It’s the first Tax Tuesday of the year. This time, you’re not only listening but watching Toby Mathis and Jeff Webb of Anderson Advisors answer your tax questions. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
- If we received PPP in our business, then get approved for forgiveness, will we still be able to deduct the rents and utilities we applied for the PPP to? Any loan forgiveness is not taxable, anything paid for with PPP is fully deductible, and any PPP loan forgiveness gives you basis
- I recently read that Elon Musk is moving his private foundation from California to Texas. Is there a tax advantage for moving a private foundation or a nonprofit from California to Texas? No tax advantage, but both states highly regulate nonprofits
- Do you have to be married to create an entity that allows you to hire your children? No, as long as they are your children
- How long after the sale of a primary residence do you have to apply the proceeds to a new home purchase to avoid taxation? No law ceased to exist, refer to Section 121 Exclusion and 1031 Exchange
- I’m 70 years old and haven’t made a deposit to my Roth in 10 years. Am I free to withdraw all my account without penalty, or am I limited by cost basis? Once you have the Roth for at least five years and over 59.5 years old; you can take it all out, but then you have no protected active income stream
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Full Episode Transcript:
Toby: Hey, guys. This is Toby Mathis.... Read Full Transcript
Jeff: And Jeff Webb.
Toby: And now you’re watching Tax Tuesday. Welcome to 2021’s first Tax Tuesday of the year. Let’s make sure we get some people on. We have some people loading up. While you’re loading up, let’s go over some of the new rules because we are using Zoom now. We’ve done many, many events on Zoom. We switched over from the GoToWebinar account and now we’re just Zooming it.
On Zoom you have question-and-answers and you have chat features. What we’re going to ask is that if you are going to ask questions, that you do it via the question-and-answer as opposed to the chat because the chat will just fly through quickly; we won’t be able to see it all. Whereas, if you do question-and-answer, we can’t get rid of it until we answer it. It sticks in our face until we actually get it done. Don’t worry. It’s not just Jeff and I answering questions. Jeff doesn’t even have a computer to type on.
Jeff: I don’t even have a phone.
Toby: We took away all of his toys. He’s not allowed to have anything except the mask. Someone’s in DC. I’m going to ask you guys where everybody’s at in the world. Why don’t we just do that? If you can go to chat and say where you’re at the world.
We’ve got South Carolina, Miami, Alaska, Virginia, Denver, Westminster, Hudson Valley, Rose Hill, Scottsdale, Utah. It’s just going so fast, it’s flying. Southern California, Cape Cod, Fremont, Irving, San Francisco, Bakersfield, SoCal, Port Orchard. Some Scandinavians, some Las Vegas, San Diego, Raleigh, North Carolina, New York, Virgina, Orlando. We got you guys from everywhere. Honolulu, I’m jealous. There’s somebody from Pennsylvania. I grew up in Philadelphia myself. Roth from Chicago, Illinois, North Dakota.
On the question and answer, if you put anonymous, then we’ll never even see your name and that’s what I’d actually prefer. As long as I ask you a question, I may say hey, somebody is asking a question about a single family with a Roth. You don’t have to put your full name. You can put in there just the scenario.
Look at this. We got so many. Napa, Houston. Minot. I knew I was saying it wrong. Seattle, go Hawks. There’s Bellevue, Washington, Austin, Texas, Greenfield, North Carolina. We have a whole bunch.
When you’re asking questions, you can always just put your first name or click anonymous. In that way, other people will not see your question unless we answer it and we forget to click, make sure it’s anonymous.
We have Pio, Elliot, Thomas. We have Patty, Tabia, Susan, all on and they’re going to be answering questions. Probably Elliot and Pio doing the accounting work, Tabia does lots of bookkeeping. Somebody says bulldogs, that must be Spokane. When you’re down in your luck in your pickup truck is Spokane. See if you can sight this on. Lawrenceville, Georgia. I used to play against Gonzaga, I played for CLU. I was a soccer guy. Back in the days I remember going to Spokane many times.
We have lots of cool folks. Somebody says if they come to Vegas, will you buy me a steak? Of course. Anybody who’s come here that hits me up knows that I like to go to places. The strip is a little different nowadays, but still there’s some things open. I don’t think we’re a little different than some states.
Jeff: We’re 25% in the restaurants.
Toby: Yeah, you just have to have reservations. I have lots of reservations, not necessarily the restaurants. You ask your question, Q&A. We’ll get to you. There’s some good questions already coming in which we’ll get knocking around. Quite around they’ll flag them for me to answer.
If you don’t get your question answered, then just type it in and email it to us at email@example.com. That happens when stuff goes fast. We’ll have 100 questions at the same time. We’re pretty good about getting through them, but every now and then somebody falls through the cracks; we want to make sure we’re getting them. If you need specific advice for you, you need to be a client. You need to be at least a platinum client so we can answer your questions, where we’re actually giving you specific advice for your situation.
What this is is tax knowledge. This is fast, fun, and educational. Let’s get rapid answers. Let’s not say ‘it depends’ all the time. Let’s get to actual answers. A lot of people are just scared of the liability of opening their mouth and giving an answer. Jeff and I don’t necessarily share that. We’ll give you advice. We think it through and we try to give you enough to go on so you can get the right answer.
Questions today. I think we had 15 or so plus we have lots of questions and we’re going to try to get these ones done reasonably on time, which means if you know me we’ll be on the hour, give or take an hour. We’ll be really close within 60 minutes. You wouldn’t be mad if you’re taking an across the world flight within 60 minutes, but people get all bent here because sometimes we go over.
Somebody says they sent questions on Prop 19. We’ll go over that. Prop 19 is freaking some people out and we’ll go through it.
“If we received PPP in our business, then got approved for forgiveness, will we still be able to deduct the rents and utilities we applied the PPP to?” We’ll answer that.
“I recently read Elon Musk was moving his private foundation from California to Texas. Is there a tax advantage in moving a private foundation or a nonprofit from California to Texas?” We’ll answer that.
“Do you have to be married in order to create an entity that allows you to hire your children? How does one set this up?” We’ll absolutely go through that.
“Can we add the minor to the title and still be able to remain the step-up benefit?” We’ll go through what all of that means and answer that.
“Do I file my business taxes with personal because I didn’t make any money this year and I just paid out a lot?” I love those types.
“How long after the sale of a primary residence do you have to apply the proceeds to a new home purchase to avoid taxation?” We’ll go over some of that and the nuances there.
“I’m 70 years old and haven’t made a deposit to my Roth in 10 years.” That’s probably a Roth IRA. “Am I free to withdraw all of my account with no penalty or am I limited to my cost basis?” We’ll go through all of those. Jeff is a bastion of knowledge on those things, so that’s going to be great.
“I have an LLC taxed as a sole proprietor but my first year has zero income. Can I deduct my house office up to 300 sq ft and auto mileage? Are there any case studies on deducting groceries as a business expense?” These are the ones that make Jeff’s hair fall out.
“I know that forgiven PPP loans are not taxable. What about grants received under the CARES Act? Are government grants to relieve financial duress received by a medical practice under the CARES Act considered taxable income?” We’ll go through all of those.
“As a real estate salesperson, is it advantageous to have an LLC or just file a 1099?”
“What is the best way to write off a cruise?”
Somebody says, “Devastated by Prop. 19 in California. Is there any legal way to leave home to children so they can still get a parent’s tax basis?” That’s going to be for the property taxes. We’ll answer that.
“In 2020 I bought a lot for $16,000, then went under contract with a contractor for $110,000 in escrow for draws.” They built a house on it. “House is a single family residence currently under construction. Do I claim the purchase as $16,000 and the $110,000 as first year expenses? It will generate rent in 2021.” Good question and is one we’ll dive into. That’s one you guys need to pay attention to because it goes over the distinction between basis and deduction.
“If my S Corp makes profit beyond my salary and distributions, I have to claim all that income on my personal taxes still too, right?” It’s a nice question.
Guys, I just picked these off. I don’t sit there and edit them. Every now again I cut out some of the more egregious ones, but typically I try to keep your voice on it and not really touch them. Maybe I’ll put punctuation at the end if it’s just a period and I’ll say hey that’s a question mark. If you’re going to yell at somebody, I guess you can still yell at me for it. Maybe someday I’ll start editing them. I just want your questions. You got to understand, we—
Jeff: Yeah, we correct a few spelling errors. Other than that—
Toby: If Google is not yelling at me or whatever service, then I just say ‘whatever.’ If there’s a bunch of red lines, sometimes I’ll pay attention to it.
“If we received PPP in our business,” Paycheck Protection Program. It’s the money that’s 2½ times basically your average monthly wages, and then you get the forgiveness. You hit their thresholds, which was this moving target all the time, “but we hit their thresholds, can you deduct?” Jeff and I, we have lots of discussions about this.
You heard us last year where we said to hell what the treasury says. We’re just going to deduct this anyway because we were ticked. We knew what Congress intended. The Congress said, not only do you not recognize it as income, but you get to write off the expenses. Otherwise, it’s wise to make it where you don’t get to recognize the income if you’re just going to deny the expense, it’s a flush. It gets annoying.
The treasure doubled down. They said twice, you can’t deduct it. They did it once, then Congress wrote out this scathing letter, and they doubled down on it again and did it again. That just changed under this most recent tax act.
Jeff: Definitely said that any loan forgiveness is not taxable the way it was in the original bill, but it also said anything paid for by these PPP loans are fully deductible. There was a third part to this where it’s actually quite important. It also said even though it’s not taxable and it’ll still take the deductions, any PPP loan forgiveness gives you basis. If you got a $100,000 PPP loan and once they forgave that PPP loan, your basis and company would go up by that $100,000. It’s still considered booking comp but not taxing comp.
Toby: It’s almost like you contributed the $100,000 to your business and it was given to you by your parents. Here’s a gift. Throw it in there.
Jeff: There is one bit of complication because of this. You may have expenses that you paid for in 2020, but you haven’t had your loan forgiven yet. You can’t collect that basis. You can’t count that as income yet. You may end up with some suspended losses that you won’t be able to take on 2021 once that loan is forgiven. If you already have enough basis to take your losses, you have nothing to worry about, but yes the loan is not taxable, the forgiveness isn’t taxable, and everything is deductible at this point.
Toby: Somebody asked, “If the PPP is excused,” so you don’t have to pay it back, “and you had to make a tax payment,” so you’re making a tax payment by 01-15-2020, “we will now have to make that payment or will the penalty will worse?” I’m not quite sure I understand that one.
Jeff: If the loan hasn’t been forgiven yet, then it’s not income. Period. It’s still a loan to the SBA or your local bank. If it has been forgiven, yeah it’s income to you but it’s not taxable income. That’s not going to affect your 01-15-2020 payment at all.
Toby: I guess the easiest way to look at it is it’s free money without a tax implication. When we say free money without a tax implication, we mean that you still get to write if off. You still get to use it for expenses and you can take that deduction. It’s like me giving Jeff a gift of $10 and he uses it to buy some office supplies. He gets to write off the $10. He doesn’t have to show $10. In this case it’s even better because he doesn’t show the $10 as income.
With the PPP loan, you’d actually show the $10 for your basis income and not as taxable income, plus it will be like if I gave you a gift and then you contributed it to your company and you wrote off.
Jeff: I’ve been doing this for 30 years and I’ve never seen anything like this. Pretty much a gift from the government.
Toby: We like it. Let’s move to the next one. Jeff, I agree with you. What they’re really trying to do in my personal opinion was they were saying rather than have the States give unemployment, we’ll give you the money and you dole it out. You may not need the people, but we’ll give you the money to pay them and you just dole it out.
As we’ve seen it was billions of dollars of fraud in California. Nevada had to get sued before they would give contractors the money. What we know for sure is the States pretty much universally suck at distributing money.
“I recently read that Elon Musk was moving his private foundation from California to Texas. Is there a tax advantage to moving a private foundation or nonprofit from California to Texas?”
Jeff: Tax advantage, there’s none. The really big difference between the two is both states are highly regulated for nonprofits. Texas is frankly cheaper to set up, register, and run a foundation.
Toby: It’s cheap either.
Jeff: I think California is more notorious for nickel and diming you for this tax form. For Elon Musk it’s going to make absolutely no difference at all.
Toby: The reason I believe that he was moving his foundation there was to create […] of everything he was doing out of Texas as opposed to California. As an individual, they’re going to want to tax his billions of dollars. California may still want to tax his growth. I think he made about $140 billion last year. They’re going to want to tax that when he sells.
What Elon wants to do is show here’s the date that I left California. I moved my foundation. I registered my cars. I bought a new house. Here I moved. They’ll go into your utility bills to determine where you were living and they’ll try to get you for partial year or some stupid argument.
Jeff: California is really notorious for finding very tenuous relationships just to keep you as a resident.
Toby: Just look at the case Hyatt v. Board of Equalization. It ended up going to the Supreme Court twice. They sent agents to Nevada to dig through some of his garbage. They think that they’re owed money and you had a substantial amount. California is about as aggressive as they come.
My guess is he just moved to make sure that he didn’t have any ties to California where California could say, hey you were running your private foundation. You’re here. No, I wasn’t. I moved it to Texas and that’s all he did. You can move a company just like you move individually. You don’t have to worry about that.
All right. Question and answer. Let’s see if I can find some Qs. One of the bad parts of Zoom is it’s sometimes hard for me to find questions that have to do with things that are currently happening. Somebody says, “AB-2088 was killed, so the wealth tax died.” They wanted to tax just whatever money you have, but what they do look at is when you made the money.
Part of Elon Musk’s compensation is deferred compensation. He’s investing, he’s getting options all the time through most of his wealth, and they’re going to say, when did you make that? Then they’re going to smack you around and say, great that’s taxable here.
Jeff: Yeah. A part of that WealthField is also a new tax bracket for over $30 million. It was 16.3%, way higher than anybody else.
Toby: California lost some residence. I think there were negative 60,000 residents this year so my guess is they’re going to be looking for some money.
Jeff: I think they’re all living here.
Toby: I think they moved all over the country. If I talk to people from Texas, they’re […]. You talk to Nevada, our real estate prices have gone through the roof. They’re up 10% over the last year and they blamed all the Californians. They’re fleeing California but a beautiful state, just could do without some of the stuff happening there. Talk about rough. If you’re a restaurant owner there, my God.
I still believe COVID lives in Costco. The day they shut down Costco because I would go to Costco—kids will laugh at this—I always get an ice cream, I’d walk around Costco with it because I hate having a mask on. You could eat the ice cream—
Jeff: Were you actively eating?
Toby: Yeah. I just wandered around and I was like that guy, like […]. I guess I’m horrible but it was Costco. I was convinced that’s where COVID goes. Any of the big box stores. When they close those down I’ll start listening to them.
“Do you have to be married in order to create an entity that allows you to hire your children? How does one set this up?”
Jeff: You can hire your children at any point. Keyword is your children. Whether you’re married or not, they have to be your children. Start hiring other people’s in-laws, nephews, and stuff like that, some of the labor laws kick in.
Toby: Here’s one thing. If you are a sole proprietor, you can pay your kids and just pay them directly. If it’s an S Corp you got to pay them through payroll. If you’re going to that, then somebody’s asking a good question, how old do they have to be. As long as it’s active income, you can set up an IRA in their name. It might be a custodial IRA where you’re setting it up for them but it’s their money that’s going in there then when they hit 18. Again somebody says when you pay them directly, via checking account? Yes. You could pay them cash. You could pay them Bitcoin. It doesn’t matter. Technically I could pay Jeff with a car. Lamborghini?
Jeff: Lamborghini, yeah. We saw a lamborghini the other day. The important difference is if you do want to just truly tax break to your children, you need to put them on payroll because they have that standard deduction up to $12,000. Was it $12,400 right now?
Toby: It’s $12,400 for 2020, so it might be up a little, but it’s over $12,000. If you have children they should be working for you. This is another thing, let’s say Jeff was my dad. I could say, hey, dad, I want to help out. Maybe you’re giving your parents money. If I paid Jeff a payroll, now I can deduct it and Jeff would pay tax on it but if Jeff is below the threshold, then he’s not going to have taxable income.
As opposed to if I gift Jeff the money. Let’s say I’m gifting my parents $10,000 a year to help them with expenses, I get no tax benefit and it’s taxed at my level. It’s the same argument we have when people are paying for their kids’ college. I always say don’t pay for your kid’s college. Have them work for your business instead because you’re going to get them $12,000—at least—of free money and more likely than not it’s going to be way cheaper than you like.
If Jeff is in the highest bracket and he’s paying 37% versus his son who he could be paying through his company and maybe he’s paying his son’s college and it’s $50,000 a year, his tax bracket’s going to have a standard deduction, plus maybe he’s putting money in an IRA. He might be at 12%. It’s going to be substantially less than Jeff’s and that’s why we say it’s a good idea to get those kids in there.
Somebody says, “What ages are the kids?” There’s actually court cases where the children as young as nine are being paid. If you’re using them in advertising, that’s active income. If you’re using them and you start using them in your brochures, on your website, in your social media, and you’re using your child with your logo or they’re doing cute things—everybody gets annoyed by that—it gives you an opportunity to pay them. Some people really like that. They’re people, human beings. Noble concept.
Jeff: We have people ask about, can I just 1099 them instead of put them on payroll? The problem with that is the standard deduction does not reduce self-employment income. I pay my son, Toby, $12,000. He’s guaranteed at least $1800 of self-employment tax on that $12,000.
Toby: It’s $12,550 now. Ricardo (by the way) had kids working less than 10 years old. Working for a CPA firm, cleaning, shredding. He had a CPA practice. The question is, can they do reasonable activities and are you keeping track of time, et cetera? What I suggest to people is that they either use their kids directly in their advertising or they find something that their kids are really good at that they suck at.
For example, social media. That’s where everybody’s better. Anything that’s tech, get your kids involved and let them do it. If you pay your kids $50,000 through work, how do you prove it that work was worthy of $50,000?
Jeff: I think at that point you’re going to have to produce time records and things of that nature and descriptions of the work, the job titles, what kind of work they’re doing.
Toby: What you do is you do the work ahead of time or you’re going to end up doing more work afterwards. If you do it ahead of time, you say, here’s what I want you to do. Here’s how I’m going to pay you and here’s a reasonable amount for that type of job. If you’re doing it after then you just have to make sure you have good record keepings. Reasonable pay is all over the place.
There are executives who believe that reasonable pay is $4 million an hour at some point. You have these ridiculous amounts. You think I’m kidding. When the tobacco cases were being settled, it was literally $40,000 an hour in some cases $100,000 an hour for some of these guys, men and women. They had all these different scenarios and it’s all over the place.
It used to be that the IRS wanted you to get paid less, then they wanted you to get paid more. Now they’re pushing back. There’s just so much grey area. If anybody says they know, they don’t. What you want to do is have a reasonable basis for your arguments. Again, if you have the kids, you’re not paying them $100 an hour to sweep. What you do is say how much for reasonable cleaning and then they do something like that.
I know somebody says, “Concerned.” George, we had everybody here get tested. Jeff and I even talk about whether we would sit near each other. Some people are worried about the COVID situation. We are very careful. Everybody walks around, Jeff wears his mask, I wear my mask. We’re not putting ourselves at any more risk other than he and I are close to each other. That’s the risk of running a show.
Jeff: Most of my employees are at home to protect them.
Toby: We have about 300 people here in Vegas and I imagine we have less than a dozen that actually come into the office. Everything we’re doing is […]. But then, there are people who don’t have that choice. Amazon, et cetera, those guys that are out there huffing and running. Now I get it and it’s just being reasonable, so I appreciate your concern. Absolutely. I’m taking it seriously.
“Can we add the minor to the title and still be able to remain…” Yes, you’ll still be able to probably receive the step-up benefit. Do you want to get over what we’re talking about here?
Jeff: Here’s what I think they’re talking about, and you may have a different idea. When you purchase an interest in a partnership, you get a step-up of basis and the assets. If it’s just gifted to you or sole proprietorship, that doesn’t happen. When you purchase an interest or somebody dies and you receive their interest in a partnership, you can get that step-up and basis.
Toby: I think on some of these they might be talking about the house, too. What we see is people slap their kids on the house thinking that they can avoid transfer issues with probate. Mom and dad have a $100,000 house that becomes a $500,000 house. Dad passes away, mom still has the house, and then adds son to the house as a joint tenant with right of survivorship.
Jeff: Might this be a Proposition 19 question?
Toby: It’s going to be, I bet you. We have another one coming up, but I’m pretty sure they’re thinking the same thing. What I tell people is I don’t encourage that. The reason I don’t encourage that is because people that you gift things to receive your basis in it.
Go back to that same example. Mom and dad have a basis of $100,000. Dad passes away. Technically, there’s a step-up in basis on at least dad’s half. Whatever the house is worth—let’s say it’s worth half a million dollars at that point—depending on the state you’re in, that could be as high as a $500,000 step-up or it could be his half.
His half would be a $200,000 step up over the $100,000, so $300,000 basis. I know this gets confusing. But let’s say the house is now worth a million dollars. You put your kid on there, they have a $300,000 basis and a house that’s worth half a million dollars. If you do not and mom passes, the child would get a step up in basis for a million dollars and then they could sell that house and they would have zero tax. As opposed to $700,000 of capital gains.
I tend to say, don’t do that. There are other reasons. There’s some asset protection reasons why you don’t do it. You put your son on your house. Son, unbeknownst to you, enters into a bad land deal, loses lots of money, goes through divorce, hits a bus full of nuns. You fill in the blanks. Son gets liability. Now, they’re gunning for your house and it’s not a homestead because it’s joint tenants and the son’s probably not living there—unless you guys are living together. It gets to be an issue.
“Can you add and remain with step up in basis?” I don’t believe so.
Jeff: Do you see any Section 121 problems with adding a minor?
Toby: They have to live in it and they have to be on title for two years. You always have an issue when you put a minor. Unless they’re living with mom, unless they’re living with dad.
Jeff: And Section 121 being the exclusion of gain when you sell your primary residence.
Toby: Somebody says, “Pay kids via sole proprietorship. Is the money deducted from the parent’s income?” Yeah. It’s from the sole proprietor’s income which would end up on the 1040. Yes, it lowers your income mostly over the child.
Jeff: It’ll also reduce your self-employment income.
Toby: Classic income shifting. And then somebody says, “What’s the difference between paying a kid in a C Corp versus an LLC?” They’ve been around for a while, I’d done these. LLCs don’t exist for the tax as far as the tax treatment. It’s an LLC taxed as a sole proprietor, partnership, S Corp, C Corp. As far as the difference, it really depends on what that LLC is. C Corp can run payroll just like an S Corp.
The big difference between doing any sort of entity where it’s a corporation versus doing just a sole proprietor when it comes to children is the withholding and the employment taxes. When you’re just a sole proprietor, you can pay kids. You don’t have to worry about that. It’s their problem. When you run it through a corp, you do the withholding, it’s the company’s problem and they do the withholding.
Fun stuff, guys. Rolling right along. “Do I file my business taxes with my personal income? Probably on my personal tax return, because I didn’t make any money this year and just paid out a lot.” Jeff, you like these.
Jeff: I would say it depends. It depends on what that business is, how it’s formed. If it’s a sole proprietor, then it certainly gets filed with your personal tax return. But it could be a partnership, it could be an S Corporation, which again, is going to eventually flow through with you personally. Could be a corporation, a C Corporation where that’s a completely separate entity. Yes, it’s possible that you do file it with your personal. But it’s also possible if it files its own return.
Toby: It all depends. If you lost money, it doesn’t matter really, whether you lost money. It depends on how the entity is taxed. Where it could end up on your personal return due to some benefit is if you’re a partnership in which you’re a material participant, if you’re a sole proprietor, if you’re an S Corp, and you have a basis. Then those losses could end up on your return.
I can just tell you, it doesn’t matter what type of entity you are. As to whether losing money, whether it goes on your personal or not. It makes no difference. The question is whether the loss is something you can take individually. If you know what the Hobby Loss Rule is—it’s Section 187—it basically says you have to make money two out of five years or you’re presumed to be a hobby. If you are presumed to be a hobby, then your losses cannot be taken and offset your personal income. That’s all it means.
Everybody says, no, it makes your business a hobby. It just means that your expenses cannot exceed the income. If I’m a photographer and I make $10,000 a year doing photos, and they say it’s a hobby, it’s not really a trader business, it’s not what you do, then the maximum amount of deductions I get is $10,000. If I spent $12,000, $2000, will it just carry forward or will I lose it?
Jeff: I think it’s a loss. I think it’s permanently suspended.
Toby: It gets suspended. It goes away. The one for profit entity is a C Corp. C Corp you can have losses and just carry it forward. You don’t get to use it personally, unless you liquidated the company and said, I’m done with this.
The answer to your question is, “Do I file business taxes with my personal because I didn’t make any money and just paid out a lot?” No. It doesn’t make any difference. It depends on how you set up that business and how it gets paid.
“How long after the sale of the primary residence do you have to apply the proceeds to a new home purchase to avoid taxation?”
Jeff: I had this question from my mother a few years back. This actually relates to a law that ceased to exist in 1998. If you remember, was the 50-year-old rule that as long as you keep purchasing a residence more expensive than your last one you could defer any gains. And then once you reach 50 or 55, you could permanently defer a certain amount. That was replaced by what we call Code Section 121 where you can exclude up to $250,000 of gain if you lived there two out of five years. If married filing jointly, you can exclude up to half a million of gain.
Toby: And there’s no requirement that you spend it at another house. If you just want to sell a home and take the money and go on vacation, you can.
Jeff: If you got a million dollar home and you got a basis of $500,000 and then you sell it.
Toby: Yeah, $500,000 gain. If you’re married filing jointly and you lived in it two of the last five years. This is the one that trips people out. It’s two of the last five. It’s not the last two years. It’s two of the last five. Which means you could rent it for three years and still go back and capture that. You can only use that rule, however, once every two years.
Jeff: But now we have something else since we’re just running for the last three years. Now we could possibly exchange it.
Toby: Yes, and we talk about that quite often. Now you have 121 exclusion and 1031. And yes, you can do both on a property. Do you want to go over a scenario? Probably have some folks that are in this boat given that real estate keeps going up?
Jeff: Yeah. I have a house that I pay $200,000 for and I sold it for $800,000. I’m single, so I only get a $250,000 deduction.
Toby: So you bought it for $200,000?
Toby: I’ll write that down. $200,000. And you sold it for how much?
Toby: You must be rich. This is so old.
Jeff: I’m old, so I’ve had this house for a really long time.
Toby: Sold for $800,000. You have $600,000 of gain and you get 121 exclusion of $250,000. You’re going to have taxable gain of $350,000 capital gain.
Jeff: But then, I mentioned I stopped living in it back in 2018, and I’ve been renting it out for the past two years.
Toby: Now, Jeff could do, what? He could 1031 exchange it.
Jeff: I don’t have to pay tax on that.
Toby: Does he still get the $250,000? This is real, right?
Toby: Jeff does not have to pay capital gains on $250,000 because he lived in it two of the last five years. He gets his $250,000 and that steps up his basis. He bought it for 200. His new basis is $450,000. Are you going to 1031 it?
Jeff: I’m going to 1031 it. I found somebody else who wants it and I found another piece of property I want.
Toby: He’s going to 1031, he’s going to sell it for $800,000. He’s going to have to buy $800,000 of new property even though his gain would be $350,000. By doing this, Jeff is going to save himself tax about $120,000, plus you’d probably have a little bit of capital gain recapture, small amount.
Jeff: Now, if you’re asking what happens if I only buy a $700,000 house. I have received a basic $100,000 for the proceeds. Unfortunately, every dollar of that’s going to be capital gain.
Toby: Yup. Would you have some depreciation?
Jeff: Would have some depreciation, which you can never offset with the—
Toby: Don’t you love accountants? Two years of capital gains, then nothing. Oh, by the way, what if Jeff didn’t take any depreciation? Somebody says, keep some of the boot. What if Jeff just doesn’t take any depreciation? He rents it to his kid and he says, you know what, I’m not going to take any depreciation. It’s too complicated. Does he have to do recapture?
Jeff: Unfortunately, yes.
Toby: Don’t think that you get away with it. Somebody says, “Is 121 exclusion $250,000 for each person or for non-spouse, you and son $500,000?” It depends on whether you live in it and whether it’s jointly titled. You have to own it and live there two of the last five years. Even when you have divorces, there are rules that allow you.
Somebody says, “What about this? What happens if Jeff hurries up and has a Vegas wedding to get a larger deduction?” Two of the last five years, he had to live there and it has to be titled in your name. If Jeff goes out and gets married, is there an automatic $500,000? No. He had to live there two years, and has to be in your name.
Jeff: The new wife also has to have the two years.
Toby: Yup. “Can vacant land be utilized for 1031?”
Toby: Yup, you can. And then somebody says, “Can you do a 1031 out of primary residence?” No, unless you make it into an investment property, which is what Jeff did. He rented it to somebody else for two years. Technically you do it for six months, two years. Jeff will probably say a year, I’ll probably say six months. See, somebody’s trying to help you out. See? That’s why we love you guys. We’re helpful.
Oh, this is what we get to talk about. I’m teaching a class with Aaron Adams. We are going over all of our fund stuff that’s been going on since COVID started and some ideas for 2021. I have some definite opinions on this if you have not been listening to us for the last year because I get so ticked off at what’s been going on in the real estate world and leaving behind such a huge section of society. I have the stats to back it up, I have reality, and we see it all the time.
Literally, we’ve been catering to folks that are making over $75,000 a year, for those of us who are landlords. We see a ton of it. Where we’re really suffering right now is affordable properties that aren’t slum. You want good quality, somewhere south of a thousand dollars a month and you still want to make money at them. That’s what we’re good at. I have a ton of those.
Just so you get an idea, between Aaron and I, we have over 3000 properties, managed or owned. Aaron has several hundred. I, myself and Clint have a couple hundred. This is what we do. If you want to join, come on over and it’s free. There is the link. Patti probably sent that out to everybody. No cost, just come out and join. It’s so much fun. We love talking about real estate.
All right, “Can Jeff use the $800,000 of gains?” We’re back to this guy here. We had that $800,000 of property sold. Somebody is asking, can you do that and use that for multiple properties? Yes, it’s just real estate. He could buy land and two condos. He could buy a bunch of mobile homes that are attached to the ground that’s considered stick build. He could buy the pads for them. He could buy an apartment building. He could go buy 10 single family residences. It doesn’t matter so long as it’s real estate.
Somebody says, “Does this 121, 1031 exchange scenario work if you have a multifamily house and you’re living in one of the units for at least two of the last five years?” It does, on that portion of the home. You’d break it into two. Let’s say it’s a duplex, half of that house and half of the value would qualify under 121 because that was the house that you lived in as a primary resident for two of the last five years. Makes sense?
Jeff: We’ve actually had some of those where we’ve had a duplex that was sold for quite a bit of money. They lived in half and rented out the other half. We had a 1031 on one side and 121 on the other side.
Toby: We have about 88 open questions that are out there. We are going to be going over all that. Somebody says, “Will they answer ongoing questions that come up?” On Saturday, for sure, we’ll be going 9:00–5:00 Pacific Standard Time and we’ll go over that. The questions I have chat and Q&A over here. Our guys are going through all the Q&A. I’m trying to see if there’s any of that pop up that had to do with the questions that we’re on, just in case somebody’s asking a clarifying question. Otherwise, they’re answering all the questions.
We have lots of stuff. There we go. Emma, join us. We always have a good time. You will not be sorry because usually there’s somebody who’s really smart—at least in the chat—to tell us good things that are really smart.
“Can you convert 1031 to a personal residence?” Yes. And then 121 has a special rule that if you did that, you have 5 years to wait before you can use the 121 again on that property. The code anticipates that you’re going to do this. Again, if you’re paying taxes and you’re involved in real estate, it’s because you’re choosing to not because you have to, more likely.
“Does the 1031 exchange work if your property is fully depreciated?” Yes, you’re just rolling your old basis into the new. You die, step up in basis, kid re-depreciates it all again or whoever inherits. That’s why we love real estate.
“I am 70 years old and haven’t made a deposit to my Roth in 10 years. Am I free to withdraw all my account with no penalty or am I limited to my cost basis?”
Jeff: The first thing I notice is obviously we had those […] for at least 10 years, you’re over 59½. Once you have it for 5 years and you’re over 59½, you tinkle every penny of it out.
Toby: But then you don’t have a protected income stream. If you leave it in there, it grows. You’re not going to pay any tax if you take it all out.
Jeff: Is the Roth IRA protected from creditors?
Toby: In some states, there’s protection. Most states, there is some protection. Not in all states is there a complete protection. If you have real estate in it, no. The real estate flows through to you, the liability. When I see people with Roths and they’re doing real estate, usually we’re going to say, please put an LLC. Have the Roth set up an LLC. It’s a specialized kind of LLC that’s owned by an exempt entity and then put that in there.
It’s pretty hard to get to an IRA. It’s one of those things. A lot of states, you have low homesteads. California has a pretty low homestead. Most lawyers aren’t going after your house because they know you’ll probably burn it down before they get anything of value and it’s really, really tough. Cars and stuff, there’s people that’ll go after. I have seen people that have lost their homes in lawsuits. But it is so remote. Usually, if you are in a knock-down drag out, you’re leveraging the house to pay the attorneys. End of the day they’re getting nothing. There’s not really much an incentive for them to go over those types of things.
I did liquidation for years growing up, which […] liquidating. We would go and we did police auctions, we’d auction off creditor’s stuff and $0.10 on the dollar. People come in and they have no idea what they’re getting. The funny one is one people had their cars that were going to get jacked. They would take parts out of the engine, keep them, and then send somebody in there to buy it at the auction for nothing and then they put the pieces that made it operational again.
Jeff: We had a taxpayer in Ohio who pulled those as business to keep the IRS from taking it, not realizing that he still owed the money that he owed them. He now has no business and he still owes somehow over much.
Toby: They took the heavy equipment that he used to pull those. All right, going back to that 1031 exchange. I know that there’s a whole bunch of 1031s and I can see it really easy when they pop up. “Does the property purchase have to be titled in the same name entity as the property sold?” The answer is yes. Same entity. That’s why it’s really tough to do those in partnerships.
“How does the 1031 exchange work if the property you buy is worth more than the one you sell?” It rolls your basis of the previous property into the value of that property, the rest of it would be a new basis on top of the new property. If you got that, it means you’re a nerd.
Jeff: What’s really important with these 1031 exchanges is you can’t touch the proceeds. We need to talk to what they call qualified intermediaries. They will take care of everything for you. The sale of your property, the purchase in your property.
Toby: Look at this one. “I have an LLC taxed as a sole proprietor, but first year income has zero. I have zero income. Can I deduct my office up to 300 square feet and auto mileage?” Jeff?
Jeff: The answer is yes. I’m assuming this is a sole proprietor or a Schedule C. You can’t deduct your office space. You can do a simplified method that sounds like a $5 a square foot. That’s a $1500 deduction. When I say auto mileage, I’m talking about business auto mileage. It has to be associated with your LLC. It can’t be going to Starbucks and picking up lunch, that you’re also trying to deduct them.
Toby: This is a good one. Just beginning the year, write down your odometer statement. In order to actually write mileage off, you have to have your beginning odometer, ending odometer and then you’re tracking which trips were for what. Use Mileage IQ because it’ll GPS you everywhere. Then you could say, these trips here between offices, these trips here are definitely business. These trips here are personal.
Jeff: It’s like the Tinder of driving. Swipe right, swipe left.
Toby: Jeff is so gross. You’re hooking up with your mileage. That’s what we know Jeff has just gone too far on hook up.
Jeff: But yeah, it does make it really easy.
Toby: All you’re doing is you’re just doing like, this year, it’s $0.56 a mile. For 2021, it’s $0.57½ a mile. In 2020 was it $0.58. In 2019, it’s been going down. Energy prices have been going down. In theory, the IRS is saying, hey, it’s getting less expensive to drive (which I think is absolute crap).
Somebody says, “What if you have loss? Do you have to carry it forward?” No, if it’s a trader business, you get to take it and offset your other income. The Hobby Loss Rule only is a presumption, it’s a rebuttable presumption.
Clive Barker, Midnight Train to Georgia. I think we’re talking about Peaches and Herbs. Clive Barker made tons of money than anyone who wants to be the next hip hop star. He spent about $38 million over 10 years trying to start a record label. He lost money every year. The IRS contested it saying it was more of a hobby. He was just trying to help his kid. Clive won because he could show that he was trying to make a profit.
That’s what you got to do. You got to show it. It’s not automatic. It’s two out of five years. You’re presumed to be a hobby and then you rebut that by showing the first two things I ask you is if you have a lawyer and do you have an accountant. Literally, that’s the first two things. Did you hire somebody, professionals, to help you with it?
Jeff: At times the home office deduction may get suspended until you have income.
Toby: When would that be?
Jeff: It’s usually when you already have losses and you’re taking the indirect expenses. They’re going to suspend a portion of not all of that loss until you income to offset it.
Toby: There might be a question, but the mileage for sure.
Jeff: The mileage, definitely.
Toby: The home office when you’re a sole proprietor. This is the big difference between being a sole proprietor and having some sort of taxable entity in your life like an S Corp, C Corp, LLC taxed as an S Corp, LLC taxed as a C Corp, even a non-profit. When you are an employee of an organization and it reimburses for your home office space, that’s just not taxable to you and it’s a deduction. It’s not a home office deduction anymore. It’s an administrative office but it’s business use of personal property. When you’re an employee, the business can just reimburse you for the reusable cost and you get a lot more out of it and you don’t have any issues. The business would take the loss.
Jeff: And I’ve heard people say, well, I’m not going to take that deduction because I can’t really use it. It’s better to take it and have it suspended or whatnot than just lose it forever.
Toby: Absolutely. There’s some good questions floating around here. I keep looking at it.
Somebody says, “I sold a business in 2020. Any suggestion on how to lower capital gains?” You could still potentially, depending on when you sold in 2020, do an opportunity zone. We probably missed it so I don’t want to ruin it for you, but there are some things you could’ve done to lower the taxes. I probably won’t tell you, I don’t want to mess with you. You would’ve done some loss harvesting and potentially some giving away of monies last year.
Jeff: One of the most important things when selling the business is classifying what you’re selling. So you get as much under the long-term capital gains rate as you can because sometimes when you sell inventory and certain other items, they’re going to be taxed at ordinary rates.
Toby: Somebody says, “Will an extension impact my 1244 election?”
Toby: “Do you have to recapture any depreciation if you did a cost segregation and later did a 1031 exchange?” Everything rolls forward.
Jeff: You’d have to recapture on the 1250—the real estate portion. The 1245, I don’t think so.
Toby: I believe it all rolls forward. I remember looking at that last year but I’m 90% certain. In case you sent that in as a question, I believe that you’re going. Somebody says, “Hey, I don’t see the questions.” It’s because it had people’s names on it.
Jeff: That’s why we give you Q&A.
Toby: When you see Q&A, it just means that I’m reading them off or we’re just answering a few. We always throw them up there. I used to just leave the questions up and then people are going to be like, you’re not answering the question. I’m going to answer this one over here. “Are there any case studies on deducting groceries as a business expense?”
Jeff: Case studies, none that I’m aware of. Deducting groceries you can if it’s business-related. That’s you’re giving, buying snacks for your employees. If you’re buying food, that you’re serving the clients, things of that nature. You’re buying groceries to feed either yourself or your family, it’s not going to be deductible.
Toby: There was one that was a case and it was a guy doing presentations in his home. I think he was doing insurance or something like that. He’d invite people into his house and his wife would go out and buy all their groceries and cook. Yeah, you can write that off because you’re providing it to a third party. But can you just write off your groceries? No, it has to be an ordinary and necessary business expense. Yeah, groceries are not going to be it.
This is the classic example of when you get yourself into trouble, especially when we’re talking piercing the corporate veil. If you use personal expenses, do not go shopping at Safeway or Smith’s or whatever they call it in your state. Winn-Dixie, that’s another one, Piggly Wiggly, Pathmark, I remember that one as growing up. Don’t go shopping for your personal groceries with a business card. Now you’re mixing and that’s going to be used against you if you’re getting into a knock down […].
Jeff: The good news is I know there’s at least one state—I believe it’s Minnesota—who offers you a grocery credit on your tax return.
Toby: That’s nice then.
Jeff: Up to $300 I believe.
Toby: All right. Let’s go into another one. Did I miss one? All right, that was that. “I know that forgiven PPP loans are not taxable.” You get a loan from a bank, it’s the Paycheck Protection, you use it for qualified deals. The CARES Act says, you do not have to recognize the cancellation of indebtedness as taxable income.
What about grants received under the CARES Act? And specifically, when they talk about grants, they must be talking about emergency grants which are the economic injury disaster loans, which are basically capped at $150,000. The Congress said they could go up to $2 million. But those were loans where they’re long-term loans.
Jeff: The loans are not taxable. The grant, as far as I know, there’s no provision to keep them from being taxed.
Toby: They added it. They added it and they said, it’s not taxable. Moreover, you would use the grant to offset your PPP loan.
Jeff: And that was my concern because if you got the $10,000 you actually had to reduce your PPP by that, correct?
Toby: Yup. And then, “Are the government grants to relieve financial address received by a medical practice under the CARES Act considered taxable income?” The answer to that is I don’t know. I don’t believe that they’re taxable, but I’d have to look at it specifically. That’s one where you give us the specifics about it and let us go look at it. But I don’t believe that any of the monies that you received are taxable.
The question becomes whether you receive those monies, if they are a loan or if there’s a payback and if that payback is forgiven. The question is whether you are within the carve-out where they said you could deduct the expenses from that.
Jeff: Yeah. I’m sure there’s probably carve-outs for COVID-related medical vaccinations, things of that nature that we’re frankly just not aware of those specific issues.
Toby: Yeah. Somebody’s asking, “Medical practices received grants via HSS CARES.” I do not believe that that’s taxable income and the only question is whether you can write off expenses with it. “Are COVID-19 stimulus payments made to every man, woman, child taxable?” That is a refundable tax credit, so it is not taxable income. It is considered a tax credit and you’re just getting it ahead of time and it’s actually for 2020. It’s still 2020 and they’re just giving it to you early and then they just increased it so you actually get more. They could do it again.
“Can we apply for the next SBA EIDL loans without employees?” Yes. What you do is you amend. If you already applied for one, you amend it. I just did one earlier today where due to the ongoing crisis, they were adding it. Then the PPP, you’ll be able to seek again. I don’t know when that opens, off the top of my head, but I believe that you’re going to be able to go back in. If your business, year over year fell 25% quarterly taxes and it might be some other periods of time you could use. But if you have suffered, then the idea is that you can go back in and get more PPP loans.
But we’ll have more on that. That just passed and it took about a year to get all the interpretations. No, it was in March. We started getting towards the end of the year.
Jeff: March 23rd until today.
Toby: Until the 27th. Whatever it was, it was March and it took us all the way up until the end of the year. We still have questions lingering that the Treasury is trying to respond.
Somebody said, “As a real estate salesperson, is it advantageous to have an LLC or just file a 1099?” Do you want to answer this one?
Jeff: I’m just going to give my point of view. Tax-wise, it’s not going to make any difference. But I do like that added protection of the LLC, especially since we’re dealing with real estate.
Toby: I’m going to throw one thing at you. What if you’re a sole proprietor and you make $100,000 as a real estate agent versus being an S Corp?
Jeff: I’m going to suggest you become an S Corporation.
Toby: Yeah, because you’re going to save a ton on the self-employment tax. If you’re a real estate salesperson and you say, should I be an LLC or just file a 1099? You can be an LLC that files a Schedule C. You can be an LLC that files an S Corp return. You can be an LLC that files a C Corp return. You could be an S Corp or you could be a C Corp. You could be a partnership if you have somebody else in.
The question really comes down to, is it just you? Do you have the ability to put that money through an entity to lower taxation? The entity is important just to keep you from getting sued. With COVID, I would just suggest everybody operate as an entity if you’re in real estate—period—because all you have to do is find yourself drawn into some drama where somebody alleges that they contracted COVID either at one of your showings, or the houses that you have listed, or somebody that’s in your care.
The biggest issue then runs over is the tax side and whether it makes sense. Right around $25,000–$30,000, you start to see about a $1500 difference, and it’ll continue to grow the closer you get to about $140,000. You’ll see that the more you make, between $25,000 and $140,000, the more you should just be doing an S Corp. If you’re making $100,000, the difference tax wise, every year, ends up being about 14% $70,000. That would be right around $10,000 that you put in your pocket versus if you just operate it as sole proprietor.
The reason is because in an S Corporation, you only pay old age, disability, and survivor’s insurance and medicare on your salary that you pull out of the entity. The rest of the money that falls down to you without getting into a ton of specifics is not subject to those taxes. You end up doing a ton better.
If you are a person that you say, hey, as an agent, I can’t be paid as an entity. They have to pay me. There is a way under tax law to move it into an S Corp even under the circumstances. You have to meet a two-prong test that we can happily show you how to do. If you want, reach out to us, I’ll show you how to do it. We love working with real estate agents.
Somebody asked, “When there are real estate professionals,” whether they’re a hard money lender, whether that time computes just moved but it was up there at one point.
Jeff: Whether that counts towards their…
Toby: The only reason I bring that one up is because when you’re a real estate professional, it’s buying and selling, developing, or doing construction on properties. Technically, it’s not lending. Even being a hard money lender, I would say no, that doesn’t qualify as a real estate professional.
Jeff: Real estate financing is not counted towards at that time.
Toby: Angie is giving me a hard time. It’s the Fleisher case. Yes, that’s very good. Making fun. Angie must be an accountant. I usually forget. There are holes in my brain and there are certain cases that for whatever reason, I can just never remember. I was going to guess, but then I usually say Fletcher instead of Fleisher for whatever reason. That one just evades me.
Let’s see, “Under Code Section 280A(c)(5), the home office deduction is limited to the activity’s gross income reduced by all their deductible expenses, that allowable regardless of qualified use and by the…” That might be what you guys were talking about, about the limitation on the sole proprietor whether you have a home office. Perfect. Thank you. We have good accountants out there helping us out.
“What is the best way to write off a cruise?” All the accountants probably just started sweating and eye twitching. You can’t write off a cruise as a cruise. The only time you can even do a business cruise is if it’s a US-registered vessel. I think there’s one or two of them in the world.
Jeff: Only sailing to US ports.
Toby: Only US ports. You can’t touch Canada, Mexico, or the Carribean. I think that you might be able to do it in Hawaii. And then you have to have your itinerary, a bunch of hoops you have to jump through.
Jeff: It is a bunch of hoops. We’re talking about conventions, seminars, things of that nature.
Toby: But here’s what fun. You can use a cruise ship to travel. I actually learned this from an IRS attorney and we went and we gave a talk in Cosmo on the beach in a tiki hut for half a day. I think we did five hours on the beach in a tiki hut. He drank way more than I did, but we are arguing tax stuff. He said, here, you got to do something that’s way different than you normally in the US. They got him liquored up and he was telling stories.
To travel to Cosmo and back, you can use any reasonable methods. You can use an airplane. If we could, we could’ve done a train. You could’ve driven or you could take a cruise ship. Cruise ship then becomes deductible. There are some limitations, it’s twice the federal max.
Jeff: It’s crazy because it changes depending on the time of the year.
Toby: It changes because the feds put out their per diem amounts.
Jeff: For luxury travel.
Toby: No, it’s not luxury. It’s any travel. It’s your travel and lodging and then you just double that up. You get about $800 a day.
Jeff: The first method we talked about, the conventions, seminars, that is limited by the $2000. Now, when travelling by cruise line, they do recommend that it’s from destination or from start to destination. Not stopping at Grand Turk and Aruba, and everything else in between.
Toby: As long as it’s the same price, I’m doing it. There’s no time limitation, it’s just reasonable. Karen is saying, were you at one where Scott came down, you know what I’m talking about? That’d be pretty funny if we had people that were actually on that cruise that are listening. I’ve done it a couple times where you end up cruising off some place and you’re like, all right, we have to be here, what’s a cool way that we can get here?
Yes, I went to several of the cruises. That’s how you do it so you’re not writing off a cruise anymore. You’re writing off your travel and that’s the joy. If you want, you do that with RV too. A lot of people try to write off RVs. And I’m like, no, no, no, no. Somebody says, “The Honolulu when it gets going again.” They’ve done NCL, Norweigian Cruise Lines. That’s the only one that I know of where you can actually write off the cruise and then you have to have the itinerary. Do it with somebody that that’s what they do. And then make sure you have your documentation. Because I think you actually have to attach it.
“Are there such things that you can re stretch your assets to qualify for college scholarship or is this a scam?” More than likely, it’s a scam. What they’re doing is they’re trying to make themselves look like they don’t have assets. I forgot what they were doing. They were doing some goofy stuff to qualify for some need based…
Jeff: We put your assets in our name for just 24 hours.
Toby: All right. Here is one that a lot of people were interested in. “Devastated by Prop 19 in California.” Actually, there are some really good benefits to it, for people that have been hurt by the wildfires. We actually have an accountant here who lost her house in the wildfires a few years back. It’s very real what a lot of these folks are feeling. It used to be you had a fire, you get replacement value. You can keep your same low basis to your replacement value in the same county.
If you left California, you would lose it or if you moved outside of that county. Now, you can move up to three times because of these situations and keep your primary basis. Prop 19 is all about property taxes. The other thing under Proposition 13, if Jeff was my kid, I could give him my property, whether he lived in there or not and he would keep my level basis for the property taxes. I could have a property that’s worth $5 million. Jeff just uses it as an Airbnb and he just rents it out. It’s paying next to nothing in property taxes. Meanwhile, somebody who lives in their house next door is paying infinitely more in property taxes.
Prop 19 popped up and said, that situation is not fair. We will let you keep some of that benefit and it’s the fair market value plus $1 million. If you give it to your kids, your kids have to live there. I said kids, right? Because if you leave it two children, they have to live there. Not one, both is my understanding. If I leave it to Jeff and Jeff is my child, Jeff would have to live in that house to keep the low low adjusted basis for property tax.
Jeff: Yeah. That’s turned into an Airbnb, Prop 19’s maximum.
Toby: Yup. You have to live there as your primary residence. I didn’t bring the link with me, but the Board of Equalization has a pretty good statement on this and you can just type in Prop 19 BOE and you will find it and they have a bunch of Q&A. It just came out and I don’t believe it takes effect for another month and a week. I believe it’s February 15th.
What people are doing is they’re doing all sorts of weird stuff. There are parents who are throwing all their stuff into trust. They think somehow they’re going to win out. Patti just did it. She just shared out that link, and it doesn’t work that way. The whole idea is that you don’t want someone to get priced out of their home.
I bought a house in Long Beach, I bought it for $300,000. It’s now being assessed at $1.5. I can’t afford the property taxes so I have to sell it. That’s what they were trying to avoid with Prop 13. What it ended up being is, I bought the house, I stayed in it, now I’m giving it to my kids. My kids make it into a rental and they’re still paying property taxes as though it was being assessed at $300,000. That’s just not right.
Somebody said, “With holidays, February 11th.” Okay. We’ll take a look at it. But I think you guys get the idea. Somebody is asking, “My son is 10, can he start an IRA in his name?” If he has active income, yes. You have to make sure that they’re actually making money. It’s going to be your business, but you’re going to have to make sure that they’re able to do something to get it and it’s not going to be much. It might be just a couple thousand bucks a year tops. Unless you have traditional business where you’re able to use them for things like advertising. And then it’s actually a much higher amount—the court cases on it.
Say you could actually use screen actors guild rates which will get you quite a bit. “Can you give mileage again?” It’s $0.56 for a mile for 2021. It was $0.57 ½ a mile for 2020. If you have more than five cars, you have to use a different method. You can’t do the mileage method. Yay!
Somebody says, “How long do you have to do a 1031 exchange?” I’ll just give you guys this. You have 45 days to identify replacement properties. There’s a couple methodologies you could use in how you identify them and how you identify which ones would qualify. You have 180 days to close. You can go backwards and you can actually buy something ahead of time which is called a reverse exchange and then sell. Again, you have to use a facilitator to do it then you have 80 days to sell.
Jeff: You usually want to identify several properties even if you really have in mind one property. In case something falls through.
Toby: People will drag you out and they’ll know that you’re on the crunch so you need to be very, very transparent. Somebody says, “For Prop 19, how long do you have to live in your current home to qualify to keep the basis of your new home?” I don’t know. If you’re moving, I believe it’s statewide now and I don’t know whether there’s a rule on that. But again, I’d have to refresh it. Email that in and what we’ll do is we’ll start getting a stockpile of Q&A for you guys on Prop 19 where we can go and see whether we can get you a whole one.
“FYI, I have a webinar in 30 minutes.” That’s Patti.
Jeff: Must be 4:30.
Toby: “In 2020, I bought a lot for $16,000 then went into contract with a contract for $110,000 in escrow. House is a single family and currently under construction. Do I claim the purchases as $16,000 and the $110,000 as first year expenses? It will generate rent in 2021.”
Jeff: No. Both the $16,000 and the $110,000 and however much you ultimately paid to have this house constructed is going to go into the basis of the property. The one difference being the $16,000 is going to be the basis of your land which will not be depreciated. You can’t depreciate land. The $110,000 plus whatever else you put into the house, that will be your depreciable basis for the property. You’ll depreciate that over 27 ½ years.
Toby: The only way that you’d be able to expense any of this is if you cost seg the $110,000 of the build of the single family residence and accelerated the depreciation on it. You’ll probably get about $25,000. It’s kind of weird.
Jeff: But they’d have to wait until it was placed in service.
Toby: You have to wait until it’s placed in service. You’re exactly right. It has to become investment property in service before you can mess around with that. For this year in 2020, you’re 100% right. You’re not getting to write off anything. Very few things. You may get the property taxes and the insurance, right?
Jeff: Yeah. There are times if you have a loan, that you can write off the interest. Or a lot of people just capitalize them into the cost of the house.
Toby: A lot of questions but I’m going to have to bust through here because I’m being bad. I will get you guys more on Prop 19. I know there’s a lot of questions there.
“If my S Corp makes profit beyond my salary and distributions, I have to claim all that income on my property taxes still too, right?”
Jeff: Let’s take the distributions out of there because it really doesn’t factor around. You are going to be taxed on the S Corporation income, taxable income after salary and all the other expenses. Whether you take distributions or not has no bearing on what’s taxable.
Toby: S Corporation, the easiest way to look at it is if Jeff and I own it together, then whatever we take as salary is on us. Whatever an employee takes as salary is on them. Then there’s profit. And in an S Corp, that profit or loss flows out to us proportionately. This is where it gets weird. It has to be proportionate equally depending on what our interest is. If it’s 70-30, then I need 70% of the profit and 30%. The distributions can actually be unequal. It’s kind of weird.
Jeff: Distributions have to be even. Salaries do not have to be even.
Toby: Salaries don’t but distributions don’t. I’d bet you a dollar. What I have to do is the tax allocation. The distribution of the tax has to be to me. Let’s say we make $100,000 and we’re 50-50. I can leave my 50 in and you could take your 50 out. Now, we just have that weird capital account issue if you took more distributions. I have more money sitting in there. That’s all it is. It’s my money. I can take it out at any time.
Jeff: The only time distributions come into play with taxes is if you’ve taken out more than you actually have.
Toby: Have a basis. And then you’re going to have the joy of capital gains. But anyway, regardless in this particular case, they said, “Hey, if I have profit beyond my salary and distributions,” which Jeff said was 100% correct which is distributions don’t matter. Distributions don’t change your profit. If you have profit, period, beyond your salary, that goes without saying because profit is whatever is left after you take your salary. That is taxable to you and it flows down to you in proportion to your ownership.
Jeff: If you’ve asked us a question, a lot of people get confused about it. They think they’re only taxed on the amount of money they take out and their salary. You get taxed on every penny that company earns for you. Whether you took it or not.
Toby: Yes sir, dood job. All right, I have to go jump off and do another. I may ask you a couple, answer a couple of questions here. Luke, I know Patti is sweating for me.
“Is an Airbnb property depreciated at the residential rate or the commercial rate?”
Jeff: It’s actually the commercial rate.
Toby: Is it commercial? Airbnb?
Jeff: It’s not considered residential.
Toby: What if it’s more than 7 day rentals?
Jeff: I think it’s still with the commercial rate just like a hotel would be.
Toby: I think it’s 27 ½ years.
Jeff: We’re going to end this podcast disagreeing on a couple of things.
Toby: I think it’s seven. You have to take a salary in a C Corp. Technically, no.
Jeff: And you don’t want to take a salary if you ain’t making any money.
Toby: That was Kentucky that just came out at Jeff. If he ain’t making any money. You need to say that. I love that.
Jeff: You all should know this by now.
Toby: I got you some whiskey for Christmas.
Jeff: You did. Bourbon.
Toby: I guess I should say it right. Took a while. I don’t drink. I’m boring. I drink wine once in a while. andersonadvisors.com/podcast, if you like listening to this. Took a new screenshot. There’s always a few podcasts floating around out there. Here’s your smiling face a couple times from October. We will get more answers to you. Our guys stay on and they’ll still be answering some of your questions, or you could always do the fun one of just emailing in firstname.lastname@example.org. I’ll show that to you in a second.
One last time, on Saturday, Aaron Adams and I, we are going over real estate and what to be looking at for this next year. We have some definite opinions on it. If you like these, go into your Platinum portal, you could see all the replays and then if you have questions that didn’t get answered, you just go to taxtuesday@andersonadvisors. Couple of really good questions at the very end.
“What are the pros and cons of accelerated depreciation in California?” They don’t recognize accelerated depreciation in California. I guess that would be gone. Federal wise, it can lower your tax, state tax wise, you’re looking at a 13% tax. That’s not going to help so much.
“How would I make money if I create a non profit organization?” Take a salary out of it. But usually your non profit is going to be a growing organization.
Somebody says, “How does taxation work if I use a bridge loan in conjunction with a 1031 exchange?” It doesn’t affect your tax at all, I believe. Unless you took more money out than you had a loan. If you have a loan, what you can do is increase the amount of loan to take cash. That’s called boot and you end up with some boot in which is taxable. You can’t take a million dollar house that has no loan and get a loan against it during a 1031 and satisfy the 1031. If you took cash, that’s taxable too.
All right. Send in your questions. If you guys see me looking up it’s because we have three screens in here and we’re trying to read them. Thank you for spending some time with us. Jeff, thank you for spending some time.
Jeff: Thank you for inviting me.
Toby: All right. I’m going to go run and jump on to another podcast. In the meantime guys, thanks for joining us and have a good one. Have a great beginning of the year. Be optimistic this year. There’s plenty of opportunities out there. And as always, send in your tax questions, we will jump on them. For whatever reason if you’re having trouble getting a response, just try and try again. We have a lot of folks that are looking at these. We do try to get to every single one, but we get hundreds. We’ll get it.
Thanks again. Somebody says, “Thanks for Patti, Susan, Pio, Elliot, and Tavia for doing all of your stuff in the back.” They’re answering questions like crazy. I could see 138 answered in writing. Another 12 and 104 that we were answering otherwise. We definitely jump all over these.