Toby Mathis and Jeff Webb of Anderson Advisors are here again to bring tax knowledge to the masses by answering your questions about company vehicles, expenses, capital gains tax, payroll tax, and much more. Do you have a tax question for them? Submit it to Webinar@andersonadvisors.com.
- Should I buy a car in my business? Pros and cons of purchasing a car with business name, including depreciation write-off and taxable costs for personal use of vehicle
- How to avoid/minimize capital gains tax on sales of stocks/mutual funds held for many years? Do it via appreciated stock; depends on losses and how much is made/sold
- I’m selling a commercial property and doing a 1031 exchange. Can I withdraw the original down payment, tax free from the sale? Never take cash out of a like-kind exchange
- If LLC is used only for trading, can it be a single-member LLC? Or, do you recommend a multi-member LLC? Usually a multi one, unless a day trader who trades a lot
- What’s the difference between Section 179 and 100% bonus depreciation? 179 is for deductions on any piece of equipment, depreciation requires 100% percent on all assets
- What’s a cash balance plan? Defined benefit plan that makes assumptions on how much money to deduct to eliminate entire income
- Should I have my main family home in my real estate business? No. Don’t give up 121 exclusion; homestead exclusion can’t take equity; and need to recognize taxable wages
- Can corporation reimburse us for our medical premiums and HSA contributions? Corporation can’t reimburse contributions for HSA because they’re pre-taxed
- Can you have a leasing company and lease a vehicle from it? Yes. But you’re paying a lease payment, sales tax, etc.
- What do you suggest for a single-member S corp for healthcare expenses? You can only write off personal insurance premiums; need a reasonable C corp
- We invested $35,000 with an education company. How would startup expenses work? Write off, if increases skill; don’t write off, if qualifies for new trade
- What happens if your business doesn’t make any money its first year? Can you write off expenses the next year? Depends on business type; may carry forward business losses
- Trader vs. Investor Status: Does trader status need to be declared? Trader status doesn’t exist in internal revenue code; make an election and write it on your tax return
- Should I run an assisted living/memory care center as a non-profit or for-profit? Such a health facility qualifies as a 501c3 and gets a tax break, but you don’t own it
- Can real estate losses offset stock capital gains? If flipping houses, no – considered inventory, not capital gain/loss property; yes, if selling rental property or real estate pro
- Which is better: Pre-nup or putting all assets in a trust? Avoid pre-nups because judges find other ways to make decisions; Nevada only state that protects alimony trust
Full Episode Transcript:
Toby:Hey, guys. This is Toby Mathis and I’m joined with Jeff Webb, CPA. Hey, Jeff.... Read Full Transcript
Toby: We are doing Tax Tuesdays again, bringing tax knowledge to the masses. Yes, we have masses. This is kind of fun. These ones are starting to get a little out of control. We already have tons of questions and we haven’t even started yet, like lying in wait. Let’s jump in this. A couple of things I’ll just go over real quick: If you ask live questions via the question field of the webinar, we will do our very, very best. I don’t think we’ve ever not answered a question before the end.
Sometimes, we’ll say you’ve got to email it in. If you email it in, go to–just do email@example.com. We separate it out from other events because we have so much email coming in off of it. Again, we’ll answer it either live or we’ll get you a response. Sometimes, people are asking for specific–more than just general advice. If you need a detailed response, you’ve got to either be a platinum member of Anderson or a tax client.
If we’re going to start advising, then we can’t do that just on a freebie because, frankly, you can hold us accountable for it. There’s accounting.
Jeff: There we go. I think we want to keep our questions and answers on Tax Tuesdays related to things that may be of general interest to everyone.
Toby: Right. Speaking of general interest for everyone, we have a bunch of questions. The ones we’re going to answer today are, “Should I buy a car in my business?” “If I have $100,000 in startup expenses, how do I get them out of my corporation?” “How can I avoid or minimize capital gains taxes on the sale of stocks and mutual funds held for many years?” “If there is no net profit for the year on a subchapter S Corporation, and therefore no wages paid, are any payroll taxes due that year?”
Those are our first ones. We have a whole bunch of more that we’re going to pull out, too, but this is where we’re going to start. Let’s go to the, “Should I buy a car in my business?” Jeff, do you have any personal preferences on this one?
Jeff: I really prefer, if you can, to purchase a car in the business name. It makes a lot of your write-offs easier, depreciation and so forth. The one problem area sometimes is when there’s personal use of that company vehicle.
Toby: Here’s what happens. I’m going to completely go the opposite direction. I tend to like to see the car out here. We’re going to compare the two. This is always fun. Here’s a plus. In a business, you get a big write-off right now because–why is that, Jeff?
Jeff: Bonus depreciation.
Toby: Yep, big write-off because bonus depreciation is–what’s the level right now?
Jeff: For bonus depreciation? If it’s a vehicle over 6000 pounds–SUV or truck over 6000 pounds, it’s unlimited, 100%.
Toby: It can be up to 100% bonus depreciation. What if it’s not 6000 pounds?
Jeff: If you’re buying a Bentley and put it in your business, you’re going to be writing it off for the next 100 years.
Toby: You’re going to have limitations.
Jeff: You’re going to have limitations.
Toby: That’s where, in a business, the big thing that everybody’s looking at is they’re buying big, old SUVs and they’re saying, “Ha, we can write it off,” but the downside is that it’s taxable personal use, which means we actually grab the old IRS. We actually grab the–they have an amount. Actually, I have to pull it up on our website. Let me see. I’m going to do something I usually don’t do, and we’re going to jump into our friends at the IRS. Let’s see if they do this.
Where is that funds? There we go. This is the annual lease value. This is actually the IRS. They publish this wonderful thing every year and they say, “Based on the value of your vehicle and the year that you acquired it, this is how much taxable income.” Jeff, pick a car, any car. Pick a value.
Jeff: I’ll go with my Toyota $32,000.
Toby: $32,000. We’d go right here. You see this little $32,000? That would take us right here. This is the amount of wages I have to report on an annual basis. Does that look like fun? Yeah, it’s not. We probably don’t want to do that. You would only pay on the portion of that 8750 that is personal use. It really comes down to doing a quick calculation. In fact, I can do the quick calculation. I have one of those calculators sitting right here on my desktop. You said $32,000?
Toby: This is how quickly we can do it. It’s a new car, less than 6000 pounds, percentage use–how much are we using it for business?
Toby: Your business use percentage, that’s a lot. Who uses a car for 70%? You’ve got to commute with that thing. Anyway, here’s where you will use the vehicle in business. How long are you going own this thing and use it in your business?
Jeff: Three years.
Toby: You’re saying that because that’s what’s on there. You’re not much fun. Projected sales price? Let’s just say it’s $5000. Your tax rate–what’s your personal tax rate with self-employment tax? Let’s just say you’re a sole proprietor.
Jeff: I’ll say 33%.
Toby: There we go. Your tax rate, excluding self-employment tax, we’d say probably you’re 33 and probably about 20%. We’re not going to have to do too much there, excluding. What bracket are you in? You’re not going to be in the 20% tax.
Jeff: Well, I’m in the 22% bracket.
Toby: 22? All right. Did you purchase or lease the vehicle? We bought it. If it’s new, do you want bonus depreciation? Do you want to write it off as quickly as you can? No, that’s not really going to matter. If the vehicle number is 20, we don’t have to worry about that because this is not a big SUV; this is a car. Let’s see. We don’t need to worry about the lease, the mileage information. How many miles are we driving it?
Jeff: About 12,000 a year.
Toby: At 12,000 miles per year – the miles-per-gallon–actually, they’re going to get more 20s, likely. What is it, a Camaro?
Jeff: Camaro is 25-26, yeah.
Toby: Okay, there we go. Then, we look and say, “All right, do you have carwashes?”
Toby: How often do you wash your car?
Jeff: About once every two weeks, so we’re probably talking–
Toby: You wash your car a lot, my friend. How much do you spend on a car wash?
Toby: You spend $25? $50 a month?
Jeff: $600 year on.
Toby: We plug that in. Do you have to replace your tires? How often?
Jeff: No, I never replace them. I’ll sell them with my $5000-sale.
Toby: All right. Other repairs and maintenance? Do you have any other costs?
Jeff: Yeah, I’m going to run probably $200-$300 a year.
Toby: All right, let’s just say–we’ll estimate high. Cost of insurance?
Jeff: About $1200.
Toby: All right. Other registration and licensing fees?
Jeff: About $500.
Toby: All right. The reason that we’re doing this is because you have choices, choices, choices. You could decide that we want to do an actual expense or we can do mileage. This is why we’re looking at this. On Jeff’s scenario, you’re going to save a little bit more money if you’re actually owning it. The only difference here is what they don’t add in underneath these calculators, is the amount of taxable income. I’m going to go back down here. You have what’s called luxury limits and things like that, when he talked about the Bentley.
We’re going to worry about our lease tables. What is he doing? We’re not going to worry about that though it is–actually, it isn’t adding it back in. What we have to do is we say, “All right, versus just the doing the mileage reimbursement, we are going to be up $1600.”
Jeff: Wait, did I say 70%? I’m sure I meant 40%.
Toby: You said 70%. You’re crazy. You said it. I’m going to stick to it. Now, we go to the IRS table and we say, “There’s $8750,” and you said 70% business so we’re just going to 30% of $8,750. Let’s see if I can actually use a calculator. We’re going to go $8750 x 0.3, $2600. You’re going to add in, in your taxable income, $2600. You’re going to have to do that every year. This one seems like it’s going to be better to buy it in the business. I’m going to say that you’re going to have tax for five years. You’re going to get the write-off, a nice big, fat write-off in one of those years, but it’s pretty darn close.
This is over the lifetime, that five years. The difference is, if you end up holding up longer, you’re going to be better off–we’ll actually use this, like being used for three years. If you’re going to own it longer, then this method, the mileage method, is going to creep up. Now, I’m going to show you the wildcard. Plus, we have taxable income of about $2600 that we have to add in so it’s going to eat away some of that.
Whatever percentage, let’s say, that it’s going to take us down to about $1000 a year, better to do it, to have it in the business. Here’s why I get scared of doing it in the business. Let me prop this thing up. Again, the reason that I get scared is because not only–if it’s in the business, if we have a car on the business, there’s a couple of factors that we have to look at. First off, insurance is more. In my experience, you’re going to pay about a 20% or 30% premium for having a vehicle actually held inside the car.
You’ve got to factor that in. You’ve got to talk to your agent and say, “Is it going to be more expensive to have a commercial policy?” Generally speaking, the answer is yes. The other thing is this taxable amount goes on indefinitely. Liability. If I get into an accident and it’s in my business, guess where that liability is: inside my business. The last little one is, in order to do this, my business has to be registered in my state.
If you’re using a Wyoming or a Nevada entity, this is not going to be for you. You’re going to want to go keep the car in your personal name, and here’s the route: All those benefits we just discussed, if this is an S Corp or a C Corp, it can reimburse me all of those expenses. It can literally reimburse me, even my depreciation, the reason being is because the way that S Corps and C Corps work is, if I have an employee and I have an accountable plan set up, I can reimburse them for their actual expense.
The reason that this is important is because what a lot of people used to do is they would try to take that expense on their Schedule A and they’d either phase out of it or, as it is right now, […] itemized expenses are gone, so you can’t write it off so you’re toast. The other little thing with this little reimbursement is, if you have multiple cars, you don’t have to track which car you’re driving. You just have to track which mile you were driving that was business, and then it can just reimburse you. It doesn’t get reported on your personals.
Either one of those ways, you have to pick. You can either do miles–and I think it’s at $54.05 right now–or you do the actual expense. You can only pick one and you have to stick with it once you do. I tend to go here. Jeff tends to go here. You can have conflicting opinions. We want to run the numbers and see which one’s better for you. If it’s a push, I’m going to go with whatever’s easiest for me, which is I just want to track my miles. I don’t want to care about what my cars are worth.
Unless I’m really riding that–like Jeff’s example of 70%, that would be one of the sorts of situations where it’d be appropriate to have a car that’s actually in a business. If it’s more likely like, “Hey, I’m doing occasional commuting around for business,” and maybe it’s 20%, 30%, then I’m doing the mileage reimbursement.
Jeff: Right, because once you get down below the 50%, you lose things like you lose your bonus depreciation in Section 179.
Toby: Yup, repeat that because that is actually huge. If you cannot have the automobile in your business–this is actually really huge. If you’re taking a 179 deduction in this bad boy and, anytime during that vehicle life, you go below 50%, then you’re recognizing all that income or all that depreciation you have to pay tax on.
Jeff: Another thing to keep in mind is when we’re talking about actual expenses versus mileage expense, that decision is made on a vehicle-by-vehicle basis. Just because you’re taking mileage on Vehicle A and you buy Vehicle B, you may have a different decision.
Toby: That’s true. Here’s the true rule: Ask your accountant. Make them run the numbers. Now, again, I tend to–my clients are all over the place. They tend to have multiple vehicles. They tend to be involved in real estate, in this set and the other. Frankly, I like mileage reimbursement just because I’m lazy, but you should run the numbers and make sure whether or not you’re leaving something on the table because if you’re like a real estate company or whatnot and you’re buying trucks and you’re buying them every four or five years and you’re just using the heck out of them, then it’s going to make a lot of sense and you’re going to get some serious play right now, some huge, immediate deductions by using the 100% bonus depreciation.
Anyway, that’s that. That’s whether I should by a car in my business. Obviously, the answer is going to be, it depends. If in doubt, keep it personal. Reimburse yourself the miles. If it’s a strong case, put it in the business, make sure that business is registered in the state where the vehicle is located and make sure you’re pricing out insurance first. The only reason I say this is because I’ve been burned on that. It’s actually quite a bit more expensive depending on which state you’re in.
Jeff: All right.
Toby: Next one: “I have $100,000 in startup expenses, how do I get them out of my corporation?” This is a fun one. Jeff, do you have an opinion on this?
Jeff: If you put $100,000 of startup expenses in your company, that money had to come from somewhere and, most likely, it came from you personally. You’ll probably have a shareholder loan on your corporation.
Toby: Or you contribute it in exchange for stocks, either way. Startup. Let’s start right there. What is a startup expense? It’s the investigation or active trade of a trader business so you’re either in it or you’re investigating it and starting it up. We like that investigation because, frankly, you may be spending a lot of money preparing to launch your business, and then you launch the business, which is what it sounds like in this situation.
When I see $100,000 in startup expenses, I imagine that you spent a lot of money in the year prior to actually starting that business. If it’s a startup expenses, you can write off $5000 in the first year and then you amortize over 15 years the balance.
Jeff: Now, in this particular case, that $5000 is limited to $50,000 total startup expenses.
Toby: He has a total limitation?
Jeff: Right, so once it goes over that $50,000–or, actually, $55,000–then he doesn’t get that $5000 in the first year. He has to do the amortization with the entire amount.
Toby: We’re just going to say, if it’s over–what’s the number?
Jeff: Over $50,000, it starts phasing out dollar per dollar.
Toby: Cross that one out?
Toby: The other thing you get is organizational expense, and the organizational expense is $5000, and that’s for tax and legal state fees. This is the cost of setting things up, licenses, all that fun stuff. Organizationally, you’re also going to get another $5000 there. For this example, this $100,000, we’re literally going to take it and we’re going to divide it up by 15. Let’s just say–I don’t know what that is. What’s 100 divided by 15? You’re an accountant.
Jeff: I’ve got my calculator, too.
Toby:It’s 6666, whatever it is. It’s going to be $6667 a year. That’s what you write off, and that’s against your active income. It can pay you back, that $100,000, the day it starts. You have to get the money in somehow, though. It’s got to either reimburse you or it’s going to be paying you back over time. Jeff talked about a shareholder loan so may carry it on the books as a loan and you get paid back.
The company, on Day 1, it’s going to get these expenses and it’s going to possibly show either a loss or it’s going to have whatever–let’s say it made $50,000. Even though you have all these expenses, it’s going to pay tax on $43,000 of it. It’s going to be writing that off for many years. If you close down the business, you’re going to take it all on the year that you close it. Is that fair?
Jeff: That’s fair.
Toby: All right. How do you get it out? Here’s how you get it out. Let’s say that you set up a corp and you’re the shareholder. You’re out here. It’s going to pay you money. It’s literally going to pay you money whenever it gets it. If it has, somehow, a great year and it makes $100,000, even though you don’t get to write it all off, it can hand you back your $100,000 in that first year. It’s just going to be limited in its deduction to that $6667.
I hope that makes sense. You’re writing it off almost like a house. You’re depreciating that big thing that you put in. $100,000 is just like you put a big house on the property and you’re writing it off over 15 years instead of 27 and a half. That’s the big difference. All right, next one is, “How can I avoid or minimize capital gain taxes on the sale of stocks and mutual funds held for many years?” You have personal issues with this one. Do you have anything you want to share?
Jeff: My favorite way of minimizing capital gains is doing depreciated stock.
Toby: All right, let’s go through this. Long, long ago in a galaxy far, far away, we had a stock that we bought for $100. It is now worth $101 today. We have gained how much?
Toby: We have $100. I bought it for $1. It’s now worth $101. My gain is $100. I would pay long-term capital gains, and that’s going to be 0%, 15% or 20%. It’s going to depend. What if it’s somebody who makes $30,000 a year?
Jeff: They’re most likely going to be paying at the 0% capital gain rate.
Toby: What if they sold $100,000 of stock? Would it still be 0?
Jeff: No, because, unfortunately, that $100,000 goes into that calculation of what bracket you fall into.
Toby: Right, in order to be 0, you’re going to have to be–and I think it’s the bottom two categories. It’s actually a dollar amount. I forget what the dollar amount is. Actually, let me have it floating around here somewhere. Let’s see. Do I have other rates, long-term? It’s single taxpayer. It’s up to 38 grand. Married filing jointly–let’s do married filing jointly. It’s 77,200. That’s married filing jointly, 77200. I pay 0%. I want to make sure that you understand that.
You can be selling it–and let’s say that I have $100 worth of gain. I sell enough to keep myself in that 0% and I just sell it over years. That’s Number 1, is to actually understand what tax bracket you’re in and how much of an impact that it’s going to have on you. Let me see if I can–I know there’s lots of people asking tons of questions, questions and questions. Oh my god, we’ve got hundreds of them. We’re not telling bedtime stories.
The next one is let’s say that we have the $100 of gain. A tax-free way to get to that–let’s say that you have lots of gain that you can borrow. You could borrow against that. It’s called a security-backed line of credit. The tax rate on borrowing is 0 so you could borrow against this gain and pay nothing. The third way, which is the Jeff way, is if you have a 501C3 that you either like or is yours and you contribute your shares, you get a deduction up to–how much of your income can you write off? 60% of your adjusted gross income.
You can write off up to 60% of your adjusted gross income by giving those shares, and it’s their fair market value. It is not the cost basis. It is based off of your today value. In English, if I have $50,000 worth of shares that are worth $50,000, my basis is $500 or $5000, whatever it is, 1/100th of that. I don’t have to worry about my basis. I get a $50,000-deduction, and I’m limited only to 60% of my adjusted gross income. I hope that makes sense. Fun stuff.
Jeff: Yeah, and this is a good way that you’re contributing to a charitable cause in getting the deduction for not recognizing any taxes on it.
Toby: Yup. Somebody did ask–and we’re getting a ton of questions. I’m just going to answer a few of them real quick. A 501C3 is a non-profit. It’s where you’re making a charitable donation. You do not have to pay tax when you borrow money on a security-backed line of credit. If I have a stock account worth $1 million, I can literally use it as security just like I would a house on a line of credit.
It’s just that they’re a lot cheaper. They’re about 3% because you’re very, very liquid. You don’t have to worry about foreclosing on a house. They have your stock, stock that could be sold in about two minutes whereas a house might take months. Then, somebody else asks, “Is this recorded for review?” Yes. You can come back and review these, and these questions, we’ll stick them out there in the world.
Anyway, really, you have choices, and what this really comes down–what it comes down to is you always want to do a calculation. I could either sell it in part and recognize some gain depending on what tax bracket I’m in. I might be as low as 15%. You might say, “Hey, that’s fine. I’ll take a little bit of taxes.” You could spread it out over a year. You don’t have to sell it all in one year. Here we are towards–what is it? October–so you can wait and sell some at the end of the year now, sell some at the beginning of the next year or push it into another year.
Jeff: Something that we didn’t really bring up about minimizing gain on taxes is a lot of the clients still have leftover capital losses.
Toby: You can use your losses against it.
Jeff: Absolutely. If you’ve got something with a lot of gain on it, this may be an opportune time to.
Toby: Not just your carry-over losses, but it could be losses that you have unrealized. In other words, I bought a bunch of Tesla way up–I’ve probably given that example. I’m watching him roll his eyes at me. Let’s just say that you have some unrealized losses. I bought a bunch of GE. It is tanked and I have $50,000 of losses. I’m like, “Ah!” This would be when you take it to offset some of your gain.
Jeff: The stock that you bought for $1, you may really love the stock. You can sell the stock and turn around and buy it the next day and still have that same stock you’ve just had.
Toby: You’ve got to wash out, the Wash-Sale Rule, if you know what I mean.
Jeff: If you sell it as a loss, you’re going to have wash sale.
Toby: You can always have wash gain. That doesn’t exist.
Jeff: They don’t mind you paying tax on that.
Toby: That’s tax and we’re nerds. Let’s go past that. We could spend all day on scenarios there, but I hope you realize that there are options for you. If you don’t want to recognize any gain, you can give it to a charity and then you just take a big tax deduction. That’s the big part. When I give it to the charity, the charity sells it at zero tax and you don’t have to worry. You get a big, fat tax deduction. It’s always nice to get appreciative assets to charity.
All right. Next one: “If there is no net profit for the year on a subchapter S, and therefore no wages paid, are any payroll taxes due that year?” Jeff, do you have to pay payroll taxes when you don’t pay yourself anything?
Jeff: No, but if you’ve paid payroll in the past, you’re going to have to file payroll reports.
Toby: Okay, Jeff likes to be tax-nerdy.
Jeff: No wages, no tax–
Toby: Equals no payroll tax. That’s an S Corp. Now, let’s say this was a sole proprietor. No wages can be paid; all net income is subject to SE tax. When somebody says “payroll taxes”, they’re really talking about old age, death and survivors in Medicare, which is code for Social Security taxes. It’s actually the most horrific tax that’s out there. Everybody gets to pay it. I always use the example: When I was in high school, I think the minimum wage was about $4 an hour, something like that, $3 and something, and worked for McDonald’s. That’s what they paid you. Every dollar that I received was subject to tax. Whenever they say, “Only half the people pay federal taxes,” that’s a bunch of BS. You pay your Social Security tax on the first dollar you make. You just have to pay it. That’s active income.
Somebody asked a really simple question related to this, cutting in line. “Does the S Corp have to pay reasonable compensation if it has no income?” No. If it doesn’t have income and, even more importantly, even if it makes a ton of money, if it doesn’t distribute any, it doesn’t have to pay taxes. It doesn’t have to pay wages. This is the accountant’s dream, which is always fun, is the scenario where the S Corp makes $500,000 and, immediately, the CPA says, “You need to pay a reasonable compensation. You need to pay wages.”
Nerdy guys like me say,” Well, actually, no, you don’t.” You just leave the money in there and you don’t have to, and I think I’m funny. All right, next one. Hey, questions. We get to dive into questions. Jeff’s favorite part of the day is answering an onslaught, which we have hundreds. Ay-ay-ay. Now, we have questions. firstname.lastname@example.org. This is where you can send in questions at a time. We grab a few of them, slap them up on the board.
I have a whole bunch that I’m going to dig into. We’re going to answer a bunch of the live questions and then, if we have time, we’re going to jump to a whole bunch of others. Somebody says a long, long question about something we’re going to talk about last week. They’re building a charted account and they have–what I have done so far was sub-accounts, reach expense and income accounts unless they are cogs and then–this is a very specific question.
Here’s what I’m asking: Please send that in via email. Please let me have a bookkeeper answer this because this is a whole bunch of fun stuff that a bookkeeper is going to have to answer. This is about sub-accounts. Last week, we talked about how you can very easily have one set of books over multiple businesses that are reporting on the same tax return. The most common example is when you have a real estate holding company.
Instead of having–let’s say you had 20 yellow fees underneath it that were all held by this holding LLC. You could have one set of QuickBooks, and each property would be a separate class. That’s what you do. Each LLC would be a separate class. That way, you have one set of QuickBooks.
Jeff: That way, you can still point out the individual units or classes.
Toby: Now, what Deana’s asking is–this is such a fun question that it’s taking up two screens. I get them in little snippets, Deana. This is a super long and narrow field so it’s kind of goofy. It says, basically, if she has DBAs and one main company, you could have sub-accounts for the DBAs, and that’s exactly what you would do. You could choose how far you want to break it down. Would you separate out the expenses and everything per sub-account or would you make them general for the main?
Jeff: I would probably break them down by subject. It really depends on how she wants to see what she has, if she needs to see the DBA reports separately so she’d tell what each one’s making and what each one has. I think that’s something that probably needs to be discussed with a bookkeeper. It’s the best way to get exactly what she wants.
Toby: Okay. Here’s a good one. I love 1031 exchange questions because they’re always flipping complicated. All right. “I’m selling a commercial property, number one, and doing a 1031 exchange.” For those of you who do not know what a 1031 exchange is, it’s when you sell a property and roll the bases under a new property.
Jeff: Others would say it’s a like-kind exchange.
Toby: It’s a like-kind exchange.
Jeff: Like that explains anything.
Toby: People like to say that, and did I do with it? You’re killing me, Smalls. “Number two, down payment on Property 1 was borrowed.” In other words, you have a family member promissory note. “Now, am I allowed to withdraw the original down payment on Property 1 tax-free from the sale or would this count as a taxable event?” This is the only time I ever get to say “boot”. Do you want to do this?
Jeff: My basic rule is you don’t ever, ever want to take cash out of a like-kind exchange because, as Toby says, it constitutes boot and the boot becomes taxable up into the amount of your total gain. People with $50,000 out of cash out of this deal when you have $100,000 of gain, you’re going to pay tax on the first $50,000 immediately.
Toby: Yeah, the only way around that is that they don’t really track once the deal is done. Let’s say you did a 1031 exchange. Your family members had loaned you money. If it’s two years later, I think it’s technically boot, but I don’t anybody who really polices that too much. It’s like borrowing against the property, again.
Jeff: Another thing I’ve seen is people will try to get cash out, which is a problem during the sale or during the 1031 exchange. What I sometimes suggest is if you want to get cash out of this property, refinance it later.
Toby: After or even before.
Jeff: I would refinance it before, pull that cash out.
Toby: You could do either, but the problem that you have is if you’re finding it in every placement property, if you have debt on it, it doesn’t mean you just have to buy a property of equal value. It doesn’t mean that you necessarily have to replace the debt. A lot of folks will have a mortgage on a property. They don’t need to. They want to pay off the mortgage and they think, “Well, does that mean I can lower the property value of the new property I buy?” No, you actually have to buy.
If I had a million-dollar property with half-a-million-dollar loan on it, then I have to buy a million-dollar property. Even if I pay off the half-a-million-dollar loan, it’s not the difference between those two; it’s, “I have to buy a replacement property of equal or greater value.”
Jeff: Mortgage is kind of throw-a-wrench-into-things because paying off a mortgage could be considered relief of debt, which can then be classified as boot.
Toby: You pick up benefit you receive. “If my LLC is used only for trading, is it okay to have a single-member LLC or do you always suggest a multi-member LLC be set up?” David, if you have an LLC for trading, then it gets kind of interesting. If you are an investor or you are not clearly a trader and you are not making a mark-to-market election, then those expenses, to the extent you would ever be able to take them because there’s a whole bunch you couldn’t, go on your Schedule A.
Schedule A has been looted. The new tax laws say no miscellaneous itemized deductions, which means you get no tax benefit. Even if you have somebody managing your account right now, you do not get to write off their management fees. A lot of you guys are going to find that out and you’re going to be shocked that the $5000 you paid the money manager is not deducted. The reason that we use a multi-member LLC is to make sure that we have a corporate partner.
Then, the payments that go to that entity to manage and to cover expenses are considered a guaranteed payment to partner in our deductible before the money flows under your return. That’s how we do it. It’s not a deduction that you get to take; it’s deduction that’s taken before you’re given the net profit. The answer to your question is, “Do you always suggest?” Almost always. The only exception is when it’s a day trader who really trades a lot. When I say “trades a lot”, I want to see hundreds of trades per month.
There’s some folks that use a 60-per-week threshold or something like that. That’s not me. I want to see it to be incontrovertible. Otherwise, I’m going to use a corporate manager 9 times out of 10, 99 out of 100 at least. This is more of that same question which goes on for pages. All right, here we go. “Is there a difference between Section 179 and the new 100% bonus depreciation, and can either or both be used for single-family home rental and/or vocational rental?”
This is always fun. This is actually really good. You’re going to find yourself in all the exceptions. Do you want to answer the difference between a 179 exclusion and/or deduction and 100% bonus depreciation?
Jeff: We’re not seeing–in the deduction itself, we’re not seeing a whole lot of difference between the new Section 179 and the new 100% bonus deduction.
Toby: All right, tax nerd, here we go. 179 is deductions on equipment. Most equipment is all going to be less than 15-year property. Bonus depreciation is on 15-year property. A lot of times, you look at it and you say, “They’re the exact same. I’m going to get to the same place.” The difference is 179, I could choose on any piece of equipment. If I use 100% bonus depreciation, I have to do 100% on all assets. I can’t not use bonus depreciation on one property but use it on another, and that’s complete geek-dom if you like tax geekiness. That is completely a tax geek answer, but it’s actually really important.
The other thing is Section 179 allows you to write off carpets, HVACs and interior improvements on commercial property. When you mentioned single-family homes, you’re not dealing with 179 anymore.
Jeff: No, you can’t use 179.
Toby: Even bonus depreciation is going to be tough.
Jeff: You’re going to be able to use bonus depreciation on your 15-year property, your fencing, your pole and mostly your outside improvements. The other issue with Section 179 is you have to have income to deduct 179.
Toby: Yeah, you can’t take a loss, but you can take a loss with bonus depreciation.
Jeff: Yes, you can.
Toby: See? That’s tax geekiness at its finest. The answer is always, “We’ve got to look at it and actually apply it to a set of facts and circumstances. Everybody’s facts are a little bit different.” All right, “Can you explain a cash balance plan?” I don’t know whether these are my favorite people plans or what because you’ve hit some really geeky stuff here, guys. Cash balance plan, also known–it’s kind of like a defined benefit plan. If you’ve never heard of that, you have things where you define the amount that you put into it like an IRA.
“Hey, I can put $5500 and I get to write that off.” In a defined benefit plan, I do a reverse-engineering. Let’s say Jeff is making $200,000 a year and he’s getting older. Sorry, Jeff.
Jeff: I am.
Toby: He wants to retire and still make $200,000 a year. A licensed actuary with the Internal Revenue Service–
Jeff: A really boring accountant.
Toby: It’s a really, really boring accountant. He says, basically, “Hey, Jeff. Based off what you’ve been making over the last few years, here’s the amount that we’re going to use as an assumption. Your $200,000 right now, you’re going to need about 220 because of inflation when you retire. We’re going to need to have about $3 million sitting in your account to pay that out when you retire, and we have 15 years to do it so we need to put a whole bunch of money in there.” Just using that math, it’s about $200,000 a year.
They do everything from calculate interest, to inflation, to all sorts of assumptions, and they come up with a number. When Bryan is talking about this, this is–”Hey, if my business is making $200,000 and they come out and say I can deduct $200,000, I can literally eliminate my entire income using a cash balance plan or a defined benefit plan. It’s nuts,” but, if you do it, I believe you’re stuck doing it for a few years, like you’re not doing it one year and then you’re out; you’re doing it and recalculating it every year.
I hope that helps. It’s potent. If you are somebody who’s making $200,000-$300,000 a year or you have been and you do not need the cash because you have other assets that you can use to live off of, then rather pay tax on your income, go ahead and do that. All right, “I have capital loss carry-forwards. Can they be offset with capital gains on collectibles even though collectibles rate is 28%?” Do you know the answer to that?
Jeff: I would say the answer is yes. First, you calculate the gain and loss, and the same thing happens with Section 1250, which is real estate, is you calculate whether or not you have a gain or loss first, and then you apply the specific rates. 20% for collectibles, I believe, it is and 26% or 25% for 1250. There’s a couple of breakout areas of how to divide your gain and how to tax it. If you got something to offset it, do it.
Toby: Cool, we like it. I believe that’s the answer. I’m not aware of having restrictions on capitals. I just know that they charge it a higher rate. If you have gains, it’s going to offset. Usually, you’re getting to a net number, and then they’re looking if they’re proportionate. If I have long-term capital gain and short-term capital gains, I have a bunch of short-term capital loss and it’s offsetting both and maybe I have, still, $1000 leftover gain, they’re taking proportionate amounts.
Toby: You’re just trying to see whether there’s anything left over. All right, somebody asked another geeky question. “Should I have my main family home in my real estate business? My business buys my assets.” Dale, probably not. Here’s why: First off, you have your house. Your house gets something called a 121 exclusion. If you have a bunch of gain in it, you can exclude, if you’re not married, $250,000, and, if married, $500,000 of the gain if you sell it and you lived in it and owned it two of the last five years.
First off, you don’t want to give that up. Also, a lot of states have a homestead exclusion where people can’t take away your equity in your house. For example, Texas and Florida have unlimited amounts. Third, if your business owns the house and you live there, that’s considered a rental property and you have to recognize taxable wages for the fringe benefit it’s giving you, which is housing unless it is a religious institution.
The only one I know is where you can do a parsonage allowance under Section 107 is if you were running a church. Everything else, you’re paying tax on. Unless this is a church, the answer is, “Don’t do that.” What you can do, however, is, under an accountable plan, if you have an S Corp or a C Corp, it can reimburse you for the portion of the house that you use exclusively for your business, and it can write off that portion of the total expenses of the home, including depreciation.
You actually run through–the IRS has a handy sheet. I have a quick spreadsheet that I share out with people all the time, and it’s actually really cool. It will show–I think on a $400,000-house, the answer is usually about $8500, is what you’re going to get to give yourself as a tax deduction. These are a few questions. Christine, I’m not following this. That’s pretty funny. This is way back when, relating to your excessive use of your car washes.
All right, “Can our corporation reimburse us for our medical premiums and our HAS contribution?” Here’s the answer. Do you want to answer that one? “Can our corp reimburse us for our medical premiums?” I don’t want to […] the whole thing.
Jeff: You do a really good job of it. I’m going to answer the questions. The corporation cannot reimburse for the HSA because the HSA is pre-taxed. The corporation doesn’t want to reimburse for anything that is pre-taxed. If you have health insurance being paid for by an employer, you don’t want to be reimbursed for that.
Toby: What if it’s an S Corp? Whenever we have benefits, what’s the downside to S Corporations and medical reimbursement plans?
Jeff: The problem with S Corporations is they’re considered separately-stated items. I know we talked about that before, and they end up right back on your Schedule A where they spend anyway.
Toby: Even more than that is if you are the owner, it’s wages to you. If I provide you–let’s say that Jeff and I owned an S Corp and we decide we’re going to have a medical plan. Let’s just say that we do medical insurance. We have to recognize the medical insurance on our 1040 as income. Then, there’s a spot on our 1040 where we can write off self-employment insurance premiums only, only the premiums. Everything else, none. If I have all my deductibles, co-pays and everything else, I could write them off of my 1040 under my Schedule A, but it has to exceed more than 7.5% of my income.
Jeff: If you’re our age, it’s 10% now.
Toby: Your age. I’m still young.
Jeff: I know.
Toby: I’m just kidding. 10%.
Jeff: If you’re under the age of 65, it’s 10%.
Jeff: At some point. They changed it with ACA, the Obama Affordable Care Act.
Toby: Okay, we’ll go over that one. The new tax law, I think, went down to 7.5%.
Jeff: He’s right.
Toby: They went from 7.5% to 10% then back down again.
Jeff: I’m still operating in 2017.
Toby: Yeah, they changed that, and I think they made it valid September. I think they actually went retroactive 2017. Let me look at that. The 7.5%, I think they made it retro. That’s code for you’re not going to write anything off so you just don’t do that. If it’s a C Corp and I don’t have any employees in another business, then I can reimburse 100% of my medical, dental, vision–everything that came out of my pocket. I don’t have to worry about an HSA. I can literally just reimburse anything that comes out of me for medical costs.
Then, they also have these funky little new ones. This came up in the new–they call it the Cure Act–right towards the end of 2016 where, if you have less than 50 employees, you can do a qualified medical reimbursement. We don’t do those very often just because we tend to stick with the C Corps where it’s doing a 105 plan, but there’s other ways to get it out if you’re a sole proprietor, even if you have a spouse that’s working with you. There’s ways to do it. The C Corp is so much cleaner just because it can literally just reimburse.
Jeff: In regards to the HSA in particular, anything that HSA is paying for, you don’t want the corporation reimbursing because it’s been already paid with pre-tax dollar.
Toby: All right. Somebody said, “What about a Tesla used for business?” This must be going back to the car. This is how many questions we have to go through. Ay-ay-ay.
Jeff: This was a case we had recently. The client had a personal-use Tesla, a Tesla under their own name, using it for company business. That worked out well for them.
Toby: It’s just not going to qualify as a heavy vehicle.
Jeff: Because it’s a personal Sedan.
Toby: Right, it’s going to be a personal Sedan so there’s limitations on how much you can write off per year. You still get a big, fat write-off.
Jeff: You do. If it’s a Tesla SUV, that’s over 6000. That’s a little different but, if it’s the standard T model or the S…
Toby: Gary, I guess the question would be if it’s an S or an X. If it’s an X, you may be able to write it all off in Year 1. If it’s an S, it’s going to be over time but, again, if you have personal use, those Teslas are expensive.
Jeff: Now, it’s my understanding also that the electric car credit is being reduced.
Toby: They’re being used up.
Jeff: In 19, I believe it’s going to drop from $3500 to a lower level, maybe half of that.
Toby: “If I choose a vehicle on a business–” it looks like what they really mean is, “If I choose a certain way to treat a vehicle in one year, do I have to keep using it that way?” If you start using the reimbursement method or the actual expense method, “Can I move over and do something else with it?”
Jeff: If you start out with the–you mean as far as reimbursing?
Toby: I think you pick it and, once you pick it, you’re toast, right?
Jeff: If you start out using standard mileage, you can go to actual expenses; you just can’t go in the opposite direction.
Toby: Good. Now, here’s another fun one. Let’s say you’re sitting on–you have a car that you’re using a lot more for business and you thought you have a home-based business and, all of a sudden, you’re getting all your commuting miles and you’re treating it as a personal vehicle and it’s just reimbursing, you can convert it at its fair market value as of today to a business asset. Just so you know, it’s almost like the business just bought it. It’s really just reimbursing you.
Jeff: That brings up–we can get to bonus for a second. One of the changes in bonus depreciation was the old rule said it had to be new to whoever was depreciating it. The new rules say if you buy a used car, you can take a bonus on it.
Toby: That’s why you can take a personal automobile that you have and you can roll it into the business, if you want. You always run the numbers. Here’s another one that’s going to solidify this point: “Can a business pay for a car leased for an owner?” Yes, but here’s the thing. Here’s the rule: All fringe benefits are taxable unless there’s an exclusion as to why they’re not. If I buy you a car, you’re paying tax on it.
Jeff: There’s also some legalese inclusion, which is IRS’s way of getting around the luxury vehicle limitations. If you buy a really expensive–or you lease a really expensive car, you have to recognize some income or reduce your lease amounts by a certain amount. It’s really not that much money.
Toby: Here’s another fun one. Somebody’s using the term “crack and pack”. We always like that. That’s with regards to the 199A. They’re relating to the idea that when 199A, which is the 20% bonus deduction, the pass-through deduction on pass-through income–people were starting to say, “Hey, we’ll separate out our business in a specified service business,” which is medical, legal, accounting or something that you are the reason the business is there, your personal services, like your reputation and skill.
There were people that were like, “Hey, we’ll just break the business up and make this part one part of the business as an S Corp, the other part of business as an S Corp and the bad part, we just won’t write-off the 20% on that one.” The IRS said, “No, you don’t get to separate out the businesses like that.” What if you have one that is an S Corp that is not a specified service and then you also have a C Corp? Here’s the thing, Kai, the C Corp doesn’t even relate to the 199A because it doesn’t get to have it nor is it a pass-through entity so the answer to your question is no. It’s not a crack-and-pack. If it was an S Corp, then the answer is maybe. That always depends.
Here’s another one: “Can you have a leasing company and lease the vehicle from them?” Yeah, of course you can, but you’re paying a lease payment, you’re paying state sales tax and stuff like that. Again, I’m really lazy when it comes to this stuff, guys. I want it so simple that I can’t screw it up. I tend to gravitate towards mileage unless I’m really using an automobile in my business. I don’t want to be using it in my business; I want there to be a good reason.
Here’s one: “What do you suggest for a single-member S Corp with no employees besides owner for healthcare expenses?” Here’s the thing. Steve asked a good questions. “If I am a single-owner S Corp, I’m really kind of toasted. I’m just going to get–I’m personally writing off my insurance premiums only. I really do want to have a C Corp floating around in there,” and you’re allowed to do this. You’re allowed to have an S Corp that does Activity #1.
I can have a C Corp that does Activity #2 especially if Activity #2 is complete oversight of all of my investment affairs. If I have rental real estate, I have stock accounts, everything else, that C Corp’s managing everything and can also manage my S Corp. It has to be reasonable, it has to be in arm’s length, and then I could get money into my C Corp and it could turn around and reimburse me under a medical plan arrangement as long as everything is reasonable.
“As of protection-wise, is it better to buy a car in LLC or personal?” If it’s in the company, companies can be exposed. If you have a company that’s doing activities, then it’s worse, and we’ve had this. We’ve had somebody who got a–where they were at a bank and they rolled into somebody and they ended up getting a lawsuit both personally and in the business, whereas if they just owned it personally, they have no idea whether you’re driving it for business or not.
I’m going to go past these. There’s a lot of questions about vehicles. People are really stuck on those vehicles. “I have an internal business–” and I shouldn’t get this. This is another vehicle one in the business name.” It’s specifically for rental business. “Does the Hummer tax depreciation work?” Tony, yes, we’ve been going over that. Yes, you can. Here’s something on personal credit. Yeah, these are just more questions.
Let’s see. “We invested $35,000 worth in an education company and then continued education with another organization. How would that work? Also, we’ve invested in other–” I think this is Christine. She’s talking about startup expenses. Here’s when you’re dealing with education: It’s actually Section 195 of the Internal Revenue Code. What it’s relating to is if it’s increasing a skill in your trade, you can write it off. If it’s qualifying you for a new trade, then you wouldn’t.
If it’s something that is investigatory into a business and you start up a business, then it is a startup expense. If you’re doing these things and it’s basically to help you become a better real estate person and you have your business, it just writes it off as an ordinary expense. It’s like if I sent Jeff to a continuing accountant education or if I go to continuing legal education, I can just write it off. If it’s in Miami and it’s for a week, it’s business.
If you are doing this and it’s part of a real estate activity, then that’s going to reimburse you and the company’s going to capture that as a deduction. You always want to have that company around because that company is what really makes it work. If it’s just you, you don’t have a company, you’re probably not going to get that deduction. There’s the Woody case where they denied it and there was a guy who was doing real estate and, until he started flipping houses, he was not a business in the eyes of the IRS. You’ve got to have that business. If it’s relating to the startup of that business, then you can at least capitalize it.
“What happens if your business doesn’t make any money in the first year? Can you write off expenses the next year?” Jeff?
Jeff: Well, it depends on what kind of business we’re talking about. If it’s corporation and you don’t make money in the first year, your losses are just going to sit as what we call net operating losses until you have income to offset it. If the losses are going to an S Corporation, a partnership or even on your individual return, it’s likely that you’re going to be able to deduct it in some fashion under your 1040. The one area that doesn’t happen is with what we call passive losses. Rental activities are typical passive loss so you may be able to write off some of your rental losses. You may not be able to write off any of your rental losses depending on your income level.
Toby: Well put. It all depends on the type of business. Typically, you can carry forward business losses. Next one: “Regarding trader status as opposed to investor status, does trader status need to be declared at some time?” Here’s the deal: Trader status doesn’t exist in the Internal Revenue Code. You literally just write it on your tax return and you say it whenever you file your tax return. Mark-to-market election has to be made, I think, by the 15th. I can’t remember if it’s the third month or the first month.
You have to make it in the beginning part of the tax year. There’s no such thing as a retroactive election in mark to market. In order to get your tax losses the way you’re looking at it, like let’s say you had losses in the market, you’ve really got to be making that pretty early on, and I don’t think you can go back retro.
Jeff: Now, what if you’re making substantial gains and you’re a trader?
Toby: It doesn’t really matter too much. You’re just trying to get expenses that otherwise wouldn’t be attributed to you. For example, an investor can’t write off workshops or investment education nor could they do the reimbursements to themselves and things like that. They don’t get to write off their–flipping their home office or computers or medical reimbursements or any of that stuff.
Jeff: Did we ever get to a point where these gains that normally would be capital gains be considered ordinary income?
Toby: Yeah, the only time is…
Toby: Even then. I believe, yeah, if you’re a securities trader. If you’re trading other people’s accounts, then you’re no longer owning the assets; somebody else does. You get ordinary income, but that’s not what we’re talking about here. It’s if you’re trading your own account. We tend to dislike trader status intensely because it gets scrutinized so often and they like to go to tax court because there’s no code provision to cover it so the only way to get to know whether or not you are is if they ask a judge.
My personal philosophy is if I never end up in front of a judge, that’s a good thing. I don’t want to end up with a judge during probate. I don’t want to end up in front of a judge during a lawsuit. I don’t want to end up in front of a judge because the IRS doesn’t know what to call something so they said, “Hey, we don’t know. Therefore, we need to go ask a third party.” That only impartial third party that they ever listen to are judges so we don’t want to do that if we can avoid it.
I think that a trader status is a good way for an accountant who likes to do audits to boost their audit practice, and I personally find it somewhat repugnant. We’ve been successful over 20 years. We’ve defended audits that have involved it and, frankly, if you put a structure around it, it’s so much easier. Here’s the thing: If you’re in the stock market and you’re trading a lot, don’t lose a bunch of money. I know it sounds cliché, but don’t engage in super-risky behavior and lose money. You don’t want to sit there and be trying to write it off against your W2 income. It’s just not why you trade. You should make money when you’re trading 99 times out of 100. You need to be a little more concerned than that.
Somebody asked on the capital gains, “Is it on adjusted gross income for the 15% category?” The taxable income is what calculates what tax bracket you’re on, and this is a great point. This one actually goes into something that was emailed in. You can control your taxable income by giving money to charity, by offsetting it with deductible contributions to cash value plans, defined benefit, defined contribution plans, 401Ks, IRAs. All of it adjust your taxable income downward.
Somebody asked about a conservation easement via email and, in a conservation easement, you get to take a deduction based on the fair market value of the easement. Actually, President Trump, years ago in Mar a Lago where he likes to spend his weekends, they have that golf course valued at about $25 million. He gave up the right to build on the golf course, like they literally said, “Hey, we’re going to keep this as an open space and we’re not going to remove the antiques out of the clubhouse. We’re going to keep it like it is, and that’s going to cause us to lose value,” like, “We’d be better off building on it.”
They got a deduction close to $6 million for doing that. That’s called a conversation easement. I am giving an easement restricting my rightful use of property. Now, what’s going on is people are going out and there’s syndications where you can buy into these things. The average, what I saw from the treasury, was about $1 for $9 of deduction. Now, this is now a listed transaction, meaning that you actually are going to get scrutinized on it. They get audited, and a lot of these guys are getting popped. It’s like going offshore.
I tend to shy away from them, but there are some halfway decent ones that are much more conservative. 1 to 3 is probably a better number, which means I give up a buck and it allows me to write off three. My tax savings might be the equivalent to what I gave up, my donation, but it adjusts my taxable income downward. The question is, “Why would you do that?” Let me answer it. Under Section 199A, I’m entitled to a 20% deduction on my qualified business income so long as I don’t exceed a certain income threshold.
For me and my wife, my income threshold is $415,000. It starts at $315,000 and it phases out completely at $415,000. If I want that 20% deduction, I need to get my taxable income to $315,000 so I might have $100,000 that I need to remove. If I could pay $30,000 in a conservation easement and get a $100,000-deduction, then it is worth it to me because, now, my $315,000 of income that flowed through from my law practice becomes qualified for a 20% deduction.
That $30,000 gets me the $100,000-deduction plus an additional $60,000. That $30,000-conversation easement got me a $160,000-deduction, and I’m thinking, “That’s worth it.” Every case is a little bit different, but that’s what you’re talking about.
Jeff: The reason is deductions are so large it has little to do with what you actually paid for the property; it’s what you intended to do with the property. We had a client that owned a large treck of land in Montana, said he was going to develop it, so they valued the land that he had developed versus if he hadn’t developed it and what it cost them. He got a huge write-off far greater than he actually paid for the property.
Toby: Again, I think President Trump himself has received over $60 million of conservation easement deductions on his golf courses because what they do is they have these golf courses and they say, “Hey, we’re going to keep it the way it is. We’re not going to build on it. We’re not going to put track housing on it. We’re not going to destroy this big, open space,” so they’re literally reducing the value of their property by doing that, and they say, “We will never do it,” and they actually impose that. In essence, a conversation easement just means, “Hey, we’re making sure that we’re putting something that flows to heirs and everybody else, but they can’t do certain activity on it.”
Jeff: Now, anytime you have an easement, you have to keep in mind that that easement will pass onto anybody that you sell the property to.
Toby: Yeah, it runs with the land. All right, here, somebody says, “I am a purchasing a 10,000-foot log cabin in the Appalachian Mountains to convert it to a 20-unit residential assisted living memory care center.” God bless you, Jim, for doing that. My father passed from Sundowner’s, which is a division of dementia and Alzheimer’s. “My goal is to help seniors with memory impairment in an affordable rate, non-profit benefits versus for-profits.”
What we’re looking at is, “Should I run this as a non-profit versus a for-profit?” Anything in the fields of religion, education, public benefit health–there’s a whole bunch of them–amateur leagues, all these things qualify as a 501C3. A memory care unit would qualify because you’re helping seniors. You’re doing something that the government actually could be doing, and they’re going to encourage you to do this by giving you and those who support you a tax break.
Now, here’s the downside of a 501C3: Nobody owns it; the public owns it. If you dissolve it at some point, you don’t get the money. It goes to another 501C3 with a similar purpose. For example in your case, it would go to either a senior housing non-profit or the Alzheimer’s Foundation or something along those lines. While you have it, though, it pays no taxes. It doesn’t pay real estate tax. It doesn’t pay federal income tax. It doesn’t pay state income tax. It pays nothing on its profits and, chances are, you’re going to get grants.
Chances are, you’re going to find organizations that are willing to give you land or other properties under land banks and, probably, you may even have people that just donate properties to you that say, “Hey, keep expanding.” That aside, the big benefit is that you literally pay no tax. Now, when you put money into it, you also get a charitable donation. I have a non-profit myself. I give it cash or assets at the end of the year, circling way back when we were talking about the appreciated stock.
That’s why you could actually give appreciative assets to your non-profit, sell it, the non-profit doesn’t pay tax on the gain, and you get a donation based on the fair market value. If you have some stock or even real estate that’s run up in value and you want a big, fat deduction, this is a great way to do it. Somebody asks–and, by the way, I hope that answered your question. If you want to sell it somebody and you want to take the money and run, chances are that’s not a 501C3.
“Could you please explain how a security-backed loan works? Do you ever have to realize capital gains on that?” Armeet, this is where it’s beautiful. If I use my stock as security, I don’t pay tax ever. If I die or if my spouse dies and I’m in a community property estate–this is for community property estates only–if one spouse passes, the bases of those shares step up to the fair market value on the date of passing. Let’s say that I have stock. It’s gone up. Let’s say I bought it at $10,000 and it’s worth $200,000 and I borrow $100,000 so I have a loan of $100,000 outstanding, my spouse passes or I pass, my spouse sells that stock, they pay 0 capital gains because the basis is now $200,000. They pay back the loan, they’ve gotten literally $200,000 with zero taxes on it, period.
Jeff: Now, are there any problems with–say the market has a really, really bad day. Are you then going to see equity calls on the loan?
Toby: You’re going to see equity calls. They usually do 80% loan to value, but it’s a line of credit. If they get caught out there, they could say, “Hey, we need more stock in security.” That’s good, but where are they going to take it against? Are they going to take your stock that’s dropped to pay back? In theory, that’s what they could do. If the market just took a tank, yeah, you could see yourself in a position where, if you’ve taken the money on the line of credit, you may have to be kicking some of that back in or you’re going to find other collaterals.
Frankly, what they care about is they want to know whether you’re going to pay it back. They may say, “Hey, do you have any real estate? The stock market’s really taken a dive. Do you have anything we could secure with it?”
Jeff: You can collateralize this one in other ways?
Toby: I’ve never seen it happen but, in theory, it could. Now, here’s a thing: If you follow what we do like at Infinity Investing because we’re really, really conservative, we tend to focus on things that don’t move with the market. The maximum, when the market dumped 38%–if you’re invested in this type of stuff that we invest in like the Dividend Kings, the maximum decrease they experienced during that same time was 14%.
They’re not going to give you a security-backed line of credit on Amazon; they’re going to give you a security-backed line of credit on something that produces lots of profits and has a history. You’re talking about Lowe’s, Johnson & Johnson, Procter and Gamble. You’re talking about companies that have been around a long time, Walmart, stuff like that, probably Exxon Chevron, things like that. You’re not going to get it on Facebook.
The next is, “What is AGI?” Adjusted gross income. Some charities can also provide credits for a large percentage of the donations. I don’t know what that means. They’re probably talking about tax credits. I’m not aware of that, but maybe we could look at that. That’s not really a question. Someone’s just asking. “Do real estate losses count to offset stock capital gains?” Do you want to hit that one?
Jeff: Real estate losses count. If we’re talking about real estate losses from selling real estate, if you’re flipping houses, no because that’s not considered capital gain or loss property. That’s considered inventory. If you’re selling rental property, yes, it could contribute to the capital gains and loss calculation. Now, if you’re talking about real estate losses in general, “I have a rental property and I lost $10,000 renting it out this year,” no, that doesn’t affect your capital gains or losses at all.
Toby: Now, if you have real estate and you’re a real estate professional, it can offset any gain. If I am an environment real estate professional, which means I spend more than 750 hours a year on real estate, and it is the number one use of my business time, then I can offset anything with it.
Jeff: That’s true. When we talk about, all of a sudden, capital gains and losses, we’re usually thinking other capital gains and losses.
Toby: “How is the payroll tax applied if you make active income?” Let’s say you’re a sole proprietor or you’re a partner in a partnership and it makes active income so you’re flipping houses, you’re a consultant, you’re a real estate agent, you’re a doctor, you’re a lawyer or you’re a candlestick maker. That’s active income. You are subject to old age, death and survivors and Medicare on all of your money. Old age, death and survivors phases out at about $120,000. Medicare goes on forever at 2.9% and then you start getting a surcharge of 0.9–boy, that stinks–once you get over a certain dollar amount. Do you know the dollar amount?
Jeff: $350,000 for a married couple.
Toby: There’s a little surcharge. The most you’re going to be paying on your active income over $250,000 is 3.8% towards Social Security, but it never stops. If you use an S Corp, it stops the minute you don’t pay yourself a wage; everything else comes through you and it’s not subject to it. “What about C Corp for payroll taxes?” C Corps, you do not payroll tax on corporation profits. Corporation profits are taxed at the C Corp-level.
A C Corp pays its own taxes. It has a flat tax rate of 21% so if a C Corporation makes $100,000, it pays $21,000 in federal taxes. There might be some state taxes, too, depending on where it’s located. If it pays that profit to you, you pay long-term capital gains on that. That’s called a dividend. Dividends from a qualified entity like that, a domestic entity, is your long-term capital gains rate, which goes back to–earlier, we were talking about it being 0%, 15% or 20%. You could literally have a C Corp that pays 21%, wait until you’re making almost nothing, pay you out a dividend and you pay 0 on the profit. Yeah, I like them.
“Does a S Corp have to pay a reasonable compensation as income?” We already answered that one. If it pays distributions, you need to make sure you’re paying a reasonable salary if you’re working. If you are not working, and, technically, if you’re passive and somebody else is receiving, technically, you could get passive income on all of it. “Why does sole owner of S Corp pay self as employee? I was told to do it that way.”
If the S Corp makes money, then all of it would flow to you as the S Corp owner. Say you’re a single-owner S Corp and it did not pay you wages. It would all be passive and you would not pay any Social Security checks. The IRS doesn’t like that. It says, “Please pay yourself a reasonable wage, and the rest of it is not subject to self-employment tax.” “What does this really mean, practically?” Old age, death and survivor is 12.4. Medicare is 2.9. It’s 15.3%.
When you factor in that you get to write off a small portion of that, it’s really 14.1% on every dollar. Let’s say you’re making $100,000. If you’re doing that as a sole proprietor, you would pay $14,100 in Social Security taxes alone, not even counting your income tax, not even counting your state income tax. If you converted that to an S Corp, you would only pay Social Security taxes on your wage. If your wage was $30,000–let’s just say– which one-third is an easy rule to follow.
Let’s say that you paid yourself $30,000. You would pay 14% on that–and, technically, the company pays half and you pay half–but the remaining $70,000 would avoid the 14% tax which is worth about $9800. You would literally save yourself $9800 for every $100,000 or the first $100,000 by converting to an S Corp. That’s why we use it, plus, if you really wanted to get technical, we could slap on a 401K and avoid tax on the first $18,500-plus. If you’re over 50, $24,000-plus. You could make a contribution of 25% of whatever your salary is. Yes, we can save some taxes.
Jeff: Now, we’re up to $54,000 in deductions for profit-sharing.
Toby: It gets pretty big. If you do a cash balance plan, it could be zero. You could literally eliminate your tax. Just keep in mind that there’s some powerful ways to eliminate tax. If you’re paying lots of taxes, stop it. Just give us a call. “I’ll be 69 years old and hope to retire from my job.” Jeff, are you writing in? I’m just kidding.
Jeff: I have a few months left.
Toby: “I will get lump sum for retirement, which we’ll have to withhold. Can I roll this into my C Corp and delay paying the tax? I’ll be 69.” What they’re saying is, “Hey, can I avoid paying tax on a retirement plan?”
Jeff: I don’t know if he’s required to even withhold.
Toby: This is kind of weird. This sounds like you may have some deferred compensation so I’m going to ask this: Mark, email us in some more details. If this is deferred compensation, then it’s a different rule than if it’s an actual retirement plan and they’re giving you a lump sum payout. Land conservation, we already hit. “Can a salary be backdated?”
Toby: Stop asking questions. Back-dated, no. “Can I apply in due salary for last year if I missed the threshold?” I think there are some limited circumstances where you can do that, but not here. “Can you buy equipment in non-profit corps and not pay taxes on the money invested?” Yes, I can literally–here’s the deal: I can either buy the equipment and contribute it to the non-profit at whatever I paid for it or I can give the money to the non-profit and buy the equipment. In either case, I’m going to get the same deduction.
If I purchased something more than a year–and this is an operating non-profit, not a private foundation–there’s a little distinction here. If I bought it over a year ago and it’s gone up in value, then I would get the fair market value. It’s always a measuring test. This is why you have an accountant. These things are complicated, but there’s always a good answer. “I have a C Corp and did not file initial tax return due last January. The corp had only made about $2000. How big is the penalty?” They have $2000 that they didn’t report.
Jeff: Delayed filing penalty is 5% of your tax per month up to, I believe, 12 months. It’s not even that high, up to 25% total.
Toby: You may have a $500-penalty.
Jeff: You may have expenses that we can write off against that $2000.
Toby: You may be surprised that, if you made it, there’s a very good chance. That $2000, I can tell you paid more to set that thing up. You’re going to have all sorts of expenses that you’re not realizing that you have, plus it can be–let’s just put it this way: You contributed without even knowing a whole bunch of expenses because it didn’t reimburse you. We’ll just call those contributions and take it. You will not have a tax, I’m certain.
“In my personal income tax filing, how can I deduct real estate cost?” I don’t know what that is. C Corp setup cost is organizational expense. He’s asking, “I have $30,000 in training before I set my company and I set up a C Corp.” Okay, Brian, you’re going to get the C Corp setup cost–you can write off up to $5000 immediately. The courses that you paid for, you would be writing off $5000 immediate; the remaining $25,000, you would write off over 15 years.
Jeff: We don’t want to combine the setup of a corp without the education expenses.
Toby: Right, we would separate those out. “Sorry, I had to step away for a few minutes and, if you answered, I apologize.” I don’t know what that was. I think we already answered it. If you can go to email@example.com, we’ll get your question answered. “When a property was rental before and then transferred the property to an LLC and then rent it for a while, can we take the LLC no longer renting it out? Is it possible?” I have no idea what that means. Email me a more comprehensive–maybe I’m missing something.
“Can we take the property back out?” Yes, you could put money in and out of an LLC so long as it is not taxed as a corporation. If you put a property into an LLC taxed as an S Corp, for example, and then take the property out, now we have problems. It’s going to be treated as–the appreciation could be treated as income to you. Don’t do that. If you’re putting in an LLC that is disregarded or taxed as a partnership, we’re fine.
“Can that debt on properties create boot?” The debt is the forgiveness of debt that causes boot so, yes, debt on property can cause boot. That’s why we always make sure that we’re going value-to-value. If you’re being released from an obligation that you do not have later, you can have issue. You’ve got to pay back that loan. If it’s no longer there on the new property and you didn’t pay it back, then that is taxable boot to you.
“Can I do a 1031 exchange with investment property which is not a rental (i.e. my parents live there and I don’t charge them rent)? How can I minimize capital gains tax in this myself?” Your parents are there, you’re gifting them the rent, would that qualify, Jeff, as a rental property? They’re not living there, so somebody else is living there more than 14 days. I would make them pay rent for a little while and then I would gift it back to them. To make sure that that is clearly an investment property, then I would 1031 exchange it.
Jeff: Right, and this is where you get into the whole below-market rates and things of that nature. In a case like this, if you’re renting out to your–if you say you’re renting out to your parents, or grandparents, or whoever but you’re not collecting rent, your losses eliminate the zero.
Toby: All right, a bunch or more. “Will corporate manager benefit for an investor as well as a trader?” Yes, if you’re trading and you have an investor, if you have an LLC that is trading in the market and you have a corporation acting as its management entity and is a partner then the payments to it are a guaranteed payment, then, yes, you’ll benefit from them. “Does it matter if it’s stocks only or can I limit my trading to futures only?” It doesn’t matter.
Futures, you get 1256 treatment, which is 60% long-term capital gains, 40% short-term gains so it’s actually a really awesome way to be treated. What else is there? “Which is better: a prenup or putting all assets in a trust?” Susan, a prenup is living out of a tax field, but I’ll just tell you. Prenups, I tend to not like them. Judges I worked for did not like them. They’ll find other ways like, for example, “Hey, this is my property and I have a prenup that says it’s my property.” They may say, “Okay, it’s your property but we’re going to give all the income to your spouse after a divorce.
For a trust, the only state that that protects you in alimony situations is Nevada. We just had a Supreme Court decision last year that backed that up so if I’m choosing between the two, I’m probably going to do a prenup and I’ll set up a protection trust leaning towards the asset protection trust. Again, if that’s a big consideration when you’re getting married, you probably want to get some other advice on that. There might be some other issues.
Toby: “Does it matter?” and this is another one. “Is there a difference between 179 in bonus and recapture?” There’s a difference in an operating loss. We already covered that. You can’t have operating loss in a 179. As far as the recapture, it’s still ordinary income. In other words, if you used a car–for example, if you buy a car in a business and use it less than 50%, you have recapture because you took a big deduction on something that you said was a business asset that’s not. “Can you apply the bonus depreciation on farm buildings?” That is weird. I don’t know.
Jeff: I want to say you can. There are some special rules for farms.
Toby: Yeah, it’s non-residential.
Jeff: Most farm properties are subject to 150% depreciation whereas regular rental properties are subject to 200%.
Toby: Yeah. You know what, Joan? You’re asking a good question. Maybe we could table it for next week to do a little more on that. If you can email in at firstname.lastname@example.org that one, we will be able to give some more thoroughness on that. “On a 1048 tax return, can one take the casualty on theft laws and multiple rental properties due to hurricane disaster?” That is a Section A and, if the President declared it a natural disaster area, then your loss, yes, but it’s on your Schedule A so you’re going to take that in lieu of not your exemption but your standard deduction, your $24,000 if you’re married or $12,000 if you’re single. If these are in an investment property, then you would just write it off as casualty loss.
Jeff: Right, and the whole presidential declaring disaster is a pretty big change from prior years or just for a house burned down, you could write that off as a casualty loss.
Toby: Somebody asked, “Is a four-condo building residential or commercial?” It depends on what they’re using it for. If it’s businesses–we have in Tacoma, where our office is located, we own a floor of a commercial building. That’s a condo, technically, but it’s a commercial condo. If people are living there, then it’s residential.
Jeff: You could have a 200-unit apartment complex, and that would all be considered residential property.
Toby: “Once I reimburse myself money put into a corp, do I have to pay taxes on the money?” Yes? Anything over the reimbursed amount, but you can have lots of reimbursements that are going to keep going on it. It depends on whether it’s deductible to the company. For example, I reimbursed myself but now I’m getting medical reimbursements and I’m getting equipment reimbursements and I have a home office reimbursement. I have cellphone reimbursement, I have my auto reimbursement, I have all these reimbursements and none of that’s taxable. We like that.
Jeff: Have we talked about differences between reimbursements and allowances? Reimbursement is good. Allowance is bad.
Toby: You come up with a great point. There was a tax case where they had a $300-allowance for employees to go out and get medical coverage taxable to them because they made it an allowance. The reimbursement was they actually had to submit in the reimbursement and they weren’t making their employees do it. They said, “Hey, that’s taxable income, guys.” Big difference. Forgot about that. Somebody asked, “Is that form shared?” I bet you were talking about cheat sheet. No, it’s not. Email. Ask for the cheat sheet. I will send it to you. It’s an Excel spreadsheet that has a whole bunch of expenses on it and how to calculate it.
“My main business is commercial, a janitorial company. Can my cleaning company buy investment mobile homes and is it safe or should I create a different entity?” Create a different entity. You do not want to bring in the liability of mobile homes into your janitorial business. You want to keep them separate, too, because investment properties or mobile homes, that’s passive. It’s not subject to Social Security tax whereas your janitorial business would be, depending on how it’s set up.
“Is there anything I need to consider in owning property in my C Corp that is exclusively used as an Airbnb rental?” Yeah, don’t do that. No, actually, it’s not fair. It’s technically your Airbnb rental depending on how active it is and how long people are staying in it. That’s a hotel; it’s not a rental property anymore. It’s literally–the IRS treats it as a hotel and it’s active ordinary income, in which case I could see possibly doing that in a C Corp.
Our recommendation is that if that’s your situation, that you own a property in LLC that passes through you so you get passive treatment, you get the depreciation, you get all the benefits of having rental property, and then you lease it to your C Corp under a monthly lease, and the C Corp turns around and do lots of short-term leases. That way, only the difference between those numbers is taxed as active income, and it’s sheltered by the corp which can then do a bunch of reimbursements to you. I know that sounds genius because it is. No, I’m just kidding.
You want to get all the benefits of having that passive rental real estate, and we normally know how we’re going to treat it. I tend to say don’t own the property in the C Corp. If it ever gives it to you, it’s active income to you; it’s wages, which is really bad. If you ever want to take it out and re-file it, the second you take it out is the second you decide a taxable event, and it may well just have paid you a whole bunch of wages.
“For a business LLC that’s located in your primary residence, can office-related utilities phoned be paid out of the business or do you pay them in a–” what I like to do is reimburse myself. Marianna, you actually reimburse and, yes, you can still do that and it’s not reportable to you. It’s deductible to the company. We talk about that stuff a bunch. “What type of documentation is needed to offset capital gains over $500,000 if married?” I have no idea what that means. Do you understand what that means, what type of documentation is needed to offset capital gains over $500,000 for married?
Jeff: Is that for the exemption?
Toby: You may be thinking of the 121. There is no documentation except you just have to show that you lived in it. The way they look and see whether or not you lived it in there as primary residence is where your cars are registered, where you were registered to vote, that type of thing. They’re just going to look at that, where your license is.
Jeff: I think one of the biggest risks are proving not only what you paid for the property to start with but, if you claim substantial improvements to your property, you want to be able to substantiate those.
Toby: “With the real estate lending LLC owned 50% by me and 50% by my wife, are there any normal business deductions impacted by the latest tax laws such as management fees?” Tom, not really, because that’s an active ordinary business. You will receive a 20% deduction against your qualified business income. Technically, interest is not QBI but if it’s a business, if it’s your business, then is that an exception?
Jeff: Yeah, if they’re on the business of lending or financing, then that interest is ordinary income to them; it’s not interest income.
Toby: If that is your business, then you’re going to get a 20% deduction. If it’s not your business, you’re going to pay it as passive.
Jeff: Where we’ve seen some problems with this is people that are maybe doing flipping as their primary purpose, but they do a little mortgage-lending on the side. Mortgage-lending tends not to be their primary business.
Toby: All right, we are way over. I still have a few more of these. What I’m going to do is I’m going to grab a few of these questions because I have a whole bunch that are not really questions. Let’s see. I’m going to answer one more and then we’ll take the rest of them and I’ll make them–”My primary residence is now in my LLC. If I pay less in rent than my mortgage and I pay myself rent, can’t I take it at loss?” No, you’re a related party and it’s you paying yourself; you can’t really–there’s a rule against that. I forget what it is, but it’s all going on your return; you’re not going to do that.
I tend to not put my personal residence in an LLC, I’ll just tell you that. The only time you do that is if you have a lot of equity in your estate that has crappy home protection laws. What’s the name of it?
Toby: Homestead, yeah. If you have a really low homestead–some states have a $35,000-homestead–then you may want to put it in there. Otherwise, you cannot to.
Jeff: I’ve also seen it where you move your primary residence into another entity, and the banks aren’t really happy with that.
Toby: Hey, somebody else asks. We’re going to get off of this here in two seconds, but – give you benefit for one year, correct. The easement, yes, if you buy the easement, it’s not an annual thing. Somebody says, “Hey, do we do non-profits?” Yes, we’ve done over 3000 with our partners, with Mark Del Guercio and Tricia Del Guercio. We’ve never had a non-profit rejected. We’ve had over 3000 successful 501C3s, and we teach a class on it. That is only on non-profits called Start, Fund, Grow. You get that if you end up using us to do your non-profit. It’s so much fun. We have people saying, “Hey, we’ve got to get rolling,” which is cool. We have lots of other questions that we will end up answering. We’re just running out of time.
Jeff: We’ve got to get rolling, too.
Toby: Yes. Thanks, guys. Shoot your questions in via email@example.com. We will get back to you within our next Tax Tuesdays in two weeks. That’s pretty close to the filing deadline so I don’t think Jeff is going to be here. Are you going to be cognizant and operating?
Jeff: That will be the day after our 1040 deadlines so I may be here.
Toby: That’s right. It’s the 16th. We will be here, celebrating. Jeff will be drinking excessively, which will be fun. If you’ve never seen an accountant drunk, don’t. No, I’m just kidding. Anyway, thanks, guys, and join us next time. Hey, share this with your friends. We don’t charge for this. We’re going to put out a bunch of the answers or the question-and-answer on our YouTube channel. That’ll be free. If you want to just watch the whole thing, you’d need to be a platinum member. You can go in there and it’d be posted in our platinum site. It’s a whopping $35 a month to be a platinum member so, if you feel like that, join in. Again, firstname.lastname@example.org with your questions. We will see you next time.
Jeff: Thank you.
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, another great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets. One of my favorites as well is our Infinity Investing Workshop.