What could happen to the step-up in basis and estate tax depending on what state you live in and how you vote in the upcoming presidential election? Before you take drastic action to change your tax plan, Toby Mathis and Jeff Webb of Anderson Advisors answer your tax questions. Do you have a tax question? Submit it to taxtuesday@andersonadvisors.
- I’m a computer engineer in California with a 350k salary. This year, I got an extra bonus of about 100k and received 70k short-term capital gain from the investment. Is there anything I can do by the end of this year to still save on tax? Yes, maximize your retirement plan contributions and offset capital gains by harvesting capital gain losses
- Our beneficiary IRAs become self-directed (SD) IRAs to purchase rental properties. We are retirement age, but don’t have to take required minimum distribution (RMD), yet. Our goal for this year is to pay 12 percent taxes on AGI. That percentage may increase in future years. Can we convert the SD IRAs to Roths? There is no limitation as far as age is concerned to convert a traditional IRA into a Roth IRA; if you have an RMD, then you have to pay the RMD before converting the traditional into a Roth IRA
- I am a high-income earner and have a short-term rental in service for 12/2020. In order to take advantage of tax benefits, would you recommend cost segregation this year and use losses toward active income? A short-term rental does not always go on Schedule C; substantial services must be provided to short-term tenants and average stay must be seven days or less or will go on Schedule E
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Full Episode Transcript:
Toby: Hey, guys. You’re listening to Tax Tuesday. This is Toby Mathis.... Read Full Transcript
Jeff: And Jeff Webb.
Toby: We got a lot to go over today. You guys are saying hello. Tell me where you’re from if you’re in the question area. You may as well just tell me. Hey there, Sherry. Sherry, good catch on the date, by the way. Sherry called you out Susan, just so you know.
Susan: Thanks, Sherry. Appreciate it.
Toby: Just to foster goodwill, we’re later to be talking politics tonight and we’re going to take whatever position you are against. Colorado, Virginia, Denver, Houston, San Francisco Bay, Spokane, Washington, […], Vancouver, North Carolina, Al from Hawaii.
Jeff: No Russian hackers.
Toby: Yeah, some bots. We’re a bot farm. San Jose, Jim from Philly. You guys got your hands full there right now. Nebraska, Texas, New Jersey, Wyoming, Florida, Sacramento, Austin, Chicago, Alameda, Sacramento, Anchorage, Charlotte, North Carolina, some more Florida, some Tennessee, Seattle. I was just in Bellevue over the weekend. Got to have some civil unrest in the middle of Bellevue, which is really weird because Bellevue is about as mellow as they come. Arlington, San Francisco, San Antonio, Ontario, Cady, Texas, Fremont California. Hi, Tim. Smoky California, Utah. We got people from all over the place. We got a pretty group tonight.
No, we’re not going to talk politics. The last time I got to go over the difference between the candidates’ tax plans, frankly, their positions tend to change. I would say nightly, but I think it’s more often than that. No, I’m just teasing. There will be some things we have to address depending on who.
I actually had some clients come in with some pretty drastic tax plans in absolute fear of what would happen to their state if the step-up in basis in the estate tax went away. They were about to take some actions and I kept saying, “Whoa, whoa, whoa, whoa.” There are some trust lawyers out there that are really pushing people. It’s kind of going crazy.
The market is historically really volatile going into the election and then immediately smooths out so what would I be doing? Probably sitting on my hands a little bit. I don’t think I want volatility. If I’m going to buy something, it’s not going to have to do anything with the Presidential election. I’m going to buy something that I think is a good company and that’s a good value. Maybe I’ll look to see if there’s any dibs but that’s about it.
You could ask your questions in the question and answer. You can see I’m already reading them. Jeff reads through them. We all read through them during the event. We also have Piao, Sam here. He’s a CPA. We have […], the bookkeeper. Elliot, the tax attorney. Is Elliot a CPA?
Jeff: No, he’s not.
Toby: He’s going to be someday.
Jeff: If you are Elliot, sorry.
Toby: Elliot, we still love you even if you’re not a CPA. I always say CPAs are like pitchers in baseball. You need to have them. You guys are wack. No offense Jeff.
Jeff: Sometimes we get books from what we call the Crack Pipe Accountant CPAs.
Toby: I always look at this like, I remember old Lou Piniella. Some of you guys have heard me say this. I was up in Seattle when the Mariners won 116 games, so it’s a big thing. Man, he hated his pitchers. He would go out there and just looked worked. He’d be like, oh my goodness.
Questions are already sent in. We answer those, Melanie, when we receive them. We’re ticking them off and we’re making sure that they’re answered. If you haven’t received answers, sometimes they flag them to be answered live, so we’ll see. If you don’t get an answer, we will make sure that we’ll get it answered. Just let us know and say, hey, I asked this last time.
Every now and again, we get hundreds of questions, and our guys are really good about trying to reach out and getting them answered. There are few questions coming in, but we will just wait for a second before we get diving into those.
If you do need a very detailed response, some of you guys write books—column books. I start reading them and then it’ll take up half the page. The way GoToWebinar, Zoom, and these things work, it’ll just suck up the whole page. Those ones we may need you to email in. Somebody has one of those 20-page, what do they call it?
Toby: No, it will be just a long thread on Twitter.
Jeff: Hey, a comment on these tax plans that the candidates are coming up with, what is presented isn’t always what happens. A good example of that was TCJA.
Toby: Tax Cuts and Job Acts, yeah.
Jeff: Back in 2017 which changed drastically within weeks of it first being prepared.
Toby: Presidents don’t write laws, you still have the house, you still have the senate. The President doesn’t really have anything to do with the bill. They may say, I’m going to veto it so don’t pass that version. But for the most part, everybody makes promises.
This president, whether you like him or not, he’s honored a lot of them. Some of them no, some of them are twisted ways of saying, yeah, I got there. But on the same token, a lot of them just say things and then never do them. I don’t know if we’re going to get this time. Trump hasn’t done much on the tax side other than saying he’s going to try to focus on the middle class, opening some of that up.
The regulations do, the lowering of corporate taxes do help the middle class. We’ve seen incomes go up. If you doubt me, go look at the St. Louis Federal Reserve Economic Data. You can look and see household incomes. They’ve gone up considerably in the last four years.
Let’s go opening questions and then we’ll answer some of the questions that are up here.
Number one, “I’m a computer engineer in California with a $350,000 salary. This year I got an extra bonus of about $100,000, also received $70,000 short-term capital gains. Under these circumstances, is there anything we can do by the end of the year to still save on tax?” We’ll answer that.
“One beneficiary IRA became self-directed IRAs to purchase rental properties. We are of retirement age but don’t have to take RMD yet,” this sounds like they’re in between 65 and 72, “Can we convert the self-directed IRAs to Roths? Our goal for this year is to pay 12% taxes on AGI. That percentage might increase in future years.” I’ll answer that.
“I’m a high-income earner and we have a short-term rental in service for December 2020,” so it’s coming up, “in order to take advantage of tax benefits.” They’re going to put it in service before the end of the year. “Would you recommend cost segregation this year and use losses towards active income?” We’ll delve into that one a little bit.
“I have a residential property that will lose next year, can I write it off this year instead to minimize my owed taxes? This property is a small lot that I bought for $65,000 cash 15 years ago. Now the property is encumbered by property tax liens and lot cleaning liens.” It sounds like there’s a lot to sit there for a while. We’ll dive into that one.
“What are your thoughts about the tax incentives given under act 20 and 22 in Puerto Rico? The caveat, I understand, is that you must be a bonafide resident in Puerto Rico in order to get the tax incentives. It almost sounds too good to be true. Can the US federal government stop this at any time?” We’ll go through that.
“How can I take a deduction on my taxes for working from home? I use a portion of my bedroom to work online. I had to upgrade my computer and internet speed.” We’ll go through that.
“If we are part of several syndications,” syndications is just a group of investors, “can we deduct requirements to be a partner of the syndication and other expenses for being part of the syndications?” It sounds like they had certain expenses that they have to incur to be part of the syndication. “Deductions/expenses such as meetings, seminars, publications on syndications, etc. as ordinary and necessary.” Chances are as ordinary are necessary expenses so we’ll dive into that one. That will be an interesting one.
“My wife and I own over 10 rental properties and we’re also passive investors in several multifamily syndications. Eight of the rental properties are managed by a property manager. How easy it is for my wife,” by the way, I just grab these from the questions that come in. Sometimes you guys see there are typos. I literally just grab whatever is flagged, whatever looked really cool. I grab them and just cut and paste them. Sometimes I’ll do a quick edit if it’s really long, but otherwise, I’m not touching these. “How easy is it for my wife to qualify as a Real Estate Professional while essentially being an asset manager on them?” That’s a good one. We’ll answer that too.
Oh, gosh. Toby must have gone crazy again. We still have more questions.
Jeff: It’s not really that bad, Toby.
Toby: “What is the difference between short-term and long-term capital gains, and the difference between owning the property in a personal name or an LLC with regard to capital gains tax? Is it always going to be like ordinary income?”
“What are the warnings and limitations of investing in real estate through the use of a self-directed IRA or a solo 401(k)? There is a limitation if the deal is leveraged, correct?”
We’re going to go through all of that. And then the last two questions, I promise. You guys send a lot of questions and it’s like, Halloween candy, you don’t just pick one.
“I am sitting on about $250,000 of equity in a rental property that is paid in full. What are my options to get the money out and in an active investment such as an LP in syndication or something to unlock the growth potential?” It’s funny they say active investment in a limited partner.
“What would you recommend as a business entity for a private music studio for instrumental education for maximizing tax benefits to allow deductions for home office studio, mileage, instrument care, maintenance, etc?” That’s good. There are a few questions you guys are already getting there. Somebody said something nice about Patty, so you’re already a suspect. Wow, you guys are already hitting a bunch of it.
“Where can I find a bunch of CPAs that specialize in real estate? I want to make sure that I’m getting all the benefits of having a real estate process.” You are in the right place. That is what we do. How many returns have we done so far this year, Jeff?
Jeff: Last count about 6030.
Toby: You’re giving a count, man. You’re going to say over 6000. You like to say 6000.
Jeff: I’m an accountant.
Toby: So precise. You’re so precise. It sounds like a bunch of people are already getting it. “I’m a realtor in California. Would I have to pay California state tax and Puerto Rico state tax?” You can’t have two houses. We will dive into the Puerto Rico Act 2022, but you have to be a resident there. You can’t have a resident elsewhere.
Let’s just jump for some in. We have so many questions coming through. Let’s see, “Other than short-term, long-term, do capital gains increase by levels?” There are no short-term capital gains.
Jeff: Capital gain rate, right?
Toby: Yeah, it’s just your ordinary tax, and yes, that increases by your tax bracket. Long term, there are really three levels—0%, 15%, and 20%. If you want to be technical, by the time you get to the 20% and a good portion of the 15%, you also have the Net Investment Income Tax and then you have your state tax. Everybody always says 20%. It’s really 23.8% and it’s depending on your state like California, you could be as high as 36.8%—13% on top of the 23%. You could still be pretty high.
Jeff: They’re the ones talking about adding the 16% bracket. For all of you people who make more than $30 million a year.
Toby: Thirty million and then we’re really going to get you.
“Is there an income limit to contribute to a traditional IRA and take a deduction for it?” On a traditional IRA?
Jeff: It’s going to depend on whether you or your spouse qualified, or else it will be an employer plan.
Toby: Yeah, there’s always a little one. I’m going to look and see. I have my little…
Jeff: Yeah, it’s close enough.
Toby: Let me see, qualified plans, IRAs, there we go, limitations. Your income limits are really on your Roth where you’re over $200,000 married filing jointly, you’re going to phase out. There’s no phaseout for a Roth 401(k). And then traditional Roths, there are some phase-outs depending on what you are doing and whether you have another plan. If you don’t, then I don’t think you have to worry. If you do or your spouse has a plan, then there are weird phaseouts. If you’re single, it goes out of your $74,000 or thereabouts above, you’re out. If you’re married and one spouse is covered, then I think it’s over $200,000.
Jeff: Those are good examples of an area where Congress took separate plans and made it really complicated.
Toby: What we usually do is we do things where there are no limits. You’re going to go to your 401(k). If you want to put money in a 401(k), one of the things we do go over—and this isn’t going to be the place that we’re going to do it because it’s a little complicated. But you can get $57,000 a year into a Roth 401(k), if you want, as long as you’re making a lot of money. It does matter how much you’re making, but you don’t have income limitations.
Somebody else asked and then we’ll dive into the questions. “I just began working as a 1099 position as a real estate assistant. I don’t have a business account setup. Will this negatively impact me? Do I need a business account?” Shannon, you don’t necessarily. The way you’re being treated right now would be considered as a sole proprietor. Will this negatively impact you? It can, only from the standpoint of sole proprietors are known by the IRS as overstating their expenses and understating their income, so they have a high audit rate, but it’s not going to hurt you.
Really where it starts to hurt you to be acting as a sole proprietor is when you make over $30,000 a year. Before that, it’s not horrible and you will be able to take expenses against it. I would recommend that you join us in one of our classes. I think I did a webinar not that long ago on sole proprietors. I crunched the numbers and I show you where the numbers are to where you may want to consider being an S Corp versus a sole proprietor. Patty, if you can drum that up maybe.
Jeff: Yeah, I agree with that. You don’t need separate accounts, but you need to separate your business expenses. The only thing I was going to suggest though is if anything you’re doing is a 1099 person can give them any legal liability.
Toby: When you’re acting as 1099, you’re a business and anything you do in that business you have personal responsibility for it unless you put a box around it.
Jeff: Yeah, so you want to consider protecting yourself from your business.
Toby: A box would be an LLC, an LLC taxed as S Corp, S Corp, C Corp, or an LLC taxed as a C Corp. There are several flavors. If you want the best answer, it would be to reach out to our guys, sit down, and get to know your situation a little bit more. They won’t charge you for it. They will just give you a blueprint and tell you, here are your options.
There is a big difference from a tax standpoint once you start making some money so we can get it. Somebody’s asking about Tax Tuesday.
Let’s dive into some of the questions so we’re not here until the wee hours. “I’m a computer engineer in California with a $350,000 a year salary. This year I got an extra bonus of $100,000 and also received $70,000 short-term capital gains from investment. Under these circumstances, is there anything I can do by the end of this year to still save on tax?” Jeff, what say you?
Jeff: I’m going to give you two easy ones. One we’ve already talked about and that’s maximizing your retirement plan contributions. If you’re over age 50—is it 50 or 55?
Toby: For which one?
Jeff: For the 401(k).
Jeff: Fifty, you can put away $21,000 out of your 401(k).
Toby: More than that actually. It’s $26,000 plus $19,000, so it’s $25,500.
Jeff: It’s a bunch of money. My second suggestion, you talk about having a short-term capital gain. If you have capital losses you can harvest—and by harvest, I mean you are selling loss positions, and not replacing them for at least 30 days with the same investment—you can offset those short-term capital gains even if it’s with long term capital losses.
Toby: Jeff is hammering the nail on the head. Any capital loss will offset capital gains. Even if you have long-term capital losses, you could sell it, offset your short-term capital gain. You have to wait 30 days like Jeff said. There’s a wash-sale rule. That does not exist by the way for profits, so if you ever want to lock in your profit, you can turn around and buy it right back. But when you have losses, you have to wait to buy it back.
Jeff: One other suggestion I have is if you are married and your spouse is not working, you might want to consider investing in real estate, rental property and cost segregate the heck out of it.
Toby: Can you grab that all for one year even if you put it in service at the end of the year?
Jeff: Yes. You’re talking about your short-term, your 15-, 7-, and 5-year properties—what we call a personal property. Those are all going to be subjected to bonus depreciation.
Toby: Everything else that you’re in, you get a quarter over it.
Jeff: Correct. If you put it in effect in December, you’re going to get very little depreciation on the building itself, but all the improvements in the building and all. Laying improvements, you could get a substantial chunk of deduction.
Toby: The only thing I would add is on a charitable side. This year, you have a $300 cash contribution, is it each spouse?
Jeff: I’m not sure.
Toby: I think it’s $300 per return.
Jeff: I think so too.
Toby: We’re actually both wrong. It’s actually $26,000 that they could put into a 401(k), $650 is the makeup.
Jeff: We’re still operating in 2019.
Toby: Jeff went for it two weeks ago that’s why. We were just getting hammered. It looked like the, what’s that show?
Jeff: The Walking Dead?
Toby: Yeah, it looked like The Walking Dead. They had blood coming out of their eyes, their ears were falling off. The other one is giving money away. If you want to lower your income by 100% this year, you just write a check to somebody. In this case, $450,000 plus the capital gain. I’m actually really dead serious on here. You give money away. This would be the year to do it.
Here’s the thing, let’s say I have the short term capital gain, it sounds like you’ve already cashed that in, but if you have assets that you haven’t cashed in, rather than make a cash contribution, you may want to give something away that has gained.
The way it works is if I give charity cash, I get to write off 100% of my adjusted gross income in 2020. If I give away an appreciated asset, I can write off up to 30% of my adjusted gross income with that portion. If I want to lower my tax for that $100,000 and I have appreciated stock, I could give that away. I could also give away a house or anything else that’s appreciated.
If I want to give away cash, I could do that as well. Here’s something that I’ve been looking at. Since we have a lot of low-income projects that we work with—for those of you who don’t know, Clint and myself have been partners for 22 years plus, and we’ve invested in real estate. We’ve really focused on the low to moderate-income, not super low-income housing, but normal wage Americans, and they got left behind the last 10 years for housing. There’s just a complete lack of it. That is something you can set up a housing charity and it does qualify.
Low to moderate-income housing, anything that would be considered […]. As long as 60% or more of your income is coming from that and a charity, you could operate it and you could do real estate. If I wanted to invest in that real estate, I could take cash this year, contribute it, and take a higher 100% deduction.
Let’s say, I really want to get into the real estate market and I want to put $200,000 in. Normally, you’d invest $200,000 and you’d start to depreciate it, it would offset some of your income. You’re not going to get a huge mass of benefit. In this particular situation, I could contribute the $200,000, take an immediate deduction for the $200,000, and then you could contribute […].
Somebody says, “If you happen to marry someone who has a capital loss carryforward?” Can you use their carryforward? Yeah. Leonor, you get a big star. You must be a tax geek, which means we like you.
Somebody says, “So I can give 30% of the stock and 20% more in cash to charity?” Yes. Actually, it’s 70% more to cash in 2020. The way it works right now is, your adjusted gross income limitation for charitable giving for 2020 was increased under the CARES Act to have no limitation. You can offset your entire adjusted gross income with cash gifts.
If you use other assets like appreciated capital assets, you have limitations depending on whether it’s a regular charity, public charity, or if it’s a private foundation. The type of charity I just talked about—housing charity, veterans housing, or single moms, or you just fill in your blank—are 30% of your adjusted gross income.
Anyway, you learned way more about charity. Those are some of the ideas. Last thing I will tell you, if you want a deduction without doing any of that, you can do a conservation easement. For every $1 you put in, you’re pretty safe to go to $5. It’s 250%. Otherwise, the IRS calls you a […] transaction. You have to disclose it so that they could take a look. But if you’re doing legitimate cost segregation, there’s no reason not to do them.
Let’s say I gave $50,000 to a reputable cost segregation fund that was taking my end that they were going to restrict its use in the future years and give away its mineral rights. You want to make sure it’s never strip-mined or developed. For that $50,000, you may receive a $250,000 deduction, which in California here looking at this scenario, you’re talking about being close to 50% taxation.
You’re looking at $530,000. You’re not quite the top bracket, but you’re knocking on it. Depending on whether you’re single. If you’re single, you’re in the top bracket. If you’re married, then you’re not. Let’s say I took my short term capital gains and said, geez, I don’t want to pay $200,000 in tax this year (or that stinks). You could give away a piece of it.
“Do you have any references for cost segregation professionals?” Yes, Tyler Surat. Somebody says, “Toby is saying cost seg,” Did I say cost? Yeah, land conservation company. Sorry. If I was saying cost segregation, sometimes it’s on the back of my head. Somebody says cost segregation or maybe they are asking about it.
I’m talking about doing conservation easement and Tyler Surat is that company. If you need to do cost segregation, Eric Oliver is that. I would say they are the cost seg authority. Those guys are pretty good. We have another one down in Texas too that is very good too. We do have relationships where we can send you over—[…] down in Texas, Eric Oliver in Salt Lake. Both are fantastic. Eric, they’ve been around a little bit longer but both are good. If you’re doing some pretty complicated stuff, then you get to take your pick.
Somebody says, “Do you have any additional information on taxing an LLC as a C Corp? I thought that changing the tax classification would result in paying extra taxes?” Caroline, LLCs are not taxed by the IRS. You tell the IRS how you want to tax it. What are your choices on how to tax an LLC, generally?
Jeff: Just throw it any way you want to tax it. It could be a partnership, S Corporation, corporation, sole proprietorship. It can be a trust. My one question is can it be a non-profit?
Toby: It can be a trust. Your LLC can be owned by a non-profit and disregarded to a non-profit. But a non-profit needs to be a corporation. It could be a trust, but why make it crazy?
Somebody says, “Wash-rule. If I sell Apple for a gain then buy more within a month, then it’s okay because it was profit, correct?” Yes, Stacey. What we often do is if I have a loss—if I’m sitting on some loss and I’m coming up to the end of the year, or I am married, filing jointly and I’m below $80,000. Let’s say that I’m at $60,000. I took my standard deduction or something and I’m down there. I now have up to $80,000 of taxable income, or I’m still on the 0% long term capital gains rate.
If I am sitting on gains, I owe it to myself to recognize them right then and just go right back and buy the stock again because it increases my basis. Let’s just say I wait a year and I don’t do that, and the next year I’m at $80,000 and I sell that. I’m going to pay tax on that at 15%. Whereas I could have avoided it. It gets funky. Whenever you’re sitting there and have some gains built-in, you owe it to yourself to really take a look and say what unrealized gains do I have and what unrealized losses do I have. Gain, you could sell and buy back two seconds later.
Jeff: Another time this really works out well—and this drives me crazy when I see clients with large capital loss carriers whereas if they only get in the take $3000 a year. When they’re sitting on a large equity position and you ask them, why don’t they sell it? They say, well, I love the stock. Okay, sell it and then in the next keystrokes, you make on you, buy it right back. You get to reset your basis to a higher number.
Toby: Now telling you that you’re too loud, Jeff.
Jeff: I’m always loud.
Toby: “What is the deadline for LLC tax classification for 2021?” It’s actually when you set it up. It’s going to be treated as a sole proprietor if you don’t do anything.
Jeff: Yeah. They’re pretty lenient about retroactive. You could easily go back to January 1 with a retroactive Form 8832, Entity Classification.
Toby: All right. We got to dive in. We love stuff. “Our beneficiary IRA’s,” you’re just regular IRAs, “traditional IRAs became self-directed IRAs to purchase rental properties. We are retirement age but don’t have to take the required minimum distributions yet. Can we convert the self-directed into Roths? Our goal this year is to pay 12% on AGI. That percentage might increase in future years.”
Jeff: There’s no limitation as far as age is concerned about converting a traditional IRA into a Roth IRA. The one condition is—and it doesn’t apply here—if you do have an RMD, you have to pay the RMD before you convert the traditional to a Roth. You’re paying your taxes and so forth. Especially if I’m in a 0% or 12% bracket and I am sure my income is going to go up, I may want to go ahead and convert even if I am older—which I am. I said it before you could, Toby.
Toby: I didn’t say it. You’re absolutely right. The way I look at it in the numbers is if your tax brackets are going to go up in the future, you might want to convert. If it’s going to go down in the future, you don’t want to convert.
Jeff: Here’s a mistake that I see a lot of people make. It’s not an all or nothing when you do a Roth conversion. You can convert any portion of it you want. You can manage your tax brackets by doing it that way.
Toby: That’s definitely right. When you sit there and you look at what you’re doing, for example, in this particular case, I might look at what your tax bracket is and say, all right, what are the chances of it going up or down?
If you guys are in a 12% tax—I guess you’ll be in the 12% tax bracket at that point—I would probably say convert your traditionals up to the point where you’re pushing to another. If you think that the percentage that you have would be going up in the future. That way, it’s not going to make that much of a difference here. I just don’t like seeing people get crushed in taxes. I see people doing that where they’re in 24 plus and you’re like, don’t do that. You’re going to be paying less when you are older.
Let’s see, […] which is a really bad way for answering her question. My wife is Columbian and she makes me do some things.
The Neuro Diverse Living group is something I want to talk about for a second. So many times, you guys see me, we’ll bring up charities that we like, this is one. This is Jim Richardson out of Pennsylvania. Neuro Diverse Living, really cool. His son […] with autism and like a lot of parents, they’re always concerned about what happens if something happens to mom and dad. They realize they’re not alone. It gave us some pretty interesting stats. You have over 5 million adults living on the spectrum. You have about 87% of adults living at home and more than 80% of adults with autism are either unemployed or underemployed.
Which makes it really, really tough for the parents because, during your lifetime, you’re going to be taking care of them. But what happens if you’re not able to? There’s just not enough housing. These guys, they’re working with the National Autism Foundation. Jim, you have to correct me if I’m wrong, if he’s on. I don’t know if he is or not. He often pops into our courses. A really good group. He’s probably not, so I’ll just say, here is what I’d ask you guys do, they’re doing a silent auction. If you go to that little link there, you could see the ndl2020.org/silentauction. It’s the Autism Housing Foundation.
It’s one of those things that as a community, we could decide that we’re going to make it important. As an investor, you can absolutely profit off of solving a problem where there’s a lack of solutions right now. I have experience in this because I rent houses to an organization that actually has autistic adults. They’ll basically have a house mom. It’s actually really cool and it’s great for us because they want two-, three-, four-, five-year leases is what we generally see.
Some of you guys know that I work a lot with Jim Green on residential assisted living. This goes hand in hand. There’s going to be solutions that we have to come up with for these folks. Just because it’s every parent’s nightmare, you’re taking care of a child, and your life expectancy is going to be less than theirs, in all reality. The last thing you want is to have a situation where you don’t know what’s going to happen with your child.
Jeff: Personal story. My nephew is getting close to age 40 and he is seriously autistic and has some serious issues. What you just talked about—the where will I live—is a huge issue. I know some parents try to keep their adult children at home and take care of them. But these are grown adults with a normal lifespan. You can’t take care of them forever. Eventually, if you take care of them until your deathbeds, they’re still going to be left to their own wills afterward.
Toby: Yup. It’s not like they’re unable to care for themselves to a certain extent. In our situation, the houses that we have, they can do everything for themselves, but they might leave the iron on and burn down the house if you’re not watching. There are certain things that they may not think of as super important. Sounds like a teenager.
Here is what we all need to do. We need to go buy some One Hope Alliance from Jim’s charity. Anyway, they have a fundraiser, silent auction. It’s on November 14. They have a silent auction ahead of time that you can go to. That’s the link I gave you guys. There it is. You can look at it again. I asked Jim to say, hey, what are some of the cool items that they can buy? The way it works is you get a donation for the amount that exceeds whatever you buy. If you buy something that’s worth $20 and you bought it for $20, you’re not going to get a donation. Buy it through your company, use it as a gift.
But if you bid something above—some of these things are really cool. They got Alaska Cruises, Iceland, you got Tango in Argentina, the Tropical Key West, Ireland. There’s a whole bunch of stuff, so then it goes to a good place. This is the last you guys are going to hear me chirp on it. But do something cool. And yes, you could go there and you buy wine from Jim.
Somebody says, “Harley Davidson.” Yes. You can win a guy named Harley. Something cool. They do have wine, you could drink. That was one of the things that was cracking me up. I was like, if I was going to do charity, that’s what I’d be doing is I would just go buy a bunch of wine. You can go to his site, check it out, and do some early Christmas. I’d probably buy a couple of cases. Sherry, you’re going to drive me to drink.
Lots of questions coming up. I know that that’s a little off-topic, guys. But I’ll tell you what, we got to do something. The government’s not doing anything about it. I don’t care who you vote for. There are portions of society where we’re left to our own to take care of these people.
Somebody says, “Toby, what is the best way to classify a California LLC active business with two owners? One has a salary and the one does not.” What do you think?
Jeff: Maybe Wyoming?
Toby: No, no, no. You have an active business and if you’re both working in it—Wendy, are you guys both working? You really only have two choices. Yes, you’re both working in it. More than likely, I would make that into an S Corp.
Jeff: I would too.
Toby: People do it as a partnership, sometimes they do what’s called a guaranteed payment to partner. But it’s clunky and you don’t get all the benefits. If you guys make money in a partnership, you have to pay old age, death, and survivors, and Medicare on all that money that you make as a profit. If it’s an S Corp, you don’t.
Jeff: One of the issues of having a business in California is that […] $800 LLC fee. It’s just the price of doing business in California.
Toby: Yeah, it’s annoying.
Jeff: It is annoying.
Toby: But you guys live in California, you should be happy where you’re doing business because it’s so sunny there. Boy, but Irvine got nailed with fires yesterday.
Jeff: Oh, did they?
Toby: Holy smokes, yeah. Fires have just been crazy this year. All right, “I am a high-income earner, and we have short-term rental and service at the end of this year in order to take advantage of tax benefits.” They own something, here’s a house, and they’re putting it into service by the end of the year. It’s going into service in 2020. Would you recommend cost segregation so that we can take some losses, and this is the big word?
Jeff: Let me talk a minute about the short-term rental. Just being a short term-rental does not get it on Schedule C. You have to provide substantial services to your short term tenants—housekeeping, maid service, and a variety of things. If you’re doing that and can put on Schedule C, I would certainly do cost segregation.
Toby: That’s called Schedule C. Here’s the big thing, in order to do that, it has to be less than seven days?
Jeff: Less than eight days, I believe. I think it’s seven days or less.
Toby: Yeah, it is. Less than eight days of average stay.
Jeff: If you have a 10 days stay it’s not going to blow it for you.
Toby: Plus extra services—more like a hotel. Otherwise, this is going to go on your Schedule E which equals passive, which means your losses will not offset W-2 income.
Jeff: This goes back to what we’re talking about earlier. Do you have somebody who can qualify as your real estate professional for this?
Toby: You’re going to look there for two exceptions. They’re both going to be in 469(c)(7). You’re either going to be an exception to the passive rule where you’re a material participant and you’re spending more than half of your time or your spouse is spending half of their time as a real estate professional—development, redevelopment, sale, construction, any of those things with real estate. Not even your own. You’re materially participating on your own. Or you’re an active participant, which means you manage the manager on your properties and you get up to $25,000.
Jeff: Now, if you’re a high-income earner, you’re not going to probably qualify for the $25,000 deduction.
Toby: If you make more than $150,000 you’re phased out. But really, it’s $100,000. It phases out $1 for every $2.
Toby: Somebody says, “Can passive loss offset interest income or dividend?” No. Interest income and dividends are considered portfolio income. No, it wouldn’t. Unless it falls underneath the real estate professional exception, then we just look at that exception. Or if it’s a hotel or similar to a hotel. I think Jeff really nailed it. The cost segregation could still give you a bunch of losses that you can’t use to offset your W-2, but you could carry it forward.
Jeff: We’ve seen a couple of clients like that. Where we’ve done cost segregations knowing they cannot use it in the current year, but they will never ever have income on that property.
Toby: Yeah. It’s going to be a long time. We got a few of those. Somebody says, “So real estate professional status also phased out on income limits?” No. There’s no limitation. It’s only active participation where it phases out between $100,000 and $150,000.
Somebody said, “Can the losses offset income in this exact case if my spouse is a real estate professional?” Yes, as long as you guys qualify. This is the big one, you have to make sure that you treat all of your real estate activities as one activity. What do they call that, Jeff?
Jeff: Aggregation of activities.
Toby: You’re saying, hey, all my activities are one. If you don’t do that, and many accountants miss it, you’re going to be pretty sad if they call you on it.
Somebody says, “If I move my rental property under my business LLC to generate more write-offs, then will this be an issue?” Yeah, don’t move your rental property under your business LLC because there’s a lot of liability.
“I’ll have low-income next year because of COVID, but lots of income expenses on my rental property. Pros and cons?” Yeah, don’t do it because you don’t want to bring the liability of a rental property into an active business. Plus, your active business is your active business. If you have write-offs, they’re your active business. If it’s a write-off on your rental, you could always have your active business manage that rental. But still, it’s going to be deductible against the rental income. If you create a loss, what are you going to do with it?
Jeff: I prefer not to mix real estate activities with active businesses.
Toby: Now, a lot of our clients will have a company manage their LLCs that hold real estate. That might be something that’s worth exploring so we get to look at it.
Somebody says, “If you don’t have W-2 income you should not do cost segregation?” No, that’s not what it’s saying. You could do cost segregation. It’s just I’m going to create a loss. In this case, where they put it in service in December—right at the end of the year—they don’t have any chance to make any real income. In 2020, they’re going to have a loss if they cost seg it.
If you had put this in place in January and you made a bunch of money, we had clients that make $260,000, $270,000 a year on a short-term rental. Your cost segregation can make that go away.
Jeff: When we say a property has been placed in service, we mean that it is available to rent. You’re advertising to rent it. It doesn’t mean that somebody’s occupying it.
Toby: It’s ready to be occupied. Which gets weird because they’re going to look and see the history on the property, what you did in 2021.
Jeff: It’s nice to have some advertising going on for that.
Toby: Somebody says, “Can my rental income loss be used to adjust my stock investment income?” That stock investment be treated as capital gains are not allowed. Correct. The capital loss offset capital gains plus $3000 a year of other income. Passive losses offset passive gains. There’s nothing else that it’s going to offset. They don’t offset each other. And then you have ordinary losses—ordinary income versus ordinary losses.
Ordinary losses offset everything. You can use ordinary losses for anything. If you have an active loss, ordinary loss. There, you guys are all CPAs now.
Jeff: See how easy it is?
Toby: When you write it out it’s not that hard. I always have to use little—all right, what type of income is this? Is it following underneath one of the exceptions?
“Is short-term gains a passive income or short-term capital gains?” Look at you guys. Short-term capital gains are capital gains that are taxed at your ordinary rate, so it’s not ordinary income. It’s not an active income. Technically, it’s portfolio income. It is not passive. Passive, there are only two types. Passive is a real estate and businesses in which you do not materially participate.
I own a piece of Uncle Lou’s Pizza Shop, but I don’t do anything. I’m not doing anything. I’m just a passive investor. Passive loss cannot be adjusted against the stock investment income. Exactly, unless you’re a real estate professional. If you’re a real estate professional, then that’s an exception and then your passive losses become ordinary. And then it could be used against everything. It’s so much fun.
Somebody says, “Talk about passive loss limitations.” We are. You can’t use them. There’s none. You can’t use it against anything else. I lose money in real estate, I am stuck. I get to use it. I get to carry it forward and until I sell that real estate, and if I sell the real estate, then I get to make it as an ordinary loss when I dispose of the asset. Otherwise, I just carry that forward and wait for passive income.
Jeff: It remains a passive loss until you dispose of that activity.
Toby: All right. “I have a residential property that I will lose next year.” It sounds like somebody is just getting […] tax lands. “Can I write it off this year to minimize my owed taxes? The property is a small lot that I bought for $65,000 cash 15 years ago. The property is encumbered by property tax liens and lot cleaning liens.” They never had any depreciation if it’s a lot. It’s just land. You’re going to have it taken away from you, which means it’s being sold. Would they even qualify for the loss?
Jeff: Yeah, they would qualify for the $65,000.
Toby: If this is part of your house, you’re living in it, and it’s your backyard, then no. Then it will be personal property.
Toby: But if it’s something that was an investment property that’s sitting there, you never got any depreciation, you would get the loss when you dispose of it.
Jeff: Correct. There are two problems. First, to answer your question, no, you cannot take the loss until you no longer own the property. The second problem is this is going to be a capital loss, and I believe we’ve talked about this in the past.
Toby: Capital loss just means you have restrictions on how much you can use because this wasn’t an investment that is being disposed of. Unless you lease this thing. The other funky one is, I wonder who is responsible for those tax liens and lot cleaning liens.
Jeff: I’m assuming they’re going to be wiped out when they do the sheriff’s auction. But I can’t say for sure.
Toby: Would there be a tax implication that you don’t have to pay back the lien? The lien would say there’s a debt. If you sell the property and the debt goes away, I’m just wondering whether they’re going to get any retribution?
Jeff: I had not seen that. I haven’t seen where any of the county agencies of cold debt forgiven debt.
Toby: Here’s a good one. I’m going to jump because I see good questions. “My husband is a real estate professional, he has an excess ordinary loss from cost segregation. Can that loss be carried forward to future tax periods?” Now, we’re going to say net operating loss, which is what you’re going to focus into. It’s an ordinary loss, a real estate professional equals NOL when you have losses.
In 2018, 2019, and 2020, you can carry back 5 years. Helen, you can carry those back and get money back. If it’s this year, you can go back to 2015 and get some of the taxes you paid, then carry it forward to 2016, 2017, 2018, and 2019, and you can carry it forward. Isn’t it indefinite?
Jeff: Indefinitely now.
Toby: That’s why we like that question because it’s a good answer. Helen, you’re a rockstar. Somebody just said, “What?” Yeah. So when you have net operating losses, this is where it really comes into play. If you are somebody who qualifies as a real estate professional and you create losses because you cost segregated a property—we’ve done this how many times, Jeff? Hundreds of times. If we create a loss, then you can go back and get some of the taxes that you paid in the past.
Your example is somebody named President Trump. The whole issue with President Trump was when they took real estate depreciation and accelerated it and it created a $96 million loss or something, he’d been carrying it forward. He keeps saying, I pre-paid my taxes. You had lots of loss you couldn’t use, you’re carrying it forward. During the Great Recession, they unlocked it and did the same thing where they said, hey, you can have a five-year carryback. He just elected to say, oh, I have all these things that I’m carrying forward. I am going to carry them back.
If you want to carry back, there are two ways you can do it. You can either amend those past returns. Somebody is asking, “How do I carry back? How do you elect to carry back?” If it’s the year of return, if we did it for 2018, do you file it for him?
Jeff: For 2018, if you want to carry it back, you have to go back and amend those years starting in 2013, 2014, 2015, and so forth.
Toby: You’d amend whatever years you’re going to use up the loss. Let’s say I had $100,00 of loss, and I had earned $100,000 of income in 2013. You’d go back to 2013, amend that return, and make it 0. Any taxes you paid that year, you would get back as a refund.
Jeff: Now, for 2019, if you have an NOL carryback, you have until December 31 to file it on Form 1045 for individuals and 1139 for corporations. This is a quick refund form, and we’ve seen a pretty quick turnaround for refunds with these. 2020 will work the same way, you have until the end of 2021 to file those quick refunds.
Now, if you go past December 31, 2020, you’ll have to do the same thing you did in 2018—go back and amend those prior years.
Toby: Yeah. You could do it a little bit easier last year, this year—2019 and 2020. You have a little bit of time in 2019. 2020, you have until this time next year and a little bit longer than that, so you’d have 14.
Jeff: One thing you want to make sure you do before you just blatantly carry these things back, forward, or whatever—run the numbers. Because if you were in $50,000 of taxable income for the past 5 years, but you’re going to be in a half a million dollars of income for the next year, you want to carry that […] forward.
Toby: And you might want to pay attention to who gets in as president. Because it brackets go up, this is your get out of jail card if you’re making a lot of money.
Somebody says, “I am fine now, can I ask you a question?” You can always ask a question.
“Do you have to have been a real estate professional in those past five years?” Jasmin, no. It matters in the year that you create the loss. For example, if I create a net operating loss because I’d become a real estate professional in 2020, then I go back to 2015, 2016, ’17, ’18, and ’19; and I’m going to use those losses against all those years. If I still have losses, then I’m going to carry them forward. You have an ordinary loss. Ordinary loss works against all other incomes. We can go back to anything that you made in the past we can wipe out.
Somebody is asking some funky questions, “Do I need to have made the real estate purchase by close of 12/31/2020?” If you’re going to create the loss, this is the last year you can carry back loss. You’ll have to close on it in order to do the cost seg for sure. It has to be in service.
Jeff: And it has to be in service.
Toby: You can’t just close. You actually have to have it ready to be occupied. We already answered carrying it back. “What about becoming a real estate pro, will that allow me to use it.” No, real estate professional is just for that particular year as to whether the loss is passive or ordinary. If you have carry forward losses, they’re always passive. They remain passive.
Somebody says, “When is the five-year form supposed to come out?”
Jeff: There is no five-year form.
Toby: It’s already there. You’re making the election. Don’t worry about that. “Sounds like I should wait. But if it helps, there is another syndication that was considering. But with answers like this, it sounds like to me I should wait.” It’s always math. I always say that there are three rules in tax and anything financial, which is calculate, calculate, calculate—those are the three rules in order. You always go back and you make sure that you sharpen up your pencil.
“How do I qualify as a real estate professional with a full-time job?” You don’t. Unless you spend more time as a real estate professional than your full-time job, which would be almost physically impossible. I suppose you could do it if you spent 2001 hours on real estate activities and 2000 hours in your full-time job, you would qualify.
Jeff: In those cases, the courts are turning them down left and right.
Toby: They don’t believe you.
Toby: You better not work so much. Sometimes you look at it. We actually had a client—it was two doctors. They made more money having one of them work part-time and qualify as a real estate professional. Because their taxes went down enough and they were able to use their losses. As a result, they ended up receiving a lot more money because every dollar they were making was being hammered at close to 50%. It just didn’t make sense.
Jeff: And hopefully your real estate is also appreciating at the same time.
Toby: Yup. “Can you carry back loss even if you have a PPP loan?” Yeah, it doesn’t matter. PPP loans are great, but they’re based on your payroll. We don’t really care about the well-being of the business. Which, by the way, is a pet peeve for me. It really bothers me that so much of the news was hammering people for taking PPP loans.
The reason that they gave the PPP loan was so you wouldn’t lay your people off. It had nothing to do with financial viability. It had everything to do with please don’t put them in unemployment where we have to care for them through the states. The Federal Government said we’ll step in, and we’ll pay the employer to keep them on their payroll. It had nothing to do with whether you need it or not. That was stupid. And then they come back and they start making you certify, well, I actually need this.
That wasn’t what congress did. Congress said, hey, please don’t lay your people off in the middle of a pandemic. We’ll pay you so you can keep them. Ridiculous. They’re going to punish you for taking advantage of the very laws they pass to benefit you.
“What are your thoughts about tax incentives given Act 20 and 22 in Puerto Rico? The caveat I understand is that you must be a bona fide resident in Puerto Rico in order to get a tax incentive. It almost sounds too good to be true. Can the US Federal Government stop this at any time?”
Jeff: I’ll start with the very last sentence in their question. There is actually a law in place that exempts residents of Puerto Rico from Federal taxation. As far as Act 20 and 22, those are the two big ones, but there are a number of other Puerto Rican acts that also give incentives.
Toby: The easy way to look at it is, if you’re a United States citizen and you live in the Continental United States or in other territories—certain nonexempt territories—everything you make in the world is taxable. If you’re a US citizen and you make money anywhere in the world, it’s taxable. But if you are a resident of the Commonwealth of Puerto Rico and its territory, then you are not subject to Federal taxes. Unless you are making that money from the United States or you’re working for the Federal Government. There are a few little exceptions.
Jeff: Act 20 is an incentive for companies to move to Puerto Rico. Act 22 is an individual incentive. What they want is investors, and it only exempts interest, dividends, and capital gains.
Toby: Yeah. I don’t think there is ever a Federal income tax when you’re working there yourself. I think that you get the Federal income tax on other things that are derived elsewhere. This exempts some so long as it’s a qualified Puerto Rico company. I believe that you have to have a Puerto Rican employee, at a minimum. And to be a bona fide resident, you have to be there physically, on that island at least one minute for 183 days of the year. You can’t have other residents elsewhere. They have to know that you’re living there.
We’ve had several clients move there because then you’re at a 4% flat tax and you have 0% tax on your capital gains, your interest income, and (I believe) your dividends. I’ve seen the numbers run. Let’s say somebody is making half a million dollars in Puerto Rico, you’d pay right around $20,000 in tax. That same individual making money in Maryland would pay $226,000 in tax. Those are the numbers.
I remember looking at it going, wow, you literally lower your tax bill 90% if you decided to live there. Just spend a month there. Sandra and I went down there, went to Puerto Rico, Rio Grande. Carolina, they have great areas. If you’ve ever been down to Puerto Rico, I’d encourage you to visit. Carolina, there is hobo beach around there. You have Downtown San Juan, which is just gorgeous. You have the Big Fort looking over the water. Absolutely gorgeous.
If you like tax stuff, we just came out with the Tax Toolbox a couple of months ago. It may have been a month ago.
Somebody says, “We are moving to Puerto Rico. Love Rio Grande.” Yeah, absolutely. There are some gorgeous areas.
In the Tax Toolbox, we go over all different types of income. There are about 20 different videos and about a 300-page manual. You can go there. It’s $595 if you want the physical version, $495 if you just want the E version. The link isn’t the cool part. The cool part is you get to come to Tax-Wise on December 1. We’re going to go over about 32 specific tax strategies, and we will know who is president. We’ll be able to do some evasive action.
Hopefully, it’ll be straightforward and we’ll know what to do. There are definitely some things you’re going to want to do depending on who gets control of the house and the senate because there are some promises that are people making. We do have things that are going to phase out at sunset.
We’re looking at a minimum, 2025. Depending on who gets in, you could bet your bottom dollar that some of those things are going to go away. It’s just a matter of putting yourself in a position to take advantage of whatever the laws are at that particular time.
There’s your little link. We always share this stuff out. But go to the Tax Toolbox—over 20 videos and a cool workbook, and then come to the Tax-Wise workshop for a day on December 1. If you do not put $10,000 in your pocket from some of the strategies we hit—I don’t put guarantees on things, but I’ll give you your money back. I’m not just worried about it. You’re going to find stuff. We’re good.
All right, question and answer. More stuff. Somebody was asking, “Can a pilot flying 600–700 hours in a year qualify as a real estate professional if he self-manages 2–3 properties and also runs short-term rentals? Takes classes, education, masterminds, an excess to 750 hours—high risk.” No, it’s not high risk and yeah, you would qualify in all those examples.
Somebody says, “I got $36,000 from the CARES Act webinar. You guys rock.” Thank you, Wendy. We put money in pockets, that’s what I always tell people. If you’re not getting at least three or four times whatever it cost to work with us, then we’re not doing our jobs right. We’re supposed to be the guys that you like to talk to because every time you talk to us, you make more money. We have all the numbers that you put on the lottery tickets. That’s what we are.
I get some people that are nice to us. Usually, they just heckle me.
Jeff: I know.
Toby: Maybe they’re feeling bad for us, Jeff. Maybe they’re feeling bad for you because you have to sit next to me for all this time.
Yes, as a pilot, you’d be able to qualify so long as you materially participate with your properties. What that really means is you are able to spend 500 hours on your properties and on the management. They don’t count the education and some of the Mastermind on that 500 hours. They want to know what you’re doing on those properties. Is there anything I’m missing?
Jeff: Your hours are going to be counted for what actual work you’re doing either on the properties or with the properties. And then we’re talking about books, renting out the properties. It’s just general management of the properties.
Toby: Remember, if you’re self-managing your properties, you don’t have any hour requirements. You automatically are maturely participating. The only ones that I’m worried about are your short term rentals. I doubt anybody’s spending more than 100 hours on it. You just want to make sure you do 100 hours. Aggregate all your properties together. The short-term rentals worry me a little bit. As long as they’re eight days or greater, then it’s passive. I want to make sure that we keep you passive. I don’t want you to become a hotel.
There’s a workaround if you do become a hotel. Somebody says they feel bad for Patty. Patty is not the one who has to sit next to me, Mark. It’s Jeff. Patty moved downstairs. She’s hiding. I could still hear her sometimes cackling from up here. I’m on a different floor, I can still hear Patty sometimes. Anyway, we were talking about them, but I’m sure it was good.
All right, “How can I take a deduction on my taxes for working from home? I use a portion of my bedroom to work online. I had to upgrade my computer and internet speed.”
Jeff: If you are working for an employer that is not you, I have bad news. There’s really no place to take deductions anymore.
Toby: Yup. You have no unreimbursed deductions. Unless you’re a teacher and you’re buying crayons and stuff. I think then you get up to $250. This is sad if you work for a third party.
Jeff: Now, that third party can reimburse you and those reimbursements are tax-free to you.
Toby: They can reimburse tax-free. You don’t have to report it, so we make a smiley face there. If it’s you—you’re a sole proprietor—then you could do what’s called a home office deduction. There’s a special form for that. Or if you’re an S Corp, an LLC taxed as an S Corp, a C Corp, an LLC taxed as a C Corp, or a nonprofit, and you’re an employee of that, then it’s the same rule here. They can reimburse you tax-free.
Here is the big difference. That sole proprietor, that home office deduction might be $5 per square foot is the safe harbor. If you have a portion of a bedroom that is exclusive use and it’s 50ft, you’re going to get a $250 deduction per year. It’s nothing.
Where it really comes into play—where the benefit is—is under these guys, when you’re an employee. Somebody says, “Possible audit.” There is the adage that they’re taking the home office deduction, but the only party that takes a home office deduction is a sole proprietor. And it really doesn’t matter whether you take the home office deduction. If you’re a sole proprietor, you’re probably going to get audited.
Jeff: If you’re doing the safe harbor for the home deduction for the $5 per square foot, unless you’re taking a ridiculous amount of square footage, they’re not going to audit you for that.
Toby: I’ll show you how to do it. The screen is going to go black and I mean to do that. Here is your house. Usually, you’re doing the total square footage. Let’s say that your apartment—I don’t even know what a good apartment is. What would it be?
Jeff: 1000 sq ft.
Toby: 100×100 and you have this little room that is work only. Is that right?
Jeff: 100×100? No, that’s a 10,000 sq ft apartment.
Toby: Really? So it’s a big long house. I don’t know. We’ll be another one. 50×20? Whatever here. We have 1000 sq ft. When you’re doing a home office as a sole proprietor, it […]. They’re going to let you use that square footage. If this is 50 ft, 50ft compared to 1000 sq ft, what is it going to be, 120? You’re going to get 5%?
Toby: Five percent tops. Now, if you do an employee reimbursement, it’s going to be closer to 20%, and here is why. You can still have the same area, but what they allow you to do is use your net usable square feet. You’re going to remove all the hallways, you’re going to remove common areas that don’t really have much use, and you’re going to knock that 1000ft down closer to 700 or thereabouts. Now, you’re going to have a much larger percentage. Now, you’re already getting up there to what would that be? Around 7% or 8%. Even if you still have that tiny little area. You can get more aggressive with it.
Or you use the room method. The room method is probably the best. What you do is you say, how many rooms do I have and how much? Let’s say that this is a two-bedroom, small area. Maybe take a total of three and you’re using ½ of the room or ¾ of a room. You’re going to basically say, hey, I’m using ¾ of a small room in a three-bedroom house or a three-room house.
Again, you have two bedrooms and a common area, then I call it three bedrooms or three areas, and you’re using ¾ of one of them. You would say the total areas you have is a total of three. I don’t know what that adds up to. It’s something of a much greater percentage. Somebody would have to tell me. It’s not quite 1/3, it’s probably closer to 27%.
Toby: I should actually do the math. I always get these backward. Whenever I’m around playing around with numbers, I always have to double and triple check myself because I just start topping things in. About 25%, somewhere around there. We’re going to be 20%+ and we get what I recalled direct expenses. This is a big one.
When you do your 20%, it’s going to be 20% of all expenses. Let’s go back to this. Remember our 20%. Our 20% means we’re going to get 20% of all expenses associated with that apartment, which means my electricity, cleaning, internet, et cetera. If I have rent, then it’ll be rent. If it’s my mortgage, it would be my mortgage.
Jeff: Mortgage interest.
Toby: Excuse me, the mortgage interest plus I would get a percentage of depreciation. Somebody just said, “This is how the administrative office is calculated too.” Yes, this is an administrative office for the home. And yes, your business is going to have a primary place of business and an administrative office. If you’re wondering whether you have work outside of it. You have an office and then you have a home office. Yes, you can even deduct the mileage between those two.
But the big one is you had to upgrade my computer—that’s 100% deductible. That upgrade is reimbursable and internet speed. I can now deduct that extra cost at 100% too. Those are called direct expenses. As a result, I go from this measly little $250 to hopefully a big chunk of money, $2500+. You should get 10x the expense of what we see. Is that about right? And it’s not reported anywhere. You’re not filing a special form that says, audit the hell out of me.
Jeff: Yeah. When you’re reimbursed by a company, the company is taking the expense, but you’re not recognizing any income on that expense.
Toby: Yup. We like it.
Jeff: I like it.
Toby: We like it. That’s one of the reasons why we tend to push people towards structuring themselves as a business because they tend to be treated much better.
“Can my daughter do this in her dorm room with the desk area versus her half of the room against the cost of the dorm?” If you have a business and she’s using it—this is a big one—exclusively for business. Yes, you can use a partial room as long as you take pictures and say, this is my area. This is the area that I am running my business out of. And yes, they can be running it at your business too.
A lot of folks that we work with have their family business, they’ll have their family corporation that’s the management entity, and I’ll say get your kids involved. A lot of times you’ll have nonprofits and they’ll put them on the board and make them officers. But yes, you could absolutely do this.
Somebody says, “Should reimbursement be paid to an employee via salary or separately?” Wendy, it’s not a salary because it’s not taxable. It is separately and it shows up as an expense to the business, whatever that business is. You do not have to report that to yourself at all. You don’t report it anywhere.
The example I give is if Patty is on the way to the office and I say, Patty, hit […] and bring in some donuts. I’ll reimburse you when you get here. Quite often we do pizzas and stuff. You guys know this, if you’ve been to the live events, sometimes we bring in lunch or whatever. And I’ll say, Patty, go out and grab something. She’ll go out and she’ll throw it on her personal credit card. She just comes back in and we’ll just pay for it. Here Patty, here are some dollars or write her a check. She doesn’t have to report that anywhere.
Same thing as if your employer said, hey, on your way into the office, could you pick up some office supplies. You grab it and you bring it in and then you do it.
Somebody says, “I asked because my payroll gave me the option to pay reimbursements.” You can. Usually, reimbursement plans, they’re doing that because they want to make sure that you’re doing it timely. Usually within 90 days is good.
Jeff: We actually do that at Anderson now. We sometimes pay directly. But we also run our reimbursable expenses through payroll. It has nothing to do with taxable income. It’s just additional money you’re getting in your paycheck.
Toby: If you like this, by the way, we do the breakdown and we give you all that stuff in the Toolbox. That’s my gentle pushing. If you like this sort of stuff, we do this during Tax-Wise and you have all the documents. It covers all the rules as well as an accountable plan, which we put in writing. We do all that fun stuff. It’s always fun to put it. Patty, where are the donuts? That’s all I want to know. Where are them donuts?
“If we are part of several syndications, can we deduct requirements to be a partner of the syndication, other expenses for being part of the syndications?” They’re basically saying, hey, I’m in the syndication but I have to be a member of a bunch of groups and probably go in places. We have to suspend a bunch of money. What say you, Jeff?
Jeff: In 2017, the answer would have been yes, you can deduct that. In 2018, the answer is likely no.
Toby: No, unless. Usually, what you’re doing here is you’re going to want to have a corporation or something in the mix. Let’s say that I have a syndication. They offer me a piece. I have 10% and I might place that in my LLC. That LLC may be partially owned by a corporation. This means that this LLC is considered a partnership. If you’re wondering why I wrote 1065 is because that is because that’s the tax form for it.
Somebody says, “Patricia, you know I can hear you. I hope it’s not me you’re referring to so we’re all muted.” That’s pretty funny. Now, I see somebody wants some Krispy Kreme too, there’s a bunch of them.
Anyway, what it means is this guy can be a guaranteed payment to partner plus they get a little interest. Maybe you’re getting 10% of your syndication going in here and that corporation is entitled to 1% of it, 99% or whatever the amount is goes down to you. You’re sitting there and going hey. This is a way that you could carve off some of it going up there.
And then, this is the corporation where you cover all your management. This is where you could do all the reimbursements for all your classes, all that stuff. That’s the way to do it is to don’t tempt fate. If you were a manager of this syndication, if we go back to here and you’re a manager, you’re not just a partner but you’re actually somebody who’s running it. Chances are, you’re going to be doing that of an active business anyway because you’re either the manager or the general partner.
“What is the difference between short-term and long-term capital gains? And the difference between owning the property in a personal name or an LLC with regards to capital gains? Is it always going to be like ordinary income?” Jeff?
Jeff: It’s dealing with basics. Short-term capital gain is a gain on any asset that you held for less than 12 months or a year, which way you’re going.
Toby: Less than 12 months or less than a year, say less than one year.
Jeff: Long-term capital gains are more than a year, a year, or more.
Toby: This one’s equal to your ordinary income.
Jeff: Correct. Back years ago, they established a law that said long-term capital gains could be taxed at a lower rate to encourage investment. That amount has been all over the place with those percentages are. Long-term capital gains to short term capital gains—they’re taxed at different rates for selling investment assets.
Toby: You can have this even if you held it longer than one year if you are a dealer, if you have inventory. It’s not really short-term capital gains at that point, it’s just ordinary income. You got to be a little careful of that. But as far as how it relates to the LLC, it doesn’t. Remember, the LLC doesn’t exist to the IRS. The IRS requires you to tell them what it is. The only entity where we have to be careful about those capital gains is a C Corp. Everything else is going to end up on your return anyway.
Jeff: There are a couple of provisions we’ve talked about taking $3000 on losses a year and the special rates that Toby wrote at the bottom of the screen. Those only apply to individuals. You cannot take capital losses in a corporation, and capital gains are taxed at 21%.
Toby: Capital gains because they’re all income in the corporation. It’s just a C Corp. Or if it’s exempt, it’s not going to have any taxable gain.
Jeff: I’ve seen those capital losses get stuck in these corporations, and they’re hard to recover from.
Toby: Yeah, we don’t like it. If you have a capital asset that appreciates in a corp and you take it out like real estate to refinance it, it’s taxable too as though you paid yourself a salary.
Jeff: Yes, it is.
Toby: It’s vicious, so don’t do it. That’s why we don’t put real estate in corporations for the most part. There are a few exceptions, but for the most part, don’t do it.
“Is there a time limit on reimbursements? I started at the end of 2019 but did not do any reimbursements. Could I amend to do them now?” The money actually has to be paid to you.
Jeff: Most of those restrictions are self-imposed by companies. Mainly, they keep employees from coming back a year later and saying, oh, I forgot to turn this expense reimbursement in.
Toby: The IRS does say timely and you’re supposed to have some sort of agreement. In all of our companies, there’s called an accountable plan. It’s what the technical term is, but it says basically that you submit, and then the company reimburses you. If the company has no money, then it says that.
Somebody says, “21% is great. If you want to get it out, you’re going to pay a dividend rate to get it out, or it’s going to sit in the corp.” And then they said, wait until the Biden Plan comes in and knock that up to 28%. Still way lower than it was.
Nobody can really argue that it was smart to have a 39% top-rate C corp. It went up to 39%, and then at the end went to 35%. Everybody says that 35% was the high tax. I’m like, no, actually the high tax was 39%. There was a good chunk of it. $300,000, you’re getting 39% which is crazy. That’s why a lot of companies didn’t want to be here and go someplace else.
Somebody says, “Does the employee have to submit bills?” You should have some back-up. Technically, you don’t have to but you should.
Jeff: On the audit, they’re going to be required to substantiate the reimbursements under the accountable plan.
Toby: But if I have the check that I wrote and I don’t have the bill, that doesn’t mean you can’t reimburse yourself. It just means you better have access to the bill, right?
Jeff: Yeah. Actually, it’s the company’s responsibility to have the bill, not the individual’s. The problem is if they can’t substantiate, it’s no longer an accountable plan.
Toby: What’s fun is, in our companies, especially all of the reimbursement plans it says if you ever have a disallowed reimbursement, we just treat it as a loan to you. You don’t have to worry about the tax event to you. The company would be like, hey, we loaned you that money. Wendy, you’re going to have to pay it back now.
Have you ever seen that where we’ve not had the back-up on it? Not here. We’re going to find it. I didn’t mean to contradict, Jeff. I’m just saying that if you know what the bill was, if you’re paying it on a credit card all the time and you know what you paid, reimburse yourself. But know that if you get audited, you’re going to have to produce the actual bill. You’re going to have to go get a copy.
Jeff: I’m often guilty as I’m sure a lot of single-employee companies are. I spent this much on it and I’m just reimbursing myself. You’ll dig up that bill if you need to.
Toby: Raise your hand if you do that. Everybody just raised their hand. That’s just the life of being in business. I say this all the time, make sure that you’re not tripping over pennies on the way to dollars. The IRS can’t even tell you what books are. I always remind people we were using abacuses when most of this code was written. I still remember doing a double entry with a pencil in a journal book that we’d go buy at the office store. We would keep our books in pencil writing. Jeff, they were probably using sheepskin and rocks in your day.
Jeff: Yes. If you’ve run out of papyrus, you use whatever you have.
Toby: “What are the warnings and limitations of investing in real estate through an SD-IRA or a Solo 401(k)—self-directed IRA or 401(k)—especially when the deal is leveraged?”
Here’s the easy way to look at this. Self-directed IRA equals custodian. You’re always going to have somebody else acting on your behalf. Somebody says, “Counting in […]. You guys are horrible.”
IRA also means unrelated debt-financed income, which equals loans, which equals tax. The portion of the income that’s derived from a loan is taxable to an IRA.
It also equals one person. If you’re a husband or wife and you’re buying things together, it means you’re going to have to combine your IRAs as co-tenants. Or you’re going to set up an LLC that they both own in order to have a single account.
401(k) does not have UDFI—it does not have unrelated debt-financed income. It can be multi people and no custodians, if you don’t want it. The ones we do here at Anderson have no custodian, you are the trustee. In any of those situations, you’re going to be fine. It’s not going to blow up your deal, but you might have some tax if it’s UDFI, which stinks.
If you’re making $10,000 a year and half of the property is financed, then you would have $5000 a year of income. You try to offset it with things like depreciation. There’d be a portion of that that you’d be able to use for depreciation, but you could be looking at a taxable event inside that IRA. If you sell it—even though it’s an IRA—a portion of that gain would be taxable because you used leverage to get it.
You don’t have to worry about that in a 401(k). You’d always going to see us saying, do a 401(k), you could put more money in them. Husband and wife could have one 401(k), whereas you have to have two IRAs, all that good stuff.
We have two more questions. Let’s jump in. “You stated not to place real estate in an LLC.” No, I didn’t say that. You always put real estate in LLC. You don’t put it in a corporation, so an LLC is taxed as a corp. “Do you need to be self-employed to have a Solo 401(k)?” You need a sponsoring entity. It could be an LLC, a C corp, an S corp. You can even have an investment LLC sponsoring a 401(k). And no, you don’t have to put money into it. You don’t technically have to be taking a salary. You could fund a 401(k).
Let’s say I had an IRA, I could technically roll that into a 401(k) as being the only money that goes in there. I can just roll an existing amount. Let’s say I have $200,000 sitting in my IRA, I can just roll it—that would be my only funding—and put $200,000 into a 401(k). I could do that.
“How would you combine a husband or wife funds in a Solo 401(k) to make one investment? There are four bank accounts—two Roth, two pre-tax?” The Roth, you can’t roll anywhere. The rule is a Roth IRA can only go to a Roth IRA. A Roth 401(k) can go to a Roth IRA, but not the other way around. You can combine your two pre-tax accounts into a single 401(k).
Somebody says, “If I maxed out my Solo 401(k), aside from leaving it in residual to my C corp, where else can I put my funds?” If you maxed out a 401(k), I’d probably be doing a DB plan, Janette. If you are maxing that out and you’re making that type of income, I’m looking at a defined benefit plan at that point. I want to be able to put a larger amount without worrying, based on your income.
Usually, depending on how old you are, it’s going to be $70,000–$150,000. We do have clients—they’re high-income earners and they’re older—where they’re able to put $600,000 plus into the defined benefit plan per year, tax-deferred.
“What is the turnaround for 1120s now that the tax deadline has passed? How long does it take to do a corporate return?”
Jeff: We’ve been quoting turnaround times for 6-8 weeks because we still have a number of returns we have to do. We have September–March errands coming up in January. We started working on that. We’ll go a little faster once I’ve revived all of our tax repairs.
Toby: Yeah, they’re still working a little hairy, but they’ll come around. They always do well after Halloween with all that candy.
Janette, let’s assume somebody is 56 and they put money into a DB plan. The way that they calculate the numbers is they look at your current income for the last three years and they come up with X dollars. They figure that before you retire, you might have nine years. In order to have X income of benefit, you have an actuary. He plugs all the numbers in and says, we need to have $2.5 million sitting in this thing. In order to kick you—whatever your current income is, it’s up to $220,000. The numbers get big quickly.
If it starts kicking it out when you’re aged 65 and it says here I need to be able to do that 20 years, there needs to be a sizable amount in there. Let’s say it’s $2.5 million, it’s not dividing it by 9 because you have to factor in things like cost of living increases, inflation rates, and the growth on the investment. You factor those. It’s essentially like that.
You might be able to put under this scenario about $250,000 a year into it that you’d be able to do first. In your scenario, you’re going to be a huge amount. If you don’t want to pay taxes for a while, Janette, we would be happy to put you in touch. Erik Dodds is who I’d sent you to right now. Let him run and crunch those numbers. If not Erik, then probably David McShane. Both those guys are really good.
Somebody would look at it and tell you—based on all your employees–how much you’d have to get for employee benefits. If you don’t have employees, then how much you’d be able to do. It really depends on whether you’re making this money through your business. Hopefully, it’s your business.
“What is DB—defined benefit plan?” There are two ways people calculate. There are defined contributions. For example, if you have a 401(k), employer-side I can defer $19,500. The company can go up to—in additional amounts—up to $57,000. They’re defining what the contribution is. And then, there’s a defined benefit where I am saying I want to receive $150,000 a year when I retire. You see how they’re different. I’m looking to say I’m reverse engineering it when I’m doing the defined benefit.
By the way, there’s more money in defined benefit plans in the US than there are in defined contributions, from what I’ve seen. In other words, we’re able to put such huge amounts in because the amount that you’re able to receive as a benefit can be up to $220,000 plus. I forgot what the number is for this year, but it’s right around there. Which means that if I have 20 years where I’m going to be receiving over $200,000 a year—just do the math in your head—I’m going to have to have, in some cases, more than $10, $15 million in there.
Jeff: When you think about all the old retirement plans before the existence of the 401(k)—the old GM plans—those were all defined benefit plans. It was the company putting in all the money, not the employees.
Toby: Janette, I will take a look at it.
Somebody says, “So I have to be a real estate professional to be able to carry back the loss.” Where did that come from? That was from way before. Yes, you have to be a real estate professional to carry back the loss on real estate losses. Other ordinary losses like if your business loses money, you’re a sole proprietor, you have a bunch of losses, or you have net operating losses out of an S Corp that you have a basis for, you’d be able to carry that back. Then you can carry those back five years as well.
“I’m sitting on about $250,000 of equity in a rental property that is paid in full.” That means that it’s worth about $250,000? “What are my options to get the money out and into an active investment such as LP?” An LP is not, that’s passive. They say active, so I’d just say, another investment such as an LP in a syndication or something on luck.
You just take it up, borrow the money. That’s all I would do is pull the equity out. You can always pull the equity out without tax implications. The only time you have an issue is when you have a negative capital account, which means you have no basis, you’re not in the hook.
The best example I can give you is, let’s say that you’re a passive investor in syndication. You put in $500,000 and the total investment was $2 million. You levered it up to $10 million. It did a bunch of repairs to an apartment building.
Let’s say that you bought it at $6 million, better yet. You put $2 million in. It’s worth $6 million when you buy it. Part of that $2 million you put in as repairs, and it’s now worth $10 million. If you pulled all that cash out and you’re not on the hook on that loan, the money that you received above your investments—in my case, you put in half a million—you can get half a million out without any tax ramifications.
If you touched the equity and it pays it out to you, the IRS treats that as long-term capital gains. Sounds weird, but the company can’t have a negative capital account. You, as an investor, can and if you do, then they look at you and say, that’s taxable income to you if you take cash. They just don’t want you leveraging the heck out of something.
Now, if it’s just you, you buy a property and you’re on the hook for it. It becomes worth a whole bunch, you borrow off of that property, and you lever it, that’s fine. You can do that without any tax hit.
Somebody says, “Do you not have to report the PPP on your taxes? The PPP loan, if you have forgiveness, no. It’s gone. You’re doing it as a form for forgiveness, but no. On the hook means you’re a guarantor.
Let’s say it’s that same scenario. We all put in money. We put in $2 million. We buy a property worth $6 million. In other words, we used $1 million down, we borrowed $5 million. We put a million into it, now it’s worth $10 million. I only have a $5 million loan. I’ll have an extra, after all the cash that I put in. I’ll have some equity, at least for $1 million.
I take that out and hand it to myself. I distribute a big portion of it. Let’s say I took $1 million out, I’m not on the hook on the loan. I’m not a guarantor on that loan. I would get my investment out—the half a million dollars I put in—and the other half-million I received would be taxable as long-term capital gains. Isn’t that fun?
Last question. “What would you recommend as a business entity for a private music studio for instrumental education for maximizing tax benefits to allow deductions?” You guys can already answer this. You guys already know.
I’m not being mean to Biden. Some of you guys are all mad at me now. No, it’s just that there’s a little bit of energy to some of the different rallies. You’re not quite as rambunctious. There’s one in Georgia he did today. Did you see him walking out?
Jeff: I didn’t see that.
Toby: Oh, they had some folk music they’re playing. It was like he walked down the steps. There are like 20 people. They’re cheering like, way to go, Joe. Not a comment on his politics. I was just saying that there’s a big difference right now in the robustness of the crowds.
“What would you recommend?” We’ve already seen this. We want to have an employer-employee relationship so you can do all the reimbursements and everything. In order to do that, you need to have—from a tax standpoint—an S corp, a C corp, or a non-profit. In these guys, it could be an LLC taxed as an S corp or C corp, and then you. If you’re just getting started and you’re making less like $20,000 a year, maybe we do the sole proprietorship. Really, I wouldn’t do it. I would do the CRE. You guys are already getting it.
Jeff: In this particular case, since it’s for instrumental education, I like the idea of the non-profit.
Toby: That’s actually a really good point. I love non-profits. Nonprofits are great.
Jeff: It still allows you to pay yourself or reassemble salary, to reimburse your expenses, and so forth while having the charitable cost.
Toby: Somebody says, “I just want to make sure I’m okay when I retire because I previously cashed out.” Yes, I’m with you on that. This is going back to that DB. Americans need more money in their retirement plans. Forty percent say that they’re not prepared. The vast majority of people that are going into retirement are actually dependent on Social Security. Don’t be dependent on Social Security.
Jeff: My guess, 40% is actually low.
Toby: Yeah, 40% is who feels confident, 60% says I’m not confident in the vast majority. It’s a pretty high percentage. There’s a lot of people that that’s their only retirement. They very easily go away.
Somebody says they would like to be in a Biden rally because they have cookies and refreshments. That is just not nice, but I would go there if I had cookies. Just about any rallies, if you had good cookies and juice.
Go to the podcasts if you like this sort of stuff. Sorry to do that to you guys tonight. Here’s your Platinum Portal. I like answering all of the questions.
Food trucks, that’s what we need. We need some food trucks. That’s what I would do. If I was going to have a rally, I would just say you got to have some beer trucks and food trucks. You just make sure everybody behaves. I’d go have a rally where all these folks who have had to suffer all those fires and stuff. I’d say, hey guys, and then, I’d hand out some cash to help them out or something.
That’s the podcast. You go listen to stuff free. We’ve actually had some pretty cool podcasts recently. I had some fun ones.
“Cookies and juice equal diabetes. Sugar-free cookies.” You guys have not met my wife. No sugar, and if I eat a cookie, oh, she’s mad at me. I’m not exactly a skinny person, but boy, she’s a fitness fanatic. She eats tilapia and she does the competitions. She likes doing sugar-free. She goes, “You’re not helping me.”
Anyway, here’s all our social media. If you have questions, by all means, go to email@example.com, send us your question. TaxTuesday, visit us.
If you didn’t get your question answered, let us know so we can make sure. I do have people on it, but they don’t get paid. They answer your questions. We try to get through them, and we do it as a public service. I like to answer questions, plus it’s good brain food every time we do this.
See, somebody says, “Tell her that tilapia isn’t good for her. It’s the wrong omega, it’s like eating donuts.” She has a trainer that’s always making her eat the really lame white meat stuff. I don’t like tilapia because I think that they eat poop. No, they do.
Jeff: It’s not carp.
Toby: No, they may as well be. It’s pretty gross.
“I guess cod has too much fat. No tilapia.” See, that’s what I’m going to tell her.
Jeff: I’m not telling Sandra anything because she’s in way better shape than I am.
Toby: She’s pretty ripped.
You guys remember the Tax Toolbox. It’s floating around up there if you want to grab on stuff. Toby’s staff is underpaid. We always over-deliver. If we say, there we go.
“Wild-caught salmon, they say that there’s too much fat in it.” Love that, Bison. That’s probably what she should be doing.
Somebody says, “If you have an installment sale right now with an option to accelerate, would you wait for the next administration?” No, would you? Do you know who’s the best? Mark is because they’re in Hawaii and imu rocks, and ona rocks. You guys have some food over there that is the best. You’re on Oahu, so you don’t have Mama’s Kitchen. I like Mama’s Kitchen. I don’t know why. It’s probably like a tourist trap too.
“No tilapia. Salmon isn’t good.” I’m going to tell you guys. I’m going to say it, not imu. Emu, the ostrich.” Oh my gosh, you’re eating an ostrich? Mark, this is not nice.
All right, guys, we’ve had enough. We just say thank you, guys. “Love Mama’s Fish House.” Let’s all meet at Mama’s Fish House. That’s where we’re doing the rally. Jeff, tomorrow at 5:00 PM, we’ll be at Mama’s and have a rally.
Alright, you guys have a good one.
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