s actually how it’s defined in the code. But if you actually go back to when this thing was written, that is not what this is about. The people that do this, they walk people into trouble all the time. And then they disappear whenever all breaks down.

Jeff: Those last couple of words, be tax-free. All this does is in a simple trust, the way you said, the beneficiaries aren’t paying the tax on it. The trust is still paying tax on it.

Toby: Simple trust distributes the income and it does not distribute the corpus. The corpus is, let’s say I have a whole bunch of shares, it distributes the income. A dividend is typically income. If you have rent, then the property itself is the corpus.

The rents, it’s required to distribute. What they’re trying to do is twist this thing to say, oh, they could treat it as an extraordinary dividend. That’s not what it is. They have a private letter ruling from something that doesn’t say what they say it says it is and they always try to hang their hat on it. They’re a bunch of goons. Run, run.

Jeff: You also have to decrease your basis by that extraordinary dividend.

Toby: Yes, you do, which means you’re going to have a much bigger taxable event at some point in the future, except what you do is you distribute it. You change it to a complex trust before you distribute it and then distribute everything out, which you’re trying to do because trusts have very, very small brackets. After $13,000, you were at 37%. You could get caught and crushed if you have money that stays in a trust and doesn’t get distributed.

Jeff: You know where I’ve seen spendthrift trust used. Most are for people you don’t want to have the money.

Toby: Yes. They’re just distorting. These people, I’ve run into them over the years, 27 years of doing this. Trust me, and they always say, oh, there’s a lawyer and it’s a Supreme Court decision. I’m like, yeah, which one? Then they go, well, this lawyer. And I said, which lawyer? They talked to the lawyer and he’s like, well, I have this, it’s a private letter ruling. I’m like, you can’t rely on a private ruling.

It’s only applicable to the one who actually wrote it. You can’t even use it as precedent, so what are you talking about? And then it doesn’t even talk about what you’re saying it talks about. Have you guys got your own private letter ruling? No, we’re flying beneath the radar. Just run when you see stuff like that. Run and get your track shoes on.

I can’t help but I just see these things and I’m just like, I already know who these people are. They’re the ones that go like this, but I’m right, and they’re in the little cell, and you’re in there with them. 

“Once you exhaust the 27 ½ years of depreciation on a rental property, is there anything that can be done to provide an additional write-off on a rental property? It seems my tax preparer uses the purchase price of my rental property 20 years ago to do the yearly depreciation for up to 27 ½ years. The property value now is triple the cost of the purchase price. Can the depreciation amount be recalculated when I am stuck with the original calculated amount?”

Jeff: The depreciation systems have been called CRS and makers. The CRS and makers is cost recovery system. When you’re depreciating, what you’re doing is the government is allowing you to write-off a certain percentage of your costs every year. Once you fully depreciate that property, there is no more depreciation unless you do something like improvements.

Toby: There you go. What they’re looking at is, hey, can I increase it? Yeah, you put a betterment on the property. You put a new roof on, for example. What could they do? If somebody, they’re 20 years in, they’ve had to replace the roof or if they haven’t, they’re about to, what can they do with that?

Jeff: They can start depreciating that again.

Toby: And they can get a deduction for whatever the value of that roof is that they haven’t taken, too.

Jeff: One thing I thought about is 1031 Exchange, but that doesn’t work because you get the basis of the old property.

Toby: The only thing I could see somebody doing in this is if you want to rewrite it off, and you’re feeling kind of cheeky about it, and you’re going to keep it. You’re never going to get rid of it. You’ve already had it for 20 years and you’re probably going to keep it for another 20. Maybe do an S-Corp and sell it to the S-Corp.

If you sell it to the S-Corp with the new price, you’re going to have a calculation of an installment sale coming back to you versus the increased depreciation. You could sit with an accountant to do those numbers to see if it makes sense to you. The problem is that now your property is at an S-Corp and you really need to die with it to get it out of there. Otherwise, you can have an adverse tax event. But if you’re going to keep it forever, you might want to look at that because then you can get a new basis.

You’ll have recapture, you’ll have capital gains. It’s just you might be able to spread it out over at least (let’s just say) 30 years. Or if you’re too old, they might look at your life expectancy and say, hey, let’s make sure. If you’re over probably 65–70, you might want to do a life expectancy table to make sure the IRS doesn’t contest it. But you might want to look at something like that. Accelerate some of your depreciation again. There, great ideas. 

“Sold a single family residence in December of 2021,” and they’re in the process of a 1031 exchange. “Our expenses for sale, repairs, painting the interior of the house, replacing carpet, deducting as expenses. Can you deduct them or do they increase the basis?”

Jeff: Most of them that they talked about. You did use the word repairs, but carpet and paint are always deductible as a repair. You never capitalized that. But anything that’s really truly repairs, I’d write it off as a rental expense.

Toby: Because if it goes to basis, you’re not getting any benefit out of it. You’re rolling the basis for it, so you don’t even get extra depreciation. We want to write it off. Yes, you want to write that off in 2021. Two, you do not want to include it in your rollover of your 1031 exchange.

All right, “My business partner and I have an LLC for our real estate investments. Our LLC is classified as a partnership. Would it be better to convert our LLC to an S-Corporation? If so, why?” What do you think?

Jeff: No, I wouldn’t convert it to an S-Corporation. I don’t see any reason to do it.

Toby: The problem is if you have real estate investments and you put it into an S-Corp, if you ever have to refi that property. Here’s the problem with an S-Corp. If it’s a partnership, I could just take the money out.

Jeff: To distribution.

Toby: Yeah, and if I have to take the property out to refi it, I can do that. In an S-Corp, that’s a taxable event and it’s taxed as ordinary income. Bad, right? It’s taxed as wages technically to you. 

There’s one other thing that keeps popping into my head. It’s the at risk. If you don’t have basis in your S-Corp and you have losses on these properties, you can’t take them.

Jeff: That’s a really good point. If I have rental property in a partnership and I have a mortgage on it, I can take that loss. That gives me basis on my losses.

Toby: If you’re doing a cost seg or something.

Jeff: If I have rental property in my S-Corp when I have a mortgage on it, it does me no good at all.

Toby: I have to be at risk. Actually, the loan has to be in my name. It can’t even be an S-Corp under those circumstances for me to get to write it off. Or I have to have basis, which means I have a whole bunch of cash that allows me to take a deduction.

Here’s an easy answer. Would it be better to convert LLC to an S-Corporation? No. If so, why? See previous answer.

All right, YouTube again, and podcast, and watching replays. If you’re not tired of Tax Tuesday, you can go and get some more. Yes, we do this every other week. Yes, we pretty much act the exact same way, which is we like to be very transparent and we don’t hide our feelings.

Jeff will throw an orange jumpsuit at you and I’ll tell you to run from crazy people doing crazy tax things. Hey, here’s a good one, actually. Five best investments for inflation. It’s actually applicable. There are a bunch of fun stuff. And they’re starting to put my Buffet stuff up. I am a big Buffett fan. If you like value investing. Plan your finances like Buffett. I know what I did. That’s the long hill and the wet snow. Cool. I’ve been enjoying that one recently.

“I have a property that was my primary residence. Our goal was to take advantage of both section 121 and 1031 to maximize tax savings. We lived in it for 10 years and started renting in October 2020. We intend to sell it around June of 2023, so we’ll have occupied it two of the last five years. We were thinking about putting it in an LLC as we have full-time tenants, but then started to get concerned that if we transferred ownership, we may no longer be qualified for the $500,000 in gain from section 121. What should we do? We purchased the house for $269,000 in 2021. We’ll likely sell it for around $900,000.”

Jeff: My house is going for $900,000.

Toby: Yeah, they’re printing cash and handing it out to everybody. Do you want some cash? Here’s some.

Jeff: Since you own the property, I think if you put it in an LLC disregarded to you, you don’t have an issue. But what if it’s a husband and wife in a non-community property state?

Toby: I would be very careful on that one. Once a spouse began ownership is attributable to both. If you put it in an LLC that was a single owner and you named your living trust or one spouse as the owner, I think you’d still be okay. There’s actually a case where the IRS gave guidance on having a property in an LLC and still qualifying for the 121 exclusion, but I believe they said it had to be a disregarded LLC.

You do not want to put it in there if you are in a non-community property state. You’re in a separate property state and you both are owners. You generate a partnership return. I think you just put your 121 exclusion in jeopardy. If you just do a disregarded LLC and have one of you on or put one person on as the owner of the LLC, maybe as trustee of your trust, then I believe you’re good.

The reason they’re doing this guys, they get a $500,000 exclusion. It’s going to take them up to, let’s just say it’s extra $500,000 so they’re going to have no tax on…

Jeff: $769,000.

Toby: And they can still 1031 the remaining $231,000. This would be 121 and the $231,000 would be part of the 1031 exchange. They’ve paid zero tax if they did this as long as it’s within three years. Then the depreciation that they grabbed during those three years, they would roll into the 1031.

They’d have literally no recapture, they’d have no capital gains. Their basis would step-up to the $769,000. Some of you guys might be saying, why wouldn’t they just do a 1031 exchange because the basis doesn’t increase, and you want the basis to increase?

Jeff: A question for you. They started running in October 2020 and they’re planning on selling in June of 2023. I’m not sure I would wait that long just because they’re planning on waiting until almost the end of the five-year period to sell a property.

Toby: Make sure that you can close before. You have until October of 2023. You’re giving yourself about a four-month stretch.

Jeff: But things can go badly wrong.

Toby: Yup, we’ve seen it.

Jeff: 2007 or 2008?

Toby: You’re thinking about the market crap tanks. You might want to look at it and say maybe we should take a bird in the hand. You might want to take that bird in the hand if you’re getting a good price now, put it into something else. Do they have some? No, that was the one before where they had somebody already identified.

You might want to think about selling it and capturing the benefits in case something does happen in the market. We’ve actually had a couple people say, hey, the market could go down. Guys, I use something called the Case-Shiller Index on home prices and I compare it to the same thing for rental of a similar unit.

If you could buy a house for X, you could rent it at a value of Y. You’re looking at those two things and saying, are there enough people renting that house at a high enough amount that it would support the purchase price? The ratio goes from about 1.3–1.6. 1.6 is 2007 right before it toppled over. 1.3, most of the time, it is going up to 1.5 right now.

It’s going like this. Prices of houses are starting to outpace rental. It doesn’t mean it’s going to stay that way. But right now, it’s going the wrong direction, which means we probably have six months to a year before it peaks out and then it’s just a matter of time.

Nobody has a crystal ball. But if you have to compete against inflation so you have to raise interest rates, and you’ve already seen runaway exuberance in the rental market, and you have Blackrock doing what they do, and everybody’s fighting for homes, and we’re underbuilt by 3 million homes, you could see, at least the top end start to top over.

You’re at $900,000, you’re right there. I didn’t see much pain in things under $200,000 in Vegas. We lost 75% of our values and you still had a very robust market for anything in the $200,000 and below because they were all rentals and everybody needed rental properties. That was in 2008, 2009, 2010, 2011, 2012.

I can’t see that being any different this time other than that number, instead of being $200,000, it’ll probably be closer to $300,000. You’re on the higher end. You might want to think about selling and maybe getting a few houses because you can 1031 exchange into multiple properties.

“I have oil and gas mineral rights in a traditional self-directed IRA. I want to convert them to a Roth. Can I use a third-party professional evaluator of mineral rights, who would assess fair market value per SEC guidelines and provide well-documented paperwork that was used to determine fair market value at the time of conversion to determine value to be used for the Roth conversion?” What they’re really saying is, I don’t know what it’s worth. If we get it valued, can I convert that to a Roth?

Jeff: Absolutely. And I’ll tell you how they’re going to do this. If it’s a working interest, which it shouldn’t be in an IRA, they’re going to give you a multiple, like two times annual revenue. If it’s a leasehold interest, which is perfectly fine in an IRA, they’re probably going to give you a five-time multiple of annual rental, just to give you an idea of what they’re going to come up with. But yes, I would get a professional evaluator. They’re probably going to just look at the numbers. They’re not even going to come out and look at the property or anything.

Toby: Is it something where they would get an appraisal?

Jeff: Probably some kind of appraisal or evaluation of the lease.

Toby: Because if we were giving it away, like if we were putting it in a charity, then we’d have to attach it.

Jeff: Or if we were gifting it to anybody. Yeah, we’d have to have that appraisal.

Toby: When is the Fed meeting? Is it tomorrow?

Jeff: I don’t know.

Toby: When is the Fed meeting? Wednesday. Yeah, tomorrow. Yeah, the reading, so watch it. My guess is 25 to 50 basis points.

Jeff: You think so?

Toby: They’re going to have to. What are they going to do? You think they’re going to tank the market?

Jeff: I don’t think they’re sure what to do at this point.

Toby: I don’t think we’ve ever been here before. Anybody who says that they’re relating into Jimmy Carter, I’m sorry. Jimmy Carter didn’t have a trillion dollars dumped in by the Fed. Inflation was pretty predictable. More cash, less goods, higher inflation.

You don’t have to blame it on anybody. Powell said 25 basis points. Yes, so if he jumps it to 50, then you might see the market react. Otherwise, if he does what he says I think it runs. But who knows?

Jeff: You know what, Powell still has a job.

Toby: Yeah, everybody else is kind of like this guy did. You answer this one.

Jeff: On that, if you get the valuation, or appraisal, or something, you don’t have to submit that to the IRS.

Toby: It’s not a red flag. They’re just happy that you’re paying the tax. And they’re so killed right now. IRS is so far behind, guys. How long is it taking you to get a response in anything in writing?

Jeff: Months, and months, and months.

Toby: Six months, nine months?

Jeff: And I believe I heard that they were going to give all this money to the IRS to hire people and then they cut it back.

Toby: Where are they going to find people?

Jeff: True.

Toby: “My father-in-law is selling a two-family home in New York, a duplex, and we’re both tenants in common. My in-laws live in one unit and rent the other out the whole time. My wife and I didn’t live there for two years of the last five years. I know my in-laws don’t need to do 1031 exchange, but I need to. My wife and I are doing 1031 exchange for bigger investment property. My question is, is there a way my in-laws can gift the capital gain from this sale to my wife so we can put it as a down payment of a 1031 exchange property?”

Jeff: This was a doozy.

Toby: It’s actually pretty easy when you think about it. You have two units, so you have a duplex one and two. Two is equal to a rental and it’s owned by X. One is owned by parents. This is a principal residence and it’s owned by the parents. We’ll just call them Y.

Parents meet the 121 exclusion—two of five years—and they own their portion of the property as tenant in common. X is an investor, so it could be 1031 exchange. You could 1031 even a regular. The problem is, how do we get the cash that’s excluded? Can they gift that? Can we do a gift?

The answer is yes. You can gift up to about $12 million each for lifetime exclusion, but you’re going to have to file your gift tax return. The big question is, how much gain is there on their side and how much of that exclusion are they going to use? It sounds like that’s what they’re doing. You still have to 1031 exchange your interest.

Jeff: Here’s my question, Toby. They said they’re tenants in common in this single building? Would they each own half of it?

Toby: Yup, that’s what I would do.

Jeff: Or would you say that you have one is the parents half, and two is the kid’s half?

Toby: Yeah, that’s what I would do.

Jeff: Okay.

Toby: But we don’t know which half it’s half. It sounds like it’s a duplex, but I might be reading more in there. Duplex makes it easy. If you live in a duplex, you can 1031 one half and keep into it. All they’re doing is they have somebody else.

The other route you’d go is if you don’t want to mess around, they don’t want the 121 exclusion. They could just gift you the property and you get it at their basis. If you then sell it under a 1031 exchange, you would just roll the whole basis into the new property. That’s another route you could go. Anyway, fun stuff.

All right, this is one of my favorites. “How do I correct my tax returns for basis heir on my vacation rental property? I incorrectly allocated too much to building versus land. I understand that my depreciation expense will decrease.”

Jeff: I like that you made this the last question.

Toby: Why?

Jeff: It’s a good question. You’ve heard us talk about change in accounting method, and having a complete godforsaken form 3115 to change your accounting method, and so forth, especially if you miss depreciation. This ain’t that. This is a change in accounting estimate. Which means if you see it’s wrong on last year’s return, you’d go in and correct the numbers on this year’s return.

Toby: This is one of those weird things. If I screw up something on a return, but I thought it was right when I did it, I’m under no legal obligation to go back and restate it.

Jeff: As long as you’re not adding new cost categories, like five-year or seven-year property, and it doesn’t sound like you’re just moving from land to building, and that’s perfectly okay.

Toby: What about as a vacation rental? Maybe I hear a vacation, I immediately think second home, but it’s a vacation rental. Maybe it’s a rental property that is a vacation rental for other people. Maybe it’s Airbnb, who knows? I always wonder whether there’s personal use, in which case, a proportion of it would be used personally. What if they screwed that up?

Jeff: They would have to go back and amend returns. Still not a chain of accounting methods. It’s just you screwed up probably your calculations. Typically, if you have more than 14 days of personal use or 10% of the total rent time, your losses are going to be limited to your income. You’re not going to be able to recognize any losses on the property.

Toby: Here, I got to go back to this one. Somebody says, “If the parents gift their half of the duplex, it could be valued at fair market value, not their basis. Correct? It sounds like you said the opposite.” If I gift Jeff a $1000 share of Tesla that I bought for $50, there’s a gift of $1000, but his basis is $50. He inherits or he gets my basis in the property, but the fair market value is what goes over, right?

Jeff: For their cost? No, they step into your shoes.

Toby: That’s what I’m saying. The basis, but the value of the gift would be the fair market value of the property.

Jeff: Yes, and that’s where it can really bite you in the butt, if you have $100,000 property that’s now worth a million.

Toby: You’re using up the $12 million exclusion, but your basis is whatever the parents are. I was just saying. There are two things. I’m giving Jeff a gift of a house. The fair market value is what we have to use, but he gets my basis. In other words, I can’t sneak around and say, hey, Jeff, you paid at yours.

Jeff: I’m not going to gift any appreciated property to my children. They’re going to have to wait till I die. And it’s actually for their benefit.

Toby: They did say it is a duplex, by the way. The people are on. That’s how you do it. What would I do if I was in this scenario is I might just have the parents. I want to use my 121 exclusion. I’m kind of greedy on those things. And then I’d say, hey, give it to me when they’re all said and done, and they can just give you the cash.

You sell your half. If you’re buying another property, you could use that extra money to add to that property. Your basis is actually higher in that property that way so you can depreciate it better if it’s another investment property.

That’s what I would do. I’d say, hey, let’s sell it. I sell my half as a 1031 exchange. Parents sell their half, take the cash and gift it. We don’t have to worry about anything. There’s no tax on them. There’s no tax on the gift. You can now take that cash and add it to the money that you received on your sale, of your half, and you can buy more property, which is going to get you more depreciation.

Toby: All right. We’re at the end, guys. Thank you so much for coming in. Make sure that if you have questions during the weeks that are in between, we do this every other week. By all means, send it in taxtuesday@andersonadvisors.com.

We do answer every question that we can get our hands on. We pick a few to do during these types of events, during the actual Tax Tuesday. Then somebody says, “Why can’t you transfer the property to your kids with a life estate? Won’t they get the step-up in basis?” No, you actually screw that up when you do that, so no.

Jeff: All gifts are at cost.

Toby: If he gets a life estate, they would devalue the property. The gift would be added. Would it step-up when they’re passed? The kids own it subject to a life estate. If you give your kids a life estate, then it would be the opposite. Then you’d get a basis up to step-up.

All right, our guys answered over 100 questions today. Thank you to Eliot. Dana, do you have something you want to just interrupt with?

Jeff: Do you want to talk about your next Tax Tuesday?

Toby: Next Tax Tuesday? It’s in two weeks, right?

Jeff: Yeah. Where are you going to be in two weeks?

Toby: I’m going to be in Hawaii.

Jeff: That’s right.

Toby: Okay, I’ll be in Hawaii next Tax Tuesday. Will I be? Yeah, I will be.

Jeff: And we’ll have a special guest from what I understand.

Toby: Will we? Who?

Jeff: Michael.

Toby: Bowman?

Jeff: Yeah.

Toby: Oh, so Michael. See? I’m the last guy to know. I probably know this. He does not like Tax Tuesday. He does not like getting asked questions out of the blue. All right, it’s Hawaii with Michael Bowman.

He’s fun. What I sometimes do is I pick questions and there’s no way he’s going to know the answer. Then I ask him because it’s just fun to watch him freak out. It’s kind of enjoyable. We all get stuff. Nobody knows anything or nobody knows everything.

Anyway, thank you, Eliot, Troy, Matthew, Piao, Dana, Dutch, Patty. Who else did we have on there? Ander. We could thank Patty twice. She does a good job. These guys do that. I’ll be in Hawaii next week, so there we go.

We’re going to be in Maui for the executive retreat. We do that. We try to do it every year. We had to punt this one from October until April because of all the restrictions that were on that island, but we’re going to go out and have some goofy time.

We do that with investors. We horse trade and drink a lot. I think it’s a good thing. I’m just teasing. I might have a lava flow. I have to put my pinky out when I drink. All right, guys. We really enjoyed it today. If you have questions, email them on in. If not, we will see you in two weeks. Thanks, Jeff.

Jeff: Thank you.

As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, a great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets.

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